Posted by: joachim in Policy,Renewable Energy,Solar on August 8th, 2011

Rising cost of capital for solar pv projects in some euro-zone countries, caused by the EU debt crisis, will mean that many projects will no longer be financially viable. Instead, investors in solar may switch to African or South American countries that have more sunshine to compensate for higher cost of capital.

Even in countries with fixed feed-in tariffs, solar pv projects are not immune to the sovereign debt crisis. Whether a solar pv project is viable not only depends on the prevailing tariff, annual irradiation and cost to build the plant, but also the cost of capital. Reflecting the risk of a project, the cost of capital comprises a basic risk component and a risk premium. For solar pv that basic risk is about 6% taking into account the low technology risk and the stable traffic from the sun. Unsustainably high sovereign debt and subsequent downgrade in credt rating causes higher cost of borrowing, increased risk of cuts in feed-in tariffs and generally dampens investor confidence. All of this leads to an increased risk premium (i.e. the required internal rate of return over and above the basic risk of 6%) of solar projects in those countries.

For a numerical analysis we use a simple formula for the net present value of the project:

Net present value of a solar park

with capital expenditure of 2,600 €/kW, operational expenditure of 0.5% of capex and a system performance ratio of 80%. No degradation is taken into account. The internal rate of return of a project is the cost of capital that makes the net present value zero. For the purpose of this illustration, we assume a basic business risk of 6%. The risk premium is the difference between the basic risk of 6% and the actual internal rate of return.

Irradiation, tariff and risk premium on solar pv generators

Current state

The diagram shows the tariff dependant on annual irradiation (x-axis) and risk premium (y-axis). If we assume 2011 feed-in tariffs for mid-sized systems, the implied risk premium in Germany is 1%, in Italy 4% and Ecuador 10%. In other words: With the high risk premium, it is no wonder that the feed-in tariff in Ecuador is as high as in Italy despite higher irradiation.

Impact of increase in risk premiums due to debt crisis

For projects still to be built in a country that faces a higher risk premium, the increased cost of capital would have to be compensated for by lower expenditure, higher irradiation or higher tariffs. With prices for systems already under pressure and tariffs only going down, the increase in the cost of capital may cause a rush for the sunniest spots in the country. However, there is a physical limit. In Germany, the maxium is around 1,000kWh/m2, whereas in Italy, the limit is reached in Siciliy with 1,700kWh/m2.

Will investors in solar move away from Europe?

However, this has another effect: Countries in Africa or South America with high irradiation, but traditionally higher risk premiums, all of a sudden become more attractive, as European countries may not have sufficient irradiation to compensate for higher cost of capital. Livingstone, Zambia, enjoys more than 2,300kWh/m2 while Riobamba in Ecuador gets 2,100kWh/m2.

 

Posted by: joachim in Renewable Energy,Solar on July 29th, 2011

With so many places on earth where photovoltaic power plants could be built, it is not always immediately obvious where the best opportunities are for investors or project developers. For instance, lack of sunshine in one country may be compensated for by a high feed-in tariff. For a first-look, crude comparison of two opportunities, projects may be scored on 5 dimensions: Irradiation, tariff, system performance, capital expenditure and a general assessment of political stability & local knowledge of the team.

If shown as an area in a graph, the ideal project has an area that is large and balanced around the center. If the area is mostly in the top half of the diagram, the project has great potential revenues, but may never be built because of costs and political risks. On the other hand, if the area is mostly in the bottom half of the diagram, the project may be safe to build, but won’t generate a lot of cash.

In the graph below, we are comparing two ficticious projects in northern Germany and Tunisia. Furthermore, the modules in Tunisia are mounted on a tracking device, resulting in higher system performance because the tracker allows the system to catch more of the available irradiation. Also, annual irradiation in Tunisia is twice as high as in Germany. On the cost side, however, the tracking devices adds to the price. Finally, the success of a project and its prospects for investment very much depend on country-specific aspects such as political stability of the law governing renewable energy, ease of doing business and getting permits as well as local knowledge. Here, a project in Germany would definitely score much higher than in Tunisia.

