Unhedged risk in hybrid energy markets: Optimising the revenue mix of Australian solar

Australia is facing a historic investment challenge, with an estimated $1.2 to $1.5 trillion in newly invested capital required by 2030 in order to meet 2050 decarbonisation targets. In response policy makers have begun “re-entering” energy markets, which were deregulated and privatised in the 1990’s. Public auctions for State-backed ‘Contracts-for-Differences’ (CfDs) now act as a key policy tool to “prime” energy markets for new variable renewable energy (VRE) capacity. In a phenomenon recently coined “market hybridisation”, market participants form long-term investment decisions that are increasingly disconnected from short-run spot pricing dynamics and day-to-day operations. Historically, it has been common practice to underpin VRE projects with some form of power purchase agreement (PPA). However, increasing investor appetites for “semi-merchant” projects (i.e. projects partially exposed to spot prices) has become an emerging trend. This article examines the semi-merchant phenomenon, aiming to explain why the investment model is becoming popular for investors in VRE. Of particular interest are the foregone advantages attributable to highly contracted plant when securing bankable project finance. Results reveal that a revenue mix comprising 70%–80% PPA coverage and 20%–30% merchant exposure appears viable and tractable for investors in utility scale solar — whilst maintaining a typical project finance capital structure of c.60%–70% gearing. By implication, policymakers targeting 4000MW of new solar capacity via CfD auction may need only offer ∼3000MW of contracted capacity, thereby reducing taxpayer exposures and protecting scarce government balance sheet resources.