The impacts of auctions on the financing conditions for renewable energy projects

Mak Dukan

Research output: Book/ReportPh.D. thesis

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The transition to carbon-neutral energy systems will require large-scale investments of low-cost capital into renewables. Renewable energy (RE) projects predominantly consist of capital expenditure on technology components and infrastructure. In contrast to fossil-fuel power plants, only a smaller share of capital is invested in operational expenditures such as fuel costs. Because of this capital distribution, the cost of generating electricity from RE is sensitive to changes in debt and equity financing conditions. Previous research has identified policy design risks and impacts on RE investments as a major risk driver. Policymakers are therefore in a position to accelerate the energy transition by enacting policies that reduce investment risks and improve the financing conditions for RE.

Until recently RE projects have mainly relied on government support payments to ensure their economic viability. Within the European Union, this primarily meant schemes like feed-in-tariffs, which paid out a predetermined amount of support for each kWh generated. Recent legislative changes in the EU have led to the widespread use of auctions to determine support-price levels and award support. Today RE investors have to compete for support payments by bidding support prices at which they can generate economically renewable electricity. Competitive auction pressure has driven down support price levels, frequently exposing projects to price variations in power markets and altering the risk-return profile of RE investments. The specific effect depends on auction designs and the remuneration scheme, i.e., the way the support payments are structured. Apart from this, auctions reduce clarity regarding the final support price, and increase the potential to incur sunk project-development costs if the auction is lost. This increase in potential risks might affect the financing costs of RE projects and make electricity from renewables more expensive.

The dissertation investigates these effects and answers the following overarching research questions:

How do auctions and different remuneration schemes affect the financing conditions for RE projects? Which specific auction designs create a low-risk support policy framework?

The main focus of the dissertation is on auctions and RE investment within the European Union, including wind-energy projects and, to a lesser extent, solar PV. Besides auction designs related to bidder qualification criteria, auction schedules, and project realization deadline and penalties, the dissertation also investigates the effects of remuneration schemes. Regarding financing conditions, the main focus is on project financing, considered the primary financing source for most RE investors in Europe. The dissertation employs mixed methods, including interviews with project developers and financing experts, cash-flow analysis, and a choice experiment.

The research undertaken in the dissertation shows that remuneration scheme designs have the greatest impact on financing conditions. We uncover this effect through interviews and validate it by quantifying the effect in a stochastic financial model. Our results show that merchant risk exposure could reduce the debt size for offshore wind farms by between 22 and 32 percentage points compared to projects with a two-sided Contract for Difference remuneration scheme. Furthermore, through a choice experiment, we show that auction designs with high bid bonds, overly long or short realization deadlines, and mandatory citizen co-ownership rules increase RE project developers' equity risk premiums. We also demonstrate that strong auction competition has some of the largest impacts on risk premiums, leading to an increase of 1.75% percentage points. These findings validate the results of our interviews, which pointed to allocation risk, i.e., the risk of winning support in a competitive auction, as one of the largest risk drivers in an auction-based support scheme. However, our interviews also reveal that project developers do not transfer auction-related risk into higher costs of equity. Instead, high-risk auction designs mainly disincentivize bidders from participating in auctions.

Finally, we demonstrate that policies that de-risk debt financing, such as enacting low-risk remuneration schemes, have the greatest potential to reduce the need for support payments and make the energy transition more affordable for taxpayers and electricity consumers. De-risking equity financing through policies such as lower bid bond levels would have less societal benefit while potentially affecting the effectiveness and efficiency of auctions. We show that a 30 EUR/kW bid bond would not significantly increase project developers' equity risk premiums. Thus, maintaining a certain level of bid bonds can seem a desirable option, given their benefits in ensuring project realization.

The dissertation contributes to instrumentalizing cash-flow analysis as a tool for answering policy-related questions. It quantifies the benefits of reducing auction-related risks in terms of savings in support costs and improvements in financing conditions such as debt size. Besides providing a qualitative account of the risks related to auction designs, it quantifies these risks as equity risk premiums. Overall, the dissertation contributes to the debate on designing support policies that reduce investor risks and catalyze the capital investments needed to decarbonize Europe's energy systems.
Original languageEnglish
Number of pages191
Publication statusPublished - 2022


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