The areas of both projects in the graph are of similar size – they both have merits. However, they are also both slightly imbalanced: Irradiation in Hamburg may be too low while political risks may jeopardize the project in Tunisia.

Please try out our interactive tool with more details.

Posted by: joachim in Policy,Renewable Energy,Solar on June 11th, 2011

How complexity of feed-in tariffs add to the price of solar power.

Among politicians it has become fashionable to state that solar power is too expensive, no doubt as a pre-cursor to drastic cuts, as witnessed in many countries. Understandably, people demand more transparency and to know how much more they pay for electricity due to renewables. The reputation of being too expensive is damaging the solar industry and the technology as a whole. If it’s so expensive, why do we support it?

While solar power has the potential to replace conventional sources on a big scale in future, it is not yet cost competitive with the exception of some niche markets. Investing in solar technology helps driving costs for products and processes down, thus helping solar power to eventually fulfil its promise. Feed-in tariffs where generators of solar power are awarded a price per kWh has proved to be the most effective instrument. This way, investors are incentivised not just to construct but also to run the pv systems.

However, by setting up complex national tariff structures, politicians have caused a significant premium themselves.

The minimum tariff is the one that gives the investor a return that is commensurate with the risk in solar while providing a reasonable margin for everyone in the value chain. If the tariff is set below this minimum (e.g. the UK’s tariff of £0.085 per kWh for installations greater than 250kW), the support is so ineffective and the government may as well drop the tariff altogether.

With only one price level, the market would seek the most efficient locations and solutions (i.e. lowest cost of ownership) by itself. In practice, however, each country has its own feed-in tariff with their own country-specific features, most of which are politically motivated. Both the multitude of tariffs and the special features increase the cost of solar power (€/kWh).

Here are some of the tariff features:

  • Size: Typically, smaller installations attract higher tariffs.
  • Host: Price discrimination dependant on the host type include the preferential rates for hospitals in France or the withdrawn support for installations on potential farm land in Germany.  
  • Index-linked adjustments: Here, the price paid out in future is linked to a defined index, such as inflation in the UK.
  • “Made-here” Bonus: This is maybe one of the crudest features – paying a bonus if components are being used that are made in the host country.

Let’s look at them in more detail:

  • Location: The market follows the feed-in tariffs. With frequent changes to the tariffs, countries go in and out of fashion, sometimes just within a year or two. That causes unnecessary volatility in the market. It also means that the decision where to invest is not cost-driven, but driven by jurisdiction. For instance, assuming the same capital costs, power from a pv system in northern Germany is 50% more expensive than in southern Italy.
  • Size: Most law-makers set higher tariffs for small installations than large ones. In Italy, the difference is 51%, Germany 26%, Ontario 49%, Greece 13%, and in the UK even more than 100%. Large-scale projects are of great importance. They help lower the supply chain costs and accelerate the creation of a local solar industry and support systems. Having preferential treatment for small installations equates to a hand-out to homeowners.  
  • Host type: As with the size discrimination, preferential treatment of hosts that are deemed to be deserving is just another premium.
  • Inflation adjustment: It’s a gimmick that makes the product more attractive to consumers that fear inflation. Unfortunately, this in-built protection against inflation creates uncertainty, as it makes it much more difficult to assess, and therefore more expensive.
  • Protectionism: By providing a bonus for the use of local manufacturers, less competitive manufacturers may be supported. It damages competition at a cost to tax payers. In fact, it runs against the primary objective of helping solar power to become cost competitive.

These politically motivated features easily add 50% to the cost of solar power. Whilst this premium may not be required to help solar to become cheaper, it is the price we pay to increase the acceptance of solar in communities. Rather than saying “solar is too expensive”, politicians should say “we could get more solar power and for the same amount of money, but we want it in our country, on our roofs and with our own modules – and that costs money.” That would be real transparency.

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