Solar
projects are now regular candidates for project deals, although enthusiasm for
assets varies according to the technology used. But rising interest rates could
make financing such expensive assets difficult.
Chris Gadomski reports.
One does not to have to look too far to see plenty of solar activity - mostly in Europe - but also in the sunny states of the US southwest. Undeniably, fuelling the market are the supportive policies of the several EU nations that have established favourable tariffs for solar generated power, and subsequently opportunities for high rates of return. In the US, a combination of federal production tax credits and state renewable portfolio standards (RPS) are driving the market. In California, for example, the California Public Utilities Commission has approved projects that could add between 500MW and 900MW of solar capacity to the California grid.
One marquee deal broke ground in early June. GE Energy Financial Services, together with PowerLight Corporation and Catavento, Producao de Energia Eolica Lda, an independent Portuguese renewable energy company are building a $75 million, 11MW solar photovoltaic tracking project at Serpa, Portugal. GE Energy Financial Services will own the plant, which is being operated by PowerLight, which makes the solar tracking technology that optimizes energy output and hopefully, project economics, by allowing the 52,000 photovoltaic panels to track the sun.
Alan Marsden, GE Energy Financial Services' managing director for Europe, declined to identify Serpa's anticipated rate of return. But he suggested that GE found the rate of return attractive enough to internally fund all of the $75 million to finance the project - the largest solar photovoltaic project in the world. And he added that GE is looking for other similar opportunities.
"Although we internally funded this project, we will look at each new project on a case by case basis," he said. "We are comfortable working with other banks, and in the future you will see us working with third party debt providers as well. GE Energy Financial Services structures these deals as non recourse project financings. It is possible we would provide debt to other solar developers, and in other cases, we will provide the equity."
Asked whether financing the deal 100% was an unusual move for GE Energy Financial Services, Peter Sweatman, director of client operations in Southern Europe for Climate Change Capital, a specialist merchant banking group providing financial, strategic and policy advice for clean power and technology, said no. He described the project as a landmark one for Europe and for the Portuguese government. "Because of their strategic thrust in renewables (more than $1 billion committed), I don't think it is so unusual. It should be a very good benchmark project to watch."
The key message from both Marsden and Sweatman, however, is the supportive environment the project found in Portugal. Portuguese legislation allows the developers of solar deals to receive Eu0.31 per kWh). Similar programs also exist in Spain, Germany and Italy.
"It can be a very lucrative business," says Michael Liebreich, CEO of New Energy Finance. "The incentives for developing solar in many European markets arise from the significant feed-in tariffs that solar generators can collect from utilities to which they sell electricity." Homeowners in Germany can receive nearly Eu0.45 ($0.50) for energy sold to the utility and producers are finding they too can make substantial profits off the back of these extremely high feed-in tariffs. "As long as you can lock in these tariffs, it appears it will be a viable business opportunity."
Liebreich cautions, however, that government balance sheets and eventually the ratepayer could start to buckle under the burden. "Although the solar feed-in tariff declines by 5% a year in Germany, the volume of solar panels being installed increases by 30% to 40% a year. So these subsidies may start to become an unmanageable issue - one that could last for 20 to 25 years."
According to Marsden, European Countries have established different photovoltaic tariffs. In Germany, the nominal tariff reduces every year, yet developers can now lock in a feed-in tariff of Eu0.406 per kWh for 20 years. In Portugal, developers get Eu0.3211 per kWh for 15 years. In Italy, 20-year tariffs range between Eu0.45 and Eu.0.49 per kWh, and in Spain, smaller projects under 100kW receive Eu0.44 per kWh while projects over 100kW receive Eu0.2502 per kWh.
The pricing discrepancy between the smaller and larger projects in Spain is one reason why BP Solar and Banco Santander have formed a venture to build and finance 278 plants - all sized between 90kW and 100kW. The plants will be financed with an investment of up to Eu160 million for an aggregated installed capacity ranging between 18MW and 25MW.
Private investors will own the plants through incorporated investment vehicles set up and financed by Santander. A Spanish government decree sets the rate paid for the power generated by these plants at 575% of an average reference rate, for 25 years, part of a plan to promote renewable energy generation in Spain to cover 12% of demand by 2010.
