INTERVIEW - Grid is becoming key constraint in financing renewable assets to allow Europe to meet 2030 targets

The major challenge across most renewable energy markets in Europe is increasingly becoming the grid, with grid connection and curtailment emerging as major factors for both developers and banks, Pavlos Trichakis, energy expert and partner at Baringa, said in an interview with Renewables Now.

The landscape of renewable energy development and financing in Europe is changing, and grid-related issues are taking centre stage. What was once primarily about securing Power Purchase Agreements (PPAs), or about clearing authorisations/permitting bottlenecks has evolved into a struggle to obtain grid connections and assess potential curtailment risks.

This shift has not only affected project development but also financing. "At Baringa, we are getting more and more questions from lenders who seek to understand the risk for curtailment in a particular location. This is because an increasing number of European lenders are attuned now to the fact that curtailment risk is an important factor that they need to consider over the long term," Trichakis commented.

While some markets like Germany have been more generous in compensating for curtailment, the situation is different in most other European markets, where curtailment is not fully compensated. According to the expert, lenders are particularly concerned with curtailment risk in markets like Spain, Great Britain, Ireland, and Greece.

The dilemma facing European policy makers is whether to relax grid curtailment rules to facilitate more connections or maintain strict rules, which would lower risks for individual projects (and therefore also their weighted average cost of capital) but would reduce the overall volumes of renewables connecting to the grid, Trichakis noted. To address this challenge, governments must simultaneously clarify curtailment rules, and enhance system flexibility through infrastructure reinforcement, building more batteries and placing them more strategically to reduce curtailment. Technologies like hydrogen and electric vehicle chargers as well as demand-side response could also play a role in tackling the problem.

"It is quite a complex topic but we need to acknowledge that an optimal level of curtailment is a more efficient solution than eliminating it altogether. We therefore need to do three things at the same time. Firstly, we need to have clear rules for when we curtail and what compensation applies for curtailment; and ideally these rules should be harmonised across European markets. Secondly, we also need to put as much flexibility in the system as we can, particularly in high-congestion areas where there is a mismatch between supply, demand and grid capacity. And finally, with emerging technologies such as advanced inverters, we should also explore the possibility of using withheld output from renewable generators to provide various non-generation grid services, and allow renewables to participate in balancing and ancillary services markets," Trichakis said.

In his view, Europe has been passive in addressing these issues to date and whilst he sees a shift emerging in some markets, citing the example of Greece where policy makers are now moving firmly in the direction of subjecting projects to increased curtailments or to install batteries, these efforts are still in their early stages and are uneven across Europe.

"The lack of harmonisation in grid arrangements is particularly evident when you compare connection procedures, curtailment rules, and grid charges which are very uneven throughout Europe, in contrast for example to wholesale market arrangements. The grid is now a topic that arises within the first five minutes of every conversation with developers and lenders, and is increasingly becoming the key constraint for meeting our 2030 targets. We need a coordinated effort from policymakers, civil society organisations, and the private sector to address this issue. Disincentivising speculative grid applications when assessing future energy systems needs in an integrated and holistic way is also vital," Trichakis commented.

Moreover, issues of market design also need to be considered here. “The fundamental reason for curtailment and grid constraints is a lack of adequate network investment. The evidence today is that in markets of all types, including the uniform pricing market we have in most European countries, the zonal pricing market we have for example in Italy, Norway and Sweden, and the nodal pricing market in New Zealand, Chile and several US markets, transmission investment is failing to keep pace with the volumes of renewables entering the system. Locational pricing is therefore not a substitute for the significant investment needed in grids, but more responsive locational signals will likely be needed to operate a very low carbon power system efficiently, which could come through zonal pricing in the wholesale market, or through reforms to the balancing market and network charging. However, that should be weighed carefully against the potential disruption caused by such changes which could create uncertainty for investors, increasing the costs of financing projects and slowing down investment in the sector," Trichakis added.

In addition to the emergence of grid-related issues in project development and financing, Trichakis highlighted also another trend -- raising debt for project financing purposes is no longer as appealing as it once was due to the rise in interest rates. Instead, there is a growing trend towards balance sheet financing of renewable energy projects. In addition, the increase in cost of debt has led to a significant upward revision in the cost of capital.

Finally, when comparing PPAs and merchant financing, Trichakis observed that decreasing PPA prices in recent months pose challenges in making projects bankable, especially in markets like Spain where the decline in PPA prices has been particularly steep. "Regarding PPAs, I don’t want to press the alarm button yet because 2023 was actually a very strong year for PPAs in Europe, especially corporate PPAs. However, we have recently seen a trend where project developers are reluctant to accept PPAs, particularly PPAs based on a pay-as-produced structure which have seen the steepest decline in prices due to cannibalisation risks raised by offtakers," Trichakis commented.

This raises concerns about how to facilitate more PPA signings, as many PPAs come with unfavourable terms for developers. If PPA volumes stagnate or decline, this would lead to an increasing reliance on merchant financing or Government auctions in order to ensure that our 2030 renewable targets are met, he noted.

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