End of October 2011, the UK announced an unexpected and severe cut of its feed-in tarff for small solar installations. The department of energy and climate change (DECC) called it a consultation. However, since the date the new tariffs were valid from (12/12/11) preceded the date of the end of the consultation, it can hardly be called such thing. In fact, there has been a court challenge regarding the legality of the process. While the outcome of this ongoing legal battle may change things slightly, it will most likely not change the conclusion of this article.
The new proposals
The proposal (Comprehensive review of feed-in tariffs for solar pv) slashed feed-in tariffs for solar for under 4kW from 43p/kWh to 21p/kWh, for 4-10kW to 16.8p/kWh and for under 250kW to 12.9p/kWh. As before, anything below 5MW (and free-standing) get 8.5p/kWh. Above the 5MW threshold for microgeneration, photovoltaic installations continue to generate 2 ROCs (renewable obligation certificates) per MWh. The department also proposes "prioritising energy efficiency by linking PV tariffs to specified minimum energy efficiency requirements from 1 April 2012". We are also proposing new multi-installation tariff rates for aggregated solar PV schemes, applying to new installations with an eligibility date after 1 April 2012.
Why is the government doing this?
Plain and simple, it boils down to money. The UK treasury has set a limit for the overall feed-in tariff program. Thanks to the combination of high tariff and decreasing panel prices, the up-take of solar has been phenomenal and much higher than the government expected. And hence, the FiT for solar had to be cut in order to have some money left for other technologies. The rationale for making solar tariffs subject to energy efficiency measures (e.g. wall insulation, double glazed windows) being in place is logical too: Energy efficiency measures are more cost effective measures to reduce carbon emissions.
What’s the issue?
A cut in the feed-in tariff is not contentious. We have long argued that the tariffs in the UK were too high and therefore vulnerable to sudden and harsh cuts due to political pressure (see article). However, there are three issues:
- Exposing political risk: The way in they were cut exposes a high political risk in the UK for renewables.
- Breaking promises: In June 2011, the government published their "Action Plan for Microgeneration", claiming "we want to help people who are enthusiastic to generate their own energy matched by an industry with the desire, creativity and tenacity to grow in a sustainable and responsible way". A roof-top solar system is exactly that microgeneration technology they were talking about.
- Misjudging consumer behaviour: We doubt very much that the link to energy efficiency measures will trigger investment in energy efficiency. We believe people have a deep-seated psychological preference for revenues (as generated by solar panels) over savings (as in energy efficiency measures). For that reason, as an entry-level investment in home energy, a solar system looks more attractive. Once established, the second investment may well be in a new boiler or a wall insulation, but less likely the other way round. Plus, many people can not afford both investments in energy efficiency and solar.
What’s the effect on the UK solar industry?
Some of the feed-in tariff cuts will have to be borne by module manufacturers. This is already evident in lower prices for systems. Solar will remain viable for the most sunny parts of the country if wholly financed by the homeowner. The many "free solar" offers where a third party finances the purchase will most likely disappear, because there isn’t enough tariff to pay for the financing. However, most damaging will probably be the linking to energy efficiency measures.
In the end, the fledgling UK solar industry will be smaller – there are 30,000 jobs at stake, and it will favour big players that can offer both solar and energy efficiency. Independent installers will find it very tough.
Does it matter to the wider UK renewables market?
The political risk in the UK that has been exposed by this action may well deter investors from putting money into other renewables. It will therefore no doubt increase the cost of capital for all renewable projects in the UK, ultimately making it more expensive for the UK to achieve its climate change or renewables targets.
The UK government will have to work hard to prove that it is serious about being the "greenest government ever".
A consolidation of the solar photovoltaic (pv) industry has long been predicted. However, unlike other industries like the pc industry or the telecommunications industry before, the consolidation in the pv industry appears to happen thru shutdowns and bankrupties rather than mergers. Three thin-film based U.S. module manufacturers became insolvent in 2011: Evergreen Solar, Spectra Watt and Solyndra, while Solon ceased manufacturing in Arizona. In Germany, Conergy has suspended cell production and been taken over by its creditors. In fact, the failure of Solyndra is perhaps the most spectacular venture captial- backed bankruptcy of all times with $1bn VC investment and also a $535m loan from the U.S. government. On the other hand, we haven’t seen any spectacular mergers of the likes of HP-Compaq or Vodafone-Mannesmann in other industries.
The reason for this is: There is no real driver for mergers in pv manufacturing. Firstly, mergers are very expensive and can only be justified if there are synergies. In pv, this can be difficult, as technologies of two manufacturers are likely to be so different that these synergies would be marginal. Secondly, as the demand curve for modules is so super-elastic, manufacturers need to maintain over-capacity so that they can adjust supply quickly. Hence, no mergers where value would come from the rationalisation of production facilities.
On the other hand, that massive over-capacity is creating an industry that is increasingly competing on price alone, forcing companies to shut down production that have no cost advantage.
In the end, we will see fewer technologies and a move to low-cost regions for manufacturing.
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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:
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.
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.