The construction of the solar plants, which will begin next May, is scheduled to be complete in December 2007. But that may be just the start. Climate Change Capital's Sweatman says that Spain is on the verge of a huge amount of activity and is looking at 400MW of new solar build by 2010 - nearly ten times the existing capacity. The more likely potential is 600MW if the tariff maximum capacity, currently set at 150MW, is increased. Not only are the feed-in rates attractive, providing a stable revenue stream, but Spain also enjoys great sunlight - 1800 to 1900 kWh per meter square per year in the South - adding to the attractiveness of the Spanish market.
GE's Marsden cautions, however, that the government appeared to be on the verge of making changes to the support network. "We are looking at a number of projects in Spain but we are also waiting to see what change, if any, comes from the government there."
Though the hours of solar radiation compare less favourably to Spain, Portugal and Italy, Germany is the site of the current largest solar station. Bavaria Solarpark is a 10MW project consisting of three solar parks - 6.3MW in Muehlhausen and 1.9MW each in Guenching and Minihof. The Eu49.5 million project was financed by the Solar Energy Fund Bavaria, a closed fund arranged by Deutsche Structured Finance (DSF).
With a legally fixed payment for the produced power guaranteed under the German Renewable Energy Law, Janine Schellhorn, chief managing director of DSF, says solar is a "highly" reliable source of power that is sustainable and environmentally friendly. "Well-structured solar energy deals offer investors a solid investment with interesting after-tax yields."
Although GE is looking at opportunities in Spain and Portugal, Marsden says the Italian market also offers a near term market of 25MW, and that there is a lot of interest across Europe.
So what are the returns?
Ralph Schneider, the business development manager, at Phönix Projekt & Service, is responsible for arranging the financing on the solar projects that the company develops. Phönix Sonnenstrom, a systems integrator serving the German and European photovoltaic sectors, recently ordered up to 265MW of thin film solar modules between 2006 to 2011. But there are also caveats - and the profitability window may close if interest rates continue to climb and German law maintains its present structure of paring the feed-in tariffs by 5% per year.
According to Schneider, who joined Phönix several months ago from Shell Solar, investors in projects in Germany typically invest in closed end funds that deliver a yield of 6.5% tax free. "Getting a tax free yield is a big benefit in Germany. Investment managers are making closer to 8-9%."
Sweatman at Climate Change Capital, who is more familiar with markets in Spain and Portugal, says a typical range of equity return for low-risk projects, such as fixed flat panel arrays, runs at around 10%. "The higher risk projects that involve a twin tracking system or other new technology can return up to 20%," he says. "There appears to be no shortage of capital."
Major Spanish banks like Santander and the Cajas are supporting individual projects both within their regions, and outside. Total investment for a 5MW facility may run to Eu25-35 million. In Germany, Schneider adds that money to fund their solar projects comes mostly from private funds raised by subsidiaries of major banks like KGAL of Dresdner Bank and Commerz Leasing of Commerzbank. Projects are typically leveraged with 70/30 debt to equity ratios or higher.
Bigger deals, but more interest rate risk
Just this past month Phönix has been commissioned to construct a 1.7MW plant for a solar fund initiated by mainfrankenSolar. Last year, the company built a 1MW green-field plant for another fund of mainfrankenSolar. The company also received an order for its first Spanish installation, a 1.4MW Eu6.7 million deal to be built for the Spanish company TSK. The German project will use thin film modules from First Solar, an American manufacturer, while the Spanish installation will use Mitsubishi equipment.
Ideally deals will grow to around 5MW in Germany, which would cost Eu20 million to provide greater economies of scale, Schneider says. That is necessary to offset the 5% annual decline in the feed-in rate tariff that developers lock in for 20 years. "We need to decrease the investment and operating cost of our projects by at least 5% to keep pace and to grow the market. This is one of the reasons that economies of scale are so important as well as adopting thin film technology."
