The sky's the limit, but not yet for green energy

Over 1 billion euros. That's how much Britain has spent this year due to an overcrowded power grid. The growth in renewable energy has caused wind farms to close when there is a surplus. With the (unnecessarily) lost revenues, they have become victims of their own success. Since growth does continue, action must be taken quickly. But how do you solve the problems?

Britain wants to become the world leader in offshore wind energy. Production from offshore wind farms has grown 50 percent in recent years and should double within five years. The only problem: the capacity of the power grid is not growing fast enough with it. Because much of the electricity has to go to the densely populated south and the wind farms are in Scotland, the entire grid has to be able to handle the large peaks. Generally, wind and solar farms are located in sparsely populated areas where capacity is naturally not as high. This difference in supply and demand causes wind farms to temporarily shut down during peaks, leading to congestion charges: Compensation to wind producers for power not generated. This has cost the British government £1 billion this year, while replacement electricity often comes from polluting sources, hurting climate goals.

source: NESO

How do congestion charges work?

Wind turbine generators are compensated through the Contract for Difference (CfD). This contract guarantees a preknown strike price for generated electricity for 15 years, regardless of the market price. If a wind farm is shut down, the producer receives compensation based on this strike price. This provides security for generators, but increases dependence on subsidies. Congestion costs also include the often fossil energy that must be purchased extra due to the shutdown.

Source: worldindata.org

Looking at the growth of wind power, that problem does not seem to be abating. To meet the plan for Net Zero, that growth would have to stay on. According to the International Energy Agency, production must triple by 2030, which is considered feasible with the necessary investment. But the increase in scale thus also brings its problems.

What developments are there for wind energy?

A major player in the British market is SSE's green arm, SSE Renewables, which co-owns Scotland's largest wind farm, Seagreen. As of last year, it supplies 1.6 million households in Scotland with electricity. It is also working with a group of companies on Dogger Bank, the largest offshore wind farm in the world. That will eventually supply 10% of Britain's energy consumption. Bureaucracy, however, slows progress: Permit approval, in particular, takes a very long time. Finally, it also needs to be connected to the power grid which therefore does not have enough capacity.

As a result, the first application for Dogger Bank dates back to 2010, but the project is still not operational. Still, through Seagreen, SSE has stable revenues over the years. The net profit margin increased from 3.93 percent to 24.73 percent. Compared to the rest of the industry, the price-to-earnings ratio is low (10.75 to 19.64) and the price-to-earnings-growth ratio (KWG) is high (4.22 to 0.92). This makes sense given that earnings per share have risen very much over the past year.

What developments are there for the power grid?

Projects such as The Great Grid Upgrade and Eastern Green Link are initiatives of National Grid PLC. It wants to build five times more transmission lines in six years than in the last 30 years. This will strengthen the connection between the north and south and build new battery stores for emergencies. Project Sea Link is intended to better connect offshore wind farms to the national infrastructure. Also at National Grid PLC, you can see that margins are higher (11.54% to 6.22%) and due to stable earnings, the dividend yield has grown (4.76% to 3.04% compared to the sector). Since it is a market leader in Europe, the valuation is inherently hefty.

With the Beyond 2030 plan and relaxed legislation, Britain is trying to shorten the long approval process and get projects done faster.

What about the rest of Europe?

The problem is not limited to Britain. For example, Montenegro and neighboring countries suffered power outages last summer due to overloads, and the overcrowded power grid is also affecting economic growth in the Netherlands.

Fortunately, major projects are on the way there as well. Iberdrola, market leader of energy from Spain, expanded its capacity this year by 2.4 Gigawatts in offshore wind power (roughly equivalent to 2.4 million households), in addition to major investments in the grid. In addition, two large wind farms are underway in Germany's Baltic Sea. Italy's Enel, whose green arm added 6.3 GW this year, has promised to put 12 billion euros into renewables and 38 billion into the grid between 2025 and 2027.

Taken together, the companies are 40 percent of the entire European market, so besides market position, only the high dividend yield stands out. That they are not growing fast is partly due to the lack of really big projects like Dogger Bank. Projects totaling 80 GW of production are delayed by bureaucracy. To speed up the process, the European Commission has therefore relaxed regulations to make approval of a permit take no longer than two years.

Two things may be true at the same time. On the one hand, there is already a lot of congestion and capacity problems for the grid. Obtaining a permit takes several years, preventing many projects from starting. On the other hand, the renewable energy sector is growing tremendously and will continue to do so. Large investments are being made in the power grid and regulations are being relaxed. For an energy company, the fixed price keeps a wind farm, once operational, very profitable, providing security for the investor. With the right combination of policy, innovation and cooperation, Britain and the EU can not only reduce congestion costs, but also remain highly influential in the global energy transition. And you can benefit from that.

By Floris de Vries