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A new challenge: Renewables face a promising—but riskier—future

In renewables projects, merchant risk could be a new challenge—though one that developers and investors can manage with a strategic approach.
Florian Kuhn

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As the cost of renewables has dropped, so has economic support for them, in the form of subsidies. Indeed, the very strength that renewables have shown—in some instances, they are now competitive with conventional sources of energy—could foster a new vulnerability.

Specifically, capital costs and construction delays used to be the biggest risks in undertaking renewable projects. When there are no subsidies involved, however—whether direct or in the form of guaranteed prices—developers are fully exposed to wholesale prices. According to a recent McKinsey report, this “merchant risk” can be up to four times bigger than construction risk. This could have a profound effect on the industry if management of merchant risk becomes decisive in winning competitive bids.

Therefore, developers and investors will need to think and act strategically in their approach to long-term merchant risk. To start, they need to ask themselves how willing they are to take risks (risk-averse, risk-neutral, or risk-taking). Most are now risk-averse, because they have been protected by regulatory and economic support. On that basis, they can decide what kind of capabilities to develop. For instance, be comfortable in taking on more risk and develop sophisticated merchant risk management expertise. Right now, few renewables entities have such capabilities and are rather risk-averse; that could open the door to new players who do.

Traders and market makers, for example, can create value by managing risk for renewables players and through their financial ability to absorb large amounts of risk. To achieve this, however, they require a strong risk framework as well as risk mitigation (hedging) strategies for the illiquid horizon. And while investing in renewables could be riskier than in the past, it is worth establishing just how big a deal that is. In Germany, for example, a comparison of the volatility of merchant risk with the volatility of equities found that that renewables projects were less volatile than the DAX-30, the major stock index.

Merchant risk is coming to the renewables industry. That will be a challenge; it does not have to be a problem—and it could be a great opportunity for those who seize the moment.