The International Renewable Energy Agency (IRENA), in a recent report, has revealed a method used to calculate the cost of capital for clean technologies to help understand the drivers of renewable costs.

The cost of capital is the minimum rate of return or profit a company must earn before generating value. It is a significant determinant of the total price to purchasers of electricity from renewable power generation technologies.

The report notes that if assumptions used for the cost of capital are not accurate – over time, between countries or technologies – then the cost of electricity might be significantly misrepresented and result in poor policy making.

With the growing maturity of solar and wind power technologies worldwide, defining the appropriate cost of capital for clean technologies has become a crucial aspect of driving the total cost of renewables, IRENA said in a recently published report.

Given the lack of reliable financing data based on the country and the technologies, specifically, the limited project finance data has also led to fluctuating costs of capital for renewable technologies.

The IRENA data was collected through a series of expert surveys and interviews covering all major world regions for onshore and offshore wind and solar photovoltaic.

To bridge the varying gap of cost of capital for different renewable technologies, IRENA collaborated with ETH Zurich’s Energy and Technology Policy Group and International Energy Administration’s Wind Technology Collaboration Programme— and surveyed various finance professionals to understand factors slowing financing for renewable energy.

IRENA interviewed 56 experts to obtain 172 valid responses from 45 countries across six continents with a focus on at least one renewable energy technology, while other major responses were collected based on the specific clean technology and country.

The cost of capital data in the responses accounts for 88% of new solar capacity added in 2020, 98% of new onshore wind additions, and 87% of the new offshore wind capacity additions during that year.

IRENA projects that the responses received for the report would enable its member nations and the global energy modeling community to improvise on the levelized cost of energy (LCOE).

The agency gathered most responses for project financing from Europe and found that deploying renewables is undertaken with guidance from experienced financial groups and developers.

Over half of the 172 responses recorded in the survey were for solar at 51%, followed by onshore wind at 38% and offshore wind at 11%.

Benchmark tool to Calculate cost of capital

IRENA combined the interview responses with a benchmark tool designed to evaluate the factors around the cost of capital in the 45 countries considered in the report.

The agency found that mature markets with access to low-cost debt can help achieve very low cost of capital values, resulting in competitive LCOEs.

The tool considers market maturity, the financial community’s familiarity with renewable energy projects, and their effect on risk premiums. It is designed to perform two functions— firstly, to provide a replicable method in calculating a first approximation of the cost of capital for all country and technology combinations, and secondly, to inform the survey and interview processes.

However, the regional differences are more significant than the variations between the clean energy technologies within a region, driven primarily by the varying risk premiums in the 45 countries.

Country-wise cost of capital data

IRENA found that the spread between technologies ranged between 100-200 base points (bps) within any given region.

Per the new IRENA report, the current cost of capital ranges from a minimum of 1.1% for onshore wind in Germany to over 12% for solar and onshore wind in Ukraine.

Other countries with higher costs of capital include Mexico, Egypt, and Tunisia. In all the clean technologies surveyed across the 45 countries, IRENA found that Germany is the country with the lowest financing cost at 1.1% for onshore wind, 1.4% for solar, and 2.4% for offshore wind, while the values for an onshore rose at 12.2% in Ukraine and rose at 8.1% for offshore wind in Vietnam.

The data from the report suggests the simple average cost of the regional cost of capital for utility-scale solar was 3.9% in China, 6.1% in other Asia-Pacific (APAC) nations, 4% in Western Europe, 7.7% in Eastern Europe, 8.7% in Middle East and Africa, 6.6% in Latin America, and 5.4% in North America.

IRENA discovered a lesser variance in the simple average regional cost of capital for onshore and offshore wind in the above regions.

Figure 1: Expected average change in the cost of capital between 2019-2021 and 2025

The agency said this was because clean technologies are concentrated in a few OECD countries (Organization for Economic Co-operation and Development) and China— where policies support deployment and pave the way for low-cost capital.

Debt share and cost of equity

IRENA further explains that the share of debt in the cost of capital is lower in North America at 35-65%, owing to the tax credits used to accelerate the deployment of solar and wind technologies.

Such a policy has increased the equity share in North America’s renewable power generation capacity assets while lowering the cost of equity.

In Europe, while the share of debt is 80% or more, the cost is lesser, driven by lower base rates supported by the seasoned banking sector, which finances renewable power generation projects.

The macroeconomic environment, like the prevailing interest rates, is a major cost of capital determinant.

Across many markets, capital seems abundant as projects have not had difficulty financing in recent years, partially due to new capital providers increasing the availability of funds. This trend has reduced the cost of capital for renewable power projects.

Uncertainty about the expected revenue leads to increased cost of capital. Such uncertainty is often a direct consequence of the nature of support programs or regulatory regimes and increasing merchant exposure.

Figure 2: Estimated cost of capital change between 2019-2021 and 2025

The respondents in the IRENA survey expect minor changes in the cost of capital for clean technologies by 2025.

Of the 172 responses, 122 were for country and technology, 97 responses included details on the changes expected in the cost of debt, equity, and debt-to-equity ratio, while 25 others included both— the total cost of capital with at least one other region-specific detail.

The respondents further stated that excluding India, the cost of capital for solar would fall by 55 bps till 2025 in other APAC regions as experience with solar grows, making financial institutions more familiar with lending to solar projects from established developers. The same for solar in Europe would rise by an average of 27 bps.

IRENA further projected that the average cost of capital of onshore wind would increase by ten bps in France, Germany, Greece, Ireland, the Netherlands, Spain, and the United Kingdom, while the same would drop in Denmark, Italy, Finland, Norway, Poland, and Sweden.

The debt and equity cost premiums of offshore wind over solar and onshore wind are also likely to fall continuously by an average of 29 bps until 2025.

IRENA also recently pointed out that to stay on track for a 1.5 degrees Celsius pathway, an annual deployment of approximately 1,000 GW of clean power is necessary.