Managing Uncertainty and Leveraging Diversity: Risks and Opportunities for Developers in a Volatile Renewables and Storage Market

The increasingly volatile renewables and storage (RS) development market presents significant risks and opportunities for developers. At the Ascend Summit 2023, keynote panelists focused on expanding markets, financing charges, and the implications of the Inflation Reduction Act (IRA). Panelists included Jon Powers, Co-Founder and President of CleanCapital; Arlo Corwin, Vice President and Head of US Wind Development for AES; Joshua Rogol, CDO and President of Strata Clean Energy; and Dr. Eric Stoutenburg, Director of Energy Storage for Eolian.

Key Takeaways

• Increased competition for tax equity financing allows investors to be more selective in financing projects, leaving less certain projects behind.
• Trends toward signing offtake agreements earlier in the development lifecycle and the integration of more complex revenue streams threaten developers' ability to properly de-risk projects.
• Developers must leverage diverse portfolios, innovative financing strategies, and new IRA rulings to de-risk and differentiate their projects.
• To mitigate potential political risk stemming from upcoming U.S. elections, the RS industry needs to unify behind renewables-friendly policy.

Tax Equity Financing Becomes More Selective  

This year’s panelists quickly took aim at a looming challenge for RS development: waning tax equity support. The cause? Traditional tax equity appetite outpaced by unfettered renewable development.  

The breakneck pace of renewable energy development has outstripped the ability of long-standing tax equity investors to keep up, resulting in reduced capacity by developers to leverage clean energy tax credits. Dr. Stoutenburg noted how this naturally raises competition for tax equity financing, giving investors leverage to select RS projects with greater scrutiny. Now, tax equity flocks to gold-plated projects with de-risked revenue streams and good queue positions, leaving less certain projects behind.  

Earlier Offtake and Complex Revenue Streams Create Risks for Developers

Trends toward earlier offtake and more complex revenue streams further complicate RS development, threatening developers’ ability to stay ahead.  

Regarding offtake, Mr. Corwin identified a recent corporate interest in “pulling contracting to the left” and signing contracts earlier in the project’s life. Mr. Corwin warned that failing to de-risk projects before offtake runs the risk of wage inflation, capital inflation, material acquisition issues, interconnection queue uncertainty and project failure. His main message to developers: “It takes discipline to drag back to the right and say, ‘we’re not ready yet.’” Late projects are better than failed projects.

Complex revenue streams – a hallmark of battery storage – present yet another hurdle for developers. Batteries push RS developers into less familiar market dynamics, ancillary service revenue streams, and hedge agreements, requiring a fundamental change in thinking about RS profits and subsequent deal signing. Gone are the days of renewable Sell-When-You-Produce models. Dr. Stoutenburg emphasized storage financing restrictions caused by offtakers waiting for the development of ITC insurance products and enduring hedge models.

New uncertainty coupled with scarce tax equity appetite yields a pessimistic outlook for short-term RS development across the U.S., unless developers leverage diverse portfolios, innovative financing strategies, and new IRA rulings to de-risk and differentiate their projects.

The Power of Diversification

As RS contracting and financing become more complicated, thoughtful portfolio strategy still stands to limit risk for prepared RS developers.

Mr. Rogol cited diverse battery development portfolios as a key tool for reducing risk. “[Strata] likes balancing a 20-year full toll in Arizona with CAISO contracted RA and [merchant exposure],” he explained. “When we look at the profile together on a portfolio basis, both we as a sponsor get comfortable with that, but we can get the tax equity and lenders to be riding along with us.” Mr. Corwin further touched on the importance of asset diversity in new projects. Strictly wind or strictly solar projects no longer attract interest. Rather, portfolios of wind, solar, and storage draw investor interest by reducing combined revenue uncertainty and improving system flexibility.  

Maintaining focus on diverse project origination insulates developers from risk, as well. Mr. Rogol explained how increasingly complicated markets open opportunity for those ready to dive into new revenue streams, saying, “(Project) origination matters…you must think like a power trader now.” Origination-led development, or meeting pre-defined offtaker need, can be balanced by development-led origination, where strong market fundamentals are the driving force. This allows developers to reach for higher-return projects while maintaining a solid base of projects backed by firm offtaker interest.

Emerging opportunities in new markets and complementary generation stacks pave the final path to diversification for developers. Mr. Corwin said, "AES is building wind in Northern Arizona…[and] building solar in upstate New York…these aren’t places that would have jumped out to us 20 years ago.” More sophisticated developers finally have the tools they need to break into these lower margin markets, effectively expanding and diversifying their asset portfolios beyond traditional areas of interest.

Ultimately, one thread persists: success rests in portfolios and diversification – whether developers mix up origination strategies, the technologies they pursue, or the locations in which they develop.

An Appetizing IRA, but Beware of the Risks

When considering the IRA, the Ascend Summit panel unanimously agreed that, while opportunities abound, now is a time to proceed with caution.  

Dr. Stoutenburg warned RS developers to carefully differentiate the “enthusiasm and euphoria” of the IRA from persisting market opportunities. He cited persistent RS financing uncertainty around the IRA’s bonus Domestic Content and Energy Community credits as a symptom of IRA ambiguity, creating pricing risk on sponsor bids. The greatest risk, however, may simultaneously come from not capitalizing on the IRA soon enough. Mr. Corwin pointed out that even though RS received a great runway from the IRA, developers need to get into the nuts and bolts of taking full advantage of new policies.

The IRA’s tax credit transferability provisions provide another timely and potentially transformative benefit. Can transferability and direct pay for tax-exempt entities alleviate the tax equity bottleneck?  

Looking Ahead to 2030: Volatility, Political Risk

So, what happens next? According to the Ascend Summit keynote panelists, certain trends have already materialized.

Mr. Rogol holds a pessimistic view of the future. “When I look at…the CAPEX [$/kWh] now versus… 2020…[the] build cost is close to two times what we had on the project then.” This trend, brought on by recent inflation, creates ripple effects throughout the RS development community. In just the past three months, swap rates for storage projects have jumped from 3.5% to 4.4%, which can put significant pressure on project economics. This jump in swaps serves as a harbinger; current market volatility outstripping developer risk tolerance signals a tumultuous future in RS development.  

The panelists also expect the industry’s focus on clean electricity to broaden to encompass the full definition of clean energy, including clean molecules and all the integrations needed to transfer between electrons and molecules.

Mr. Powers ended the panel by referencing the upcoming U.S. elections. He emphasized how the 2024 election will either continue the momentum of the IRA or put a pause on vital funding and policy initiatives. Despite all the haziness surrounding RS projects through 2030, Mr. Powers asserts that the renewables industry needs to unify behind renewables-friendly policy. If that doesn’t happen, he says, “We won't see those dollars, we won't see the process, we won't see the progress.”