Less need for government support, falling technology costs and ample lower cost capital have led to significant growth in renewable energy. This means that we are getting closer to the tipping point for renewable energy in certain parts of the world which is also referred to as “reaching grid parity”. This means that energy can be generated from renewable sources at a cost that is less than or equal to the price of purchasing it from the electricity grid which still relies heavily on fossil fuels.
$201 billion was invested globally in utility scale renewable energy projects alone in 2016, with wind and solar leading the way. Many of the investors allocating capital to the sector are the larger funds looking for long-term and stable inflation indexed cash flows. The discount rate (a proxy of cost of capital) is important for all investors. It is a key driver in determining the fair value or market price for projects. However, this data is extremely hard to gather causing investors to rely solely on their own experience and advice from valuation experts in evaluating the cost of capital.
More than 100 investors, representing billions of pounds of capital under management, across ten strong renewable energy markets were asked about their views on levered and unlevered cost of capital across hydro, solar, onshore wind and offshore wind projects.
Some of the key results are:
- Unlevered discount rates across Europe and North America average 6%, 6.5% and 7.5% for solar, onshore wind and offshore wind respectively;
- Unlevered discount rates in the Nordics average 5% for hydro; and
- Unlevered discount rates in Australia average 6.75% and 7.5% for solar and onshore wind respectively.
The cost of capital needs to be considered in the context of the various underlying assumptions such as power curves, inflation, project lives, etc. which will vary for all of the respondents.
What does this mean for business?
There is a significant amount of capital out there wanting to find a home. With interest rates being so low, it's a constant hunt for yield by annuity investors, such as pension funds, and here you have an ideal asset class with proven technologies and inflation-indexed cash flows.
As valuers, we need to have robust insight into each of the renewable energy sources across the markets where we value projects. When it comes to having a view on cost of capital, it is important to be as close to funds and transactions as possible. Hence, we launched this survey to help augment our experience valuing such projects.
Find out more about our valuations team, or get in touch with Tomas Freyman.