High inflation and rising costs increasingly a ‘disaster’ for UK clean energy investors

A sigh of relief for green investors in Britain this morning, as the country's Office for National Statistics (ONS) announced that the UK's annual inflation rate dropped last month, to 6.8% in July, down from 7.9% a month earlier.

However, the still relatively high inflation is having a "disastrous" impact on investment flows into the renewable energy space, according to industry insiders, as they warn the British government is taking "a penny-wise, pound-foolish approach."

In fact, investing into clean energy projects or related-firms is becoming so unattractive that some investors are cancelling projects altogether.

According to Adam Berman, the deputy director at UK trade body Energy, this is partly due to the terms of the UK government's main support scheme for renewables, the contracts for difference (CfD) program.

Firms are invited to submit open bids for these deals, which guarantee minimum prices consumers will pay once energy generation starts.

However, the maximum price per unit of electricity available under the scheme is based on costs in 2012, when the average inflation was about 2.6%. In comparison, inflation hit 7.9% in June.

To make matters worse, industry observers do not expect UK inflation to significantly come down anytime soon. 

Neil Birrell, chief investment officer at Premier Miton Investors, told Net Zero Investor this morning that "we are not yet at the stage in the UK that we can say that we are winning the battle on inflation, there are too many pressures." 

In fact, he stressed "the Bank of England has no room for complacency and would have been hoping, as we all were, for a bigger improvement in inflation last month."

Vattenfall shock decision

The current market conditions are slowly starting to bite as they are impacting the investment decisions of some multi-billion pound sector players.

Berman singled out Swedish industry giant Vattenfall, which cancelled a large offshore wind project off the coast of Norfolk only weeks ago.

The firm explained the project was no longer attractive to investors as input costs had skyrocketed by more than 40%.

The state-owned company explained that rising gas prices, high inflation and rapidly increasing costs had led to the rare decision to cancel the project altogether. 

“It simply does not make sense to continue this project,” explained Anna Borg, Vattenfall’s chief executive. 

“Higher inflation and capital costs are affecting the entire energy sector, but the current situation has made offshore wind and its supply chains particularly vulnerable.”

"This situation is putting significant pressure on all new offshore wind projects," Borg warned.

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Vattenfall's decision sent shockwaves through the UK's clean energy space.

“Everyone in the industry is gutted that this project is not going forward,” Berman said. "But tis is not an isolated case. It’s reflective of a broader fundamental issue, which is that the costs for clean energy infrastructure have risen in recent months."

He stressed "the government has not yet recognised what that will mean for the rollout of clean energy.”

Berman went on to warn that CfDs may fail to produce any substantial offshore wind project this year, calling the current situation "disastrous" for investors, given that the sector is under pressure to quadruple its capacity by 2030 in order to meet ambitious decarbonisation goals five years later.

CfDs are increasingly emerging as an important way for governments to reduce revenue risk. These contracts of 12 to 15 years essentially work by having one party pay the difference between a pre-agreed strike price and a reference price.

The reference price is typically the market price for a “high carbon” alternative, such as electricity generated from natural gas, while the strike price is set at a sufficiently high level to compensate producers for the green premium that they face today.

CfDs are increasingly deployed at scale. For example, managed by the Low Carbon Contracts Company (LCCC) in the UK, they have supported projects that have produced more than 29 gigawatts (GW) of renewable energy generation capacity.

Electricity produced by these projects is estimated to have avoided 28 megatonnes of carbon dioxide (CO2) emissions to date.

Compared with approaches that provide a fixed amount of subsidy to producers, CfDs avoid “over-compensating” producers when market prices rise, as seen in the payments some renewable energy generators in the UK had to make to the LCCC when electricity prices rose above their strike price.

Targeted specifically at reducing revenue risk, CfDs can attract a wide pool of investors to invest in the climate solutions that they would otherwise shun, making more projects economically viable.

However, CfD funding has been slashed by the UK government by more than a third to £205m this year, Berman pointed out.

"This shows a penny-wise, pound-foolish approach in which the government is keen to drive down costs for such projects. But the scale of the cost increases is so substantial that it’s clear we don’t have sustainable prices being reflected in the CfD regime," he noted.

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Net zero approach

The high inflation, rising costs and criticised CfD regime is hitting renewable investors at the same time the UK's approach to net zero is under fire.

A range of corporate chiefs recently warned the British government that its policy is deterring clean energy investors from committing to projects in the UK, as reported by Net Zero Investor.

To attract fresh investments in renewables, clean technologies and low carbon solutions, it is vital government policies are consistent and long-term, they argued, with many saying that is currently not the case.

James Alexander, chair of impact investment firm Finance Earth, stressed "it is super-important that the government is clear on the signalling and then the follow-through."

“What any investor in the UK requires is confidence about the future."

Alexander said that the "mixed messages" from the UK government is providing potential new investors no such confidence, namely by stating fossil fuel dependency should be reduced while at the same time issuing new oil and gas drilling licenses for the North Sea.

The move led to investor and billionaire Andrew Forrest to say he mulls moving his battery tech investments away from Britain.

The Australian green financier said if the UK government continues its "clickbait cycle" of mixed messages he may transfer his firm to the US, as he said the administration of President Biden has been more consistent.

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