Wind and solar project financing is experiencing significant difficulties in Australia, particularly in New South Wales (NSW), where the need to incorporate new generation capacity contrasts with the conditions developers face when seeking capital.
A key factor lies in how these projects are perceived from a financial standpoint. As long as they remain exposed to short-term electricity price fluctuations, they may be less attractive to certain institutional investors compared to other assets considered infrastructure.
In this scenario, long-term power purchase agreements (PPAs) appear as a mechanism capable of reducing part of that exposure and providing greater predictability regarding future revenue.
Wind and solar financing faces higher capital costs
Firstly, the increase in bond yields directly affects the conditions under which new wind and solar capacity can be financed.
According to estimates presented in the analysis, a one-percentage-point increase in bond rates can add around $10 per MWh to the levelized cost of energy (LCOE), considering the capacity factors recorded in New South Wales.
Inflation adds to this. Rising costs for concrete, wages, and other construction-related items also increase project costs.
Therefore, the financial problem shifts to the price required for a new facility to recover the investment and provide the return required by its capital providers.
Pension funds could provide capital to projects
On the other hand, Australian pension funds collectively have billions of dollars available each year for investments in unlisted infrastructure. However, a large portion of that capital is directed toward other types of assets.
The analysis estimates that these funds have at least $5 billion annually available for this class of investment. A potential collective allocation of $2 billion annually to renewable project capital could represent a considerable source of financing.
There is, however, an obstacle: wind and solar projects directly exposed to the electricity market do not necessarily present the same risk profile as infrastructure with predictable long-term income.
Thus, converting those variable flows into more stable income could modify the financial perception of the assets and facilitate the entry of institutional capital.
Long-term PPAs can reduce market exposure
One tool to achieve this is long-term PPAs backed by high-credit-quality counterparties.
These contracts can provide greater certainty regarding the future income of a wind or solar farm. This reduces part of the risk associated with relying directly on electricity market prices.
The problem arises when the price required by the capital provider to finance the project exceeds the price the electricity buyer is willing to accept through the PPA.
This gap makes it difficult for supply and demand to reach an equilibrium point capable of driving sufficient new capacity.
In this context, the analysis suggests that governments could intervene through long-term contracts or other mechanisms capable of reducing the financial risk associated with new projects.
Capacity factor increases the importance of capital costs
Furthermore, the situation is particularly relevant for wind energy in New South Wales.
Taking a 31% capacity factor as a reference—identified in the analysis as the median recorded by the state’s wind farms over the last five years—the LCOE changes considerably depending on the discount rate used.
With a real pre-tax rate of 6%, the levelized cost would be around $123 per MWh. With a 7% rate, it would reach approximately $134 per MWh, and with an 8% rate, it would rise to about $145 per MWh.
The figures place the generation cost in an approximate range of between $120 and $140 per MWh under most of the scenarios considered.
Additionally, the lower the capacity factor of a facility, the greater the influence of capital costs on each MWh produced.
Stable contracts could reduce financial costs
According to the presented approach, federal and state governments could reduce costs by nearly $20 per MWh through long-term PPAs for wind projects in New South Wales.
For more than 10 GW of contracted wind capacity, that difference could represent around $500 million annually compared to a scenario where financing depended entirely on merchant conditions.
Rather than a reduction in the physical cost of building a wind farm, the effect would stem from decreasing the perceived risk for those providing capital. Likewise, providing more predictable income would allow these projects to align more closely with the financial profile traditionally associated with infrastructure.
The central issue for renewable development in New South Wales then hinges on financing conditions. Wind and solar farms require considerable capital during construction, and their final cost depends largely on the return demanded by those financing these assets.
Long-term PPAs offer a way to reduce that uncertainty and facilitate the participation of institutional investors, including Australian pension funds, in the expansion of new renewable capacity.
Source: Renew Economy
Photo: Shutterstock
