Freeing solar

“Unsubsidised solar era begins: Utilities’ customers turn into competitors.” Taken out of context like that, you can almost imagine an early 20th century paperboy shouting that headline from a street corner, trying to flog papers to gaping bystanders.

In this case, the headline comes from the research arm of investment bank UBS. But even though it has not been hollered by street vendors, the pronouncement has certainly been raising eyebrows over the last few months. And with good reason, because what the report, aptly named The unsubsidised solar revolution, is touting, could have profound implications in the years to come.

In short, across key European markets, “solar has turned from a heavily subsidised technology into a mainstream source of power generation,” UBS states. “Sharply decreasing costs for solar panels and batteries, combined with rising electricity tariffs, make solar viable without any subsidies in several key European markets, such as Germany, Spain, and Italy.”

As UBS colourfully puts it, “investment in solar becomes a no-brainer” in these countries.

Depoliticising renewables

This is a potentially ground-breaking development for an industry that, while phenomenally successful, especially in Europe, has been heavily politicised from the outset – with visible and well-known consequences in places like Spain, for example.

Put simply, solar went from zero to hero on the back of generous feed-in tariffs implemented by various European Union countries in the 1990s.

And even though it only accounts for about 1 percent of global electricity supply, solar has grown from an installed capacity of about 2.8 gigawatts (GW) 10 years ago to over 102GW today – with 200GW to be in place by 2016, according to a recent report in the Financial Times.

This momentous development has precipitated a “sharp decline in PV [photovoltaic] system costs globally, which have decreased by more than 50 percent in the past five years,” UBS wrote, adding that it expects “this trend to continue on the back of further increasing manufacturing efficiency” to the point where “even if solar subsidies disappear (like in Spain, for example), there is now a business case for solar systems”.

For Scott Lawrence, founding partner and solar expert at Glennmont Partners, the renewables fund manager that spun out of French bank BNP Paribas, solar power decoupled from feed-in tariffs is the “future of the industry. From a cost perspective, solar has come a long way in a very short time”.

So how does the thought of a depoliticised solar industry sit with infrastructure investors? “In principle it’s very interesting, because there would be no sovereign risk,” Allard Ruijs, managing director with the Netherlands fund manager DIF, told Infrastructure Investor.

The flipside is that an unsubsidised, depoliticised solar industry brings with it a fundamental change to the rules of the game. “Without subsidies, a solar system’s profitability depends almost entirely on the amount of solar power directly consumed by its owner,” UBS points out.

As much as investors dislike the political volatility that comes with a subsidised industry, “we need long-term power PPAs [power purchase agreements] at attractive prices for unsubsidised solar to make sense for us,” Ruijs points out.

In fact, one can argue that it’s the visibility and favourable return profile of subsidised solar that has made these assets so attractive to key players in the infrastructure industry, be it funds or institutional investors. To quote Ruijs, “we [DIF] will not take on merchant risk” – and that also goes for many other infrastructure investors.

Besides, as UBS correctly points out, “under the current subsidy schemes […] it is financially more attractive to feed the entire solar power into the grid at guaranteed tariffs, which exceed the retail electricity price”.

That’s certainly one of the reasons behind the onslaught of retroactive measures implemented by Spain in its solar sector, particularly its latest legislative proposals, which, if approved, would effectively cap returns in the sector at between 7.0 percent and 7.5 percent.

Glennmont’s Lawrence argues that the real question is not the risks that equity sponsors will be able to take on, “the bigger questions is what will it take for banks to feel secure to lend on a non-recourse, project finance basis” to this new wave of solar projects?

“The key here will be counterparty risk,” he answers. “Who is going to buy your power and how creditworthy are they? That will have to be analysed on a case-by-case basis.”

A ‘new wave’

The other question is what will the unsubsidised solar projects of the future look like and are any of them actually in development already?

“There are [unsubsidised solar] projects in development right now, but large assets have not yet been built,” Lawrence says, although he believes these projects will need scale – “let’s say, around 100 megawatts” – to succeed.

For DIF’s Ruijs, future deals in the space might look similar to the arrangement it has with the Casino supermarkets group, in France, via GreenYellow, Casino’s renewables subsidiary.

Earlier this year, DIF bought a majority stake in four solar projects under construction on the rooftops of Casino supermarkets and car parks in southern France, with a combined installed capacity of 10.2MW, with GreenYellow retaining a minority stake. Under the deal, Casino off-takes all the energy produced by the rooftop solar panels directly.

Ruijs can see this model being easily replicated: “I can imagine a large car manufacturing company for example, or some other industrial company [with which] we could get a long term PPA in place. That could pave the way for a new wave of deals once unsubsidised projects prove themselves.”

“The solar market is growing globally. It used to be a pure European play – and of course Europe is still the focus. But there is a large world out there, and as these projects become tried and tested, more opportunities will arise.”

Unintended consequences

Jenny Chase, head of solar analysis for Bloomberg New Energy Finance, said it best when she told the Financial Times that unsubsidised solar is not only a momentous change, “it will [also] cause problems we haven’t even begun to imagine”.

There is one problem, however, that is already becoming readily apparent: utilities are not happy at the prospect of seeing many of their customers, both on the residential and commercial fronts, turning into competitors – a phenomenon UBS has aptly termed “demand destruction”.

“We expect unsubsidised solar to replace conventional generation by utilities. We calculate that up to 14-18 percent of electricity demand in Germany, Spain and Italy could be met by self-produced solar electricity. We estimate 6-9 percent of demand could be replaced on these markets by 2020 already,” the bank’s research unit wrote in The unsubsidised solar revolution.

In raw number terms, some 43 gigawatts of unsubsidised solar energy should be produced across Germany, Spain and Italy by 2020. To make matters worse for utilities, as battery storage solutions improve, solar will be in an even better competitive position, impacting on key peak times.

What this means, in UBS’ opinion, is that “an increase in unsubsidised PV [photovoltaic] capacity will ultimately lead to higher electricity prices: the demand reduction that results from higher energy efficiency and an increase in unsubsidised PV capacity makes it necessary to spread the grid investments and cost of the renewables subsidies over a smaller base”.

“At some point, we think this will trigger a political debate about how the grid fees and renewable subsidies should be paid for,” UBS predicts.

What the outcome of that hypothetical debate might be, though, is anyone’s guess at this stage.