Financing the energy transition: Renewable energies and storage systems

Economies of scale in the expansion of solar PV and wind energy have led to massive reductions in electricity production costs. The third article in this series shows that industrialized countries in particular are driving the energy transition. One reason for this is the country risk premiums that lead to increased capital costs, which must be paid in developing countries. Development banks can play a key role in accelerating expansion in developing countries through their special mechanisms.

In comparison, large-scale battery storage is still in its infancy in terms of expansion figures. However, the current momentum shows that massive growth is to be expected in the coming years due to rapid cost reductions for cells and high revenue potential. New financing models for large-scale battery storage are beginning to establish themselves due to the special risks involved and will also be considered in the following article.

Renewable energies and large-scale battery storage systems constitute the foundational infrastructure of low-emission value chains. The transition from fossil fuels to renewable energy sources therefore requires a sustained high level of annual investment in these technologies. Current global annual investments must more than double to achieve the desired climate targets. Of the current total of approximately €670 billion, 80% is being invested in the expansion of renewable energies and 20% in storage systems. In the future, annual investments totaling 1,425 billion euros will be required for the energy sector. Of this, around 1,225 billion euros will be spent on expanding emission-free power generation capacity and 200 billion euros on improving grid flexibility through battery storage and seasonal storage systems. [1]

In recent years, the expansion of renewable energy has progressed significantly. Particularly noteworthy is the strongest growth in renewable energy capacity in 2024, amounting to 585 gigawatts. This represents record growth of 15.1% compared to the previous year and the largest annual growth since 2000. [4]

In comparison, the expansion of large battery storage systems is still in its infancy, with global growth of 41 GW (60 GWh) in 2023. However, the average annual growth rate has been high since data collection began in 2010, at around 46%. [5]

The total global installed capacity of renewable energies amounted to 4,442 GW in 2024. The most important technologies are hydropower with 1,427 GW of installed capacity (2024 additions: 17 GW), wind power with 1,133 GW (2024 additions: 125 GW), and solar PV with 1,866 GW of installed capacity (2024 additions: 475 GW). In recent years, measured in terms of installed capacity, the strong expansion of solar capacity worldwide has replaced hydropower as the most important renewable energy source. [6]

However, the markets for those technologies are developing very differently around the world, which can be attributed to varying cost structures, market conditions, and subsidy programs. Hydropower, a proven renewable energy technology, is losing importance in terms of additional capacity due to the rapid expansion of wind and solar energy.

Cost trends for renewable energies

The levelized cost of electricity (LCOE) for renewable energies have fallen sharply in recent years (see Figure 3). For example, the production costs for one kilowatt hour of onshore wind power in Germany were still around 20 cents in 2000, and those for solar PV were even around 50 cents in 2010. [5]

Photovoltaic and wind power plants now have the lowest electricity production costs of all technologies and have thus fallen below the electricity production costs of fossil fuels in many parts of the world in recent years.

There is a clear difference in levelized cost of electricity, particularly when compared to conventional power plants (Figure 4). The price of CO2 plays a key role in the development of electricity production costs from fossil fuels and should be used as a market mechanism to make the transition from fossil fuels to renewable energies economically cost-effective.

This is necessary because the consequences and risks of CO2 emissions by companies have been externalized, while profits have been internalized. The continuous rise in the price of CO2 is making the generation of electricity from fossil fuels increasingly uneconomical, while revenues from the ETS in Germany flow directly into the Climate and Transformation Fund. [7]

Framework for financing renewable energies

Technological developments and economies of scale for renewable energies have been particularly favored by the creation of the EEG (Renewable Energy Sources Act) in Germany [8]. The EEG regulates the mandatory and priority feed-in and cost-adjusted remuneration of renewable energies over the project term and thus represents the most important investment basis for renewable energies. This is a key factor in creating investment-friendly framework conditions in the field of renewable energies and has contributed significantly to reducing investment-related risks. It has now been adapted internationally in over 80 countries [9]. Since the development of renewable energies is associated with high upfront costs and long project lifetimes, sales revenues for future years must be predictable in order to ensure the most accurate economic analysis possible at the lowest possible financing costs.

