PATH TO NET ZERO: Cost surge puts European utility targets under pressure

This article is part of the Path to Net Zero series examining the metals and mining, electric utility, oil and gas, chemicals and shipping sectors. To see all features in this series, join us on Platts Connect.

European utilities are sticking by their net-zero targets, but the path is getting steeper.

Rising interest rates and a surge in costs in parts of the renewables supply chain are making the delivery of new wind and solar capacity more expensive and putting installation targets at risk.

Major offshore wind projects, which are central to Europe's energy transition ambitions, have been delayed or even shelved in recent months, with developers struggling to make their business cases stack up in the inflationary environment.

Europe is aiming for 300 GW of offshore wind by 2050. While a few projects could run aground and that target still be met, it becomes harder if the issue is not addressed by policymakers, according to Mark Dooley, global head of green investments at Macquarie Asset Management.

"If we have a vintage of projects that were tendered and won in good faith and they never happen, then ... that's a hiccup, mainly for volume, but not huge in the scheme of things," Dooley said in an interview. "If it then takes a longer time than it needs to for government procurers to adjust and accept the new reality, then that could eat even more materially into our prospects of meeting those targets."

Tailwinds now headwinds

The industry's cost inflation is not solely an offshore wind problem, with onshore wind and solar projects in Europe also facing higher capital expenditure costs.

"Several of the tailwinds that propelled [renewable energy] to its current level in the past decade are shifting and becoming headwinds," Morningstar analysts said in a Sept. 28 note, pointing to inflation and rising rates. "This all will likely translate into higher power prices, which will likely raise political opposition, threatening the very targets themselves."

Fossil generation is not unaffected by the inflationary environment either, but industry players point out that renewables will still be cheaper over the long term, especially as carbon markets like the EU Emissions Trading System continue to raise the cost of emissions. But increased costs still risk slowing the rate of change.

The market expects a lowering of interest rates in late 2024 or early 2025, according to Patricio Alvarez, energy and utilities analyst at Bloomberg, meaning relief could be on the near-term horizon.

In the meantime, financial markets are punishing capital-intensive renewable energy companies, with Alvarez noting a negative correlation between clean energy stocks and interest rates.

While the cost pressure may require governments to revisit the remuneration systems under which renewable energy is marketed, Alvarez said the main catalyst is a streamlining of project permitting, which right now "just takes too long."

Rui Teixeira, CFO of EDP - Energias de Portugal, said it takes between five and 10 years to develop renewables projects and it needs to be closer to two. The European Commission and national governments have identified permitting acceleration as a key policy priority.

"Reducing the cost of capital will be key to ensure we are not slowing down investment," Teixeira added, speaking at the BNEF Summit in London on Oct. 10.

Political resolve under pressure from rising costs

While the challenges facing the renewables industry are many, market players point out that significant progress continues to be made in climate and energy policy.

Led by President Ursula von der Leyen, the EC has spearheaded a fundamental reshaping of the EU's energy market in response to Russia invading Ukraine in February 2022.

EU climate policy is "simply much more ambitious than it was 18 months ago," Ben McWilliams, affiliate fellow in energy and climate policy at Brussels-based think tank Bruegel, said in an interview. "The trajectory for renewable deployment ... to my mind has accelerated."

While cleaning up power grids is one thing, market watchers say the next few years will force many individuals to make more personal, and potentially more expensive, changes to the way they live and move around.

The cost pressure is already feeding through to consumers, with the political pendulum swinging away from climate priorities in some parts of Europe.

In September, UK Prime Minister Rishi Sunak announced a five-year delay for a ban of fossil fuel-powered cars, for instance, citing the cost burden on motorists.

"It's a reminder that the energy transition is very much exposed to political risks," said Alvarez, adding that rollbacks on electrification of new settings is concerning for the business case of renewables developers.

"That business case relies on demand for electricity to rise significantly over the next decades. We need to see this uptick in [electric vehicles] at least in some parts to justify that investment," he said.

Strong demand for clean solutions

German utility E.ON said it continues to see strong appetite for clean solutions from its customers, citing a recent support scheme by German development bank KfW for electric charging stations and solar installations. The Eur300 million budget for such installations was snapped up within one day.

"Even though people are willing to actively engage in the energy transition, there is still a need for low-threshold and attractive funding programs to help them make the switch," David Radermacher, vice president of sustainability at E.ON.

The utility surveyed customers on their willingness to switch to new solutions, finding that 32% of homeowners would switch to a heat pump if they were to change their heating system and that 61% of Germans could imagine buying an electric car.

At the same time, Germany's far-right Alternative für Deutschland party is enjoying record-high polling and showing strong results in regional elections, a trend seen as a backlash against the climate ambitions set out by the government and its Green Party energy minister Robert Habeck.

On the EU level, much has been achieved to set the bloc up for success in meeting its climate goals.

Von der Leyen's five-year term leading the commission comes to an end in 2024, having also helped push through the Green Deal, the EU's 2035 fossil fuel-powered car ban and a tightening of its emissions trading system, among other measures.

"For the next decade from today we've set most of the broad policies in place that will help us achieve climate targets," McWilliams said.

S&P Global Commodity Insights reporters Camilla Naschert and Alex Blackburne produce content for distribution on S&P Capital IQ Pro. S&P Global Commodity Insights is a division of S&P Global Inc.