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.
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