Hero to zero

How Spain has gone from being the world’s most attractive destination for solar infrastructure investors to the scene of a massacre.

At our European fund management roundtable last year, participants were laid back about the effects of changes to Spain’s tariff regime for its solar photovoltaic industry.

The view of John McCarthy, head of Europe at RREEF Infrastructure was typical: “There was a lot of fear about what might happen, but they [the Spanish government] haven’t penalised the industry,” he said. “They appear to have decided that the risk of capital flight was more important than the short-term political drivers.”

Spanish solar:
sad story

At the time, McCarthy was representative of infrastructure investors’ take on developments. And it was, at the time, probably the correct interpretation. A royal decree issued by the Spanish government in late November revealed that, while it would be reducing tariffs by up to 45 percent for new photovoltaic plants, subsidies for existing plants would be relatively untouched: payments were capped to a maximum of 25 years. It was the threat of a retroactive cut to subsidies that had been most feared, and investors consequently breathed a sigh of relief.

But then, just before Christmas – take note of the timing – came a u-turn. A new royal decree usurped the one issued just a month prior with a proposal to retroactively limit the number of production hours for which plants qualify (or qualified) for the tariff.

The ploy leaves the government able to claim that it has not technically adjusted the tariff. But it nonetheless has had a devastating effect on cash flow assumptions, with many business plans shot to pieces. The Asociación Empresarial Fotovoltaica (AEF), an industry body, claims that the measures will prevent the repayment of €20 billion in debt – opening the door to a wave of bankruptcies. Sighs of relief have been replaced by feelings of profound nausea.

So why did the government backtrack? The simple answer is that they were too generous in the first place. Spanish incentives were of an entirely different magnitude to those offered elsewhere. The government bent over backwards to create an investor-friendly environment. A testament to its apparent success was that Spain became one of the world leaders in solar energy production.

The government’s largesse made it a hostage to fortune, however, and the 2008 Crisis made the tariff regime unsustainable. The stress point turned out to be the working capital burden of solar projects, which rested on the shoulders of the country’s utilities – a burden they could no longer afford. The government tried to refinance the so-called ‘tariff deficit’ through a bond issue, but was unable to do so. Realising that they would be saddled with the burden for some time to come, the utilities – by now favouring wind power over solar in any case – pleaded with the government to find ways of easing their plight. Hence the Christmas Eve massacre.

For debt and equity investors watching on with horror, there is still hope. The AEF has promised to fight the new law all the way to the European Court of Justice if it gets approved by a Parliamentary vote, due to take place by 25 January. One fund manager with equity exposure to the Spanish solar market told Infrastructure Investor the likely basis of any legal action would be that the proposed tariff alterations are typical of road concession/public franchise adjustments – but are unprecedented when applied to private investment incentives. Others are still hoping that the government may voluntarily backtrack to a less punitive position.     

Whatever happens, the debacle is a reminder to infrastructure investors that political expediency has a tendency to scupper sensible long-term plans. Any evaluation of regulatory risk should keep this in mind.

It also revives an old adage: if something looks too good to be true, it probably is.
Check out the February 2011 issue of Infrastructure Investor magazine, which includes a cover story on renewable energy.