This can be secured either by the feed-in tariff regulated by law in the EEG, so-called PPAs (power purchase agreements), tax relief, or contracts for difference [10]. PPAs are individual, bilaterally negotiated long-term electricity purchase agreements and help financing renewable energies by long-term offtake agreements.  In comparison, contracts for difference specify a fixed reference value as the market price for electricity produced from renewable energies. If the price is below the reference value, the difference is subsidized; if the price is above the reference value, excess profits are skimmed off and transferred to the state. All three mechanisms have in common that they enable long-term planning for stable cash flows and thus offset the risk of default.

As a general rule, the easier it is to classify the risks of an investment, the lower the risk premium on the cost of capital and the higher the proportion of debt capital that banks will make available for investments. This means that the risks and the probability of future cash flows are directly dependent on the cost of capital. Capital costs are a decisive cost factor that influence the electricity production costs of new plants, which in turn affects their competitiveness compared to other electricity generation technologies. In Germany, before the interest rate rise in 2022, very low capital costs of around 2 to 3 % were quoted for new solar projects in Germany with a debt ratio of 80% or more [11].

Thanks to active mitigation of the above risks, coupled with mature and liquid financial markets, as it is the case in Europe, China, and the US, and the technological maturity of generation and storage technologies, capital costs due to the rise in interest rates (see Fundamentals and basic concepts) currently amount to cost of capital between 3 to 7% for new renewable energy plants. This means that, under the current legal framework, renewable energies have capital costs that are 2 to 5% lower than those of manufacturing industries such as cement, steel, and chemicals [12].

In contrast to industrialized countries, developing countries often have significantly higher renewable energy potential, but fail to realize it due to a lack of financial resources, legal frameworks, or suitable integration into the local power system. The risk premiums for investments in developing countries lead to significantly higher capital costs, which in some cases are more than three times higher than in industrialized countries. These increased financing costs can result in an increase in total project costs of over 80% [11].

Figure 6 shows the countries with a cumulative total of more than 90% of installed solar PV capacity. It is striking that a large part of the installed capacity was installed in countries that are below the median for annual global radiation and the country risk premium (CRP). This confirms that the expansion of solar PV was driven in particular by countries with comparatively poor solar PV potential and strong financial markets. In comparison, the African continent has an average CRP of 7.3 % and average annual global radiation values of 2250 kWh/m2. At the same time, less than 1% of the global installed solar PV capacity is located in Africa.

In this regard, expansion is also being driven primarily by industrialized countries. However, it is particularly important that defossilization does not only take place in industrialized countries. Since many young coal-fired power plants generate electricity in developing countries, the expansion of renewables must also be promoted there, and coal-fired power plants would have to be shut down before the end of their economic life cycle.

Development finance institutions (DFIs) play a crucial role in accelerating defossilization in these countries and removing barriers to access to private capital. Often supported by industrialized countries, they can grant low-interest loans. The lower interest rates that development banks can offer mean that high-risk projects in developing countries can achieve interest rates similar to those in industrialized countries, which increases the attractiveness of expanding affordable renewable energy.

Development banks in particular therefore play a key role in accelerating the global defossilization process. The capital and guarantees they provide serve to establish the framework conditions and expertise for the ramp-up of renewable energies in developing countries in order to remove the barriers to the inflow of private capital. Development banks thus actively contribute to market opening and risk minimization. Currently, the financial instruments provided by development banks amount to approximately €24 billion, although a significantly higher sum is needed to achieve the renewable energy expansion targets in developing countries in order to quickly establish expertise, legal frameworks, and a functioning market [16]. Many developing countries in South America and Africa in particular have excellent renewable energy potential that needs to be made accessible to the market.

Cost development batteries

Similar to renewable energies, lithium-based battery storage systems have also seen significant cost reductions in recent years. Between 2010 and 2023, the cost of battery storage projects fell by 89%, from €800/kWh to €140/kWh [15]. In some cases, prices for battery systems are even below €100/kWh [17]. This corresponds to a cost reduction of more than 90% within 10 years. This reduction was achieved through scaling up production, improved material efficiency, optimized manufacturing processes, the development of massive manufacturing capacities, and the establishment of stable supply chains. This has driven the expansion of installed gross capacity from just 0.1 GWh in 2010 to 95.9 GWh in 2023. [5]

The drivers behind this development are interdependencies with the expansion of home storage systems, large-scale storage systems, and, above all, batteries for the automotive industry. In 2023, 90% of all capacity for lithium-based batteries was installed in electric vehicles [15]. EV batteries must be energy-efficient, small, and lightweight, while batteries for energy storage focus on low cost and durability. Advances in research and development in EV batteries often also favor the development of stationary large-scale storage technologies due to their modular design.

The rapid growth in annual battery storage capacity over the past five years has been driven primarily by China, the EU, and the US, which together accounted for nearly 90 % of newly installed capacity in 2023. China is the leader in the battery storage market, increasing its share of global capacity growth from 20% (2019) to 55% (2023). The reason behind the growth in China is primarily access to raw materials needed for the manufacture of batteries and related components. With 90% of global graphite mining, 85% of global cell manufacturing capacity, and control of 90% to 98% of various cell components, China dominates the value chain of lithium-based battery storage. Despite the high concentration in the battery value chain, little progress has been made in recent years to increase diversification in supply chains. [15]

Framework for financing batteries

In Germany, a massive increase in the expansion of large-scale storage facilities is currently expected. At the turn of 2025, transmission system operators had received 650 connection requests with a capacity of 226 gigawatts [18]. By comparison, around 1.8 gigawatts are currently in operation in Germany [19]. However, it should be noted that only a fraction of the requested capacities can be realized as projects. How much this will be in total remains to be seen. The Federal Network Agency’s current network development plan assumes that 40 to 95 GW of large-scale battery storage could be installed by 2045 [20]. In particular, flexible operation with negligible battery response times is perfectly suited to providing primary and secondary control power, thereby stabilizing the grid frequency. In addition, it can be used as an arbitrage tool. The increasing expansion of renewable energies, especially solar PV, is creating a significant gap in electricity prices between midday and evening hours, the difference between which can be skimmed off by battery storage. In order to maximize the revenue from batteries, daily optimization of the control power offered and electricity trading is advantageous (see Figure 7). Particularly in Germany, where the expansion of solar energy is leading the way globally, coupled with high electricity prices, the market environment for battery storage is currently favorable, with the positive effect of smoothing out the volatile electricity prices caused by the feed-in of variable renewable energies.

Since battery storage can be operated most economically through the use of optimization models, this poses a particular challenge for investors. Daily optimization and the possibility of generating multiple revenue streams increase the complexity for investors when evaluating investments, which traditional cash flow models are unable to adequately reflect. In addition, the expansion of batteries is closely linked to the expansion of the power grid and the integration of additional flexible loads. There is no guaranteed purchase price for batteries, and interactions with cannibalization and substitution effects cannot yet be definitively classified in the long term. Comprehensive access to capital from institutional investors with a low-risk/low-return profile has not yet been fully realized. Nevertheless, this access is a key prerequisite for implementing cost-efficient and user-friendly financing solutions on a large scale. Consequently, in order to minimize risk, the share of equity capital must generally be greater than that of renewable energy projects. The cost of capital can also be 1 to 2% higher than that of renewable energies [12].

To facilitate access for risk-averse investors to investments in battery storage and to optimize capital costs, the tolling model is increasingly becoming the focus of contractual arrangements. Under this model, a contract is concluded between the owner of the battery storage facility and a commercial operator or optimizer. The owner receives a fixed remuneration from the operator, while the operator assumes the risk and the potential returns from the volatility of the energy market. This instrument is particularly effective if the operator or optimizer itself has a high credit rating and therefore a low default risk. [22]

Summary and outlook

In particular, the recent records achieved in capacity expansions show that the market environment for the expansion of renewable energies and storage remains positive, which could not be slowed down by COVID-19 and the accompanying inflation and rising capital costs. The designation of renewable electricity generation as being of overriding public interest has given wind energy in Germany in particular a new momentum.

However, geopolitical tensions are also increasingly emerging that could disrupt the supply chains of renewable energy technologies. While manufacturers of solar modules and storage systems are currently still undercutting each other due to overcapacity in the markets, China has publicly proposed introducing cartel-like structures to stabilize the margins of the domestic solar industry at the expense of the global pace of expansion [22]. Given China’s market power in the manufacture of solar modules and lithium-ion battery storage systems, the geopolitical situation surrounding China will be key to determining the extent to which these technologies will achieve full global market penetration and scaling.

Literatur

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