Thin film solar modules differ from crystalline technology in that they use much less silicon as they are electrostatically deposited on metal or glass substrates. Accordingly, they lend themselves better to mass production, and are consequently less expensive. They are also, however, less efficient - 8-12% as opposed to 17-20% for poly and single silicon crystal technology, according to Climate Change Capital. As a result they produce less power given the same space and there have been concerns regarding their power output stability.
Over time, power output from thin film modules can decline before eventually stabilizing. The extent of thin film panel degradation can be a potential problem given the 20- to 25-year power generation expectation to generate revenue to pay off project debt for large scale central power generation. Schneider says thin film modules can initially degenerate by .5% annually compared to .2% to .3% for crystalline silicon. Nevertheless, Dr. Andreas Hanel, CEO of Phönix Sonnenstrom AG, "sees great potential for this technology to reach economic viability in a few years without subsidy programs" especially as regards to grid-connected large-scale power plants.
According to Manfred Kittelmann at DSF, a combination of declining feed-in tariffs and rising crystalline module costs have forced them to explore for profitable opportunities elsewhere. "Although the Bavaria Solarpark is a great investment for our clients, that approach in Germany no longer works for us. We can't compete with homeowners for crystalline panels who simply want the technology on their roofs without concern for the IRR. With no chance to get cheaper crystalline panels, we are looking to get higher feed-in tariffs elsewhere."
Accordingly, Kittelmann is pursuing opportunities in Spain where DSF is structuring an 8MW project that would be sold to investors as eighty 100kW investments. By doing so, investors can benefit from the higher Eu0.44 per kWh feed-in tariffs available for solar projects up to 100kW. Kittelmann will finance the deal with debt from German banks alongside German equity investors. "It will be a plain vanilla debt structure with 15-year debt priced over Libor. Using crystalline solar panels we are selling a low-risk investment that will provide 7-8% after tax returns."
Unlike wind, there are no moving parts in fixed panel solar arrays. So according to Sweatman, provided no one steals the panels, and they are cleaned, and the interconnect to the grid is stable, there is a low risk of mechanical failure with poly or single crystalline panels. "So the key challenge is extending the debt term to closer match the rather long expected life of the technology. Single and dual axis tracking systems, unlike fixed panel arrays, have less operating experience and lenders need to understand the O&M implications of the tracking systems and assess the risk accordingly. Despite the added output, tracking systems will push down the debt/equity ratio."
Another challenge facing the industry is rising interest rates. Current deals, say Schneider, typically carry a 4.5% to 4.6% interest rate for a 15-year term. But with the European Central Bank's 9 June announcement of higher base rates, increased pressure falls on the financing structure. "A 25bp rise could decrease a project's yield by almost 1%," he says. "A 100bp rise could decrease the yield by 3%. It is important to watch the market carefully and to examine all finance models."
Solar thermal poised to take off
Whereas solar photovoltaic technology - the direct conversion of sunlight into electricity - makes sense for smaller projects, building much larger solar power stations requires a look at solar thermal technologies. This technological approach uses mirrors to concentrate solar radiation using parabolic troughs, reflective dishes or power towers to heat/boil a working fluid to spin a turbine and generate power.
"Solar thermal power stations does open up another very interesting opportunity. The efficiency levels through thermal are more interesting than photovoltaics," says CCC's Sweatman. "So we need to watch the space. Solar thermal is largely in the pilot phase with several projects in Spain at the pilot and/or planning level, nothing yet is approaching the mainstream project financing stage."
Nevertheless, published reports indicate that there are a lot of projects in the pipeline in Spain - some estimate nearly 1,000MW - though no commercial scale concentrating solar projects are yet on line. The European Investment Bank (EIB), however, approved the Andasol-1 Central Termosolar Uno, project last September.
This 50MW parabolic trough solar thermal collector project, described by EIB as "the first large-scale commercial thermal solar power plant to be developed in Europe" has an estimated cost of Eu300 million, of which the EIB is likely to finance Eu225 million. The project, according to EIB, "will benefit from a fixed tariff for solar thermal power generation equivalent to three times the reference tariff in Spain, guaranteed for 25 years."
Another area of new announced solar thermal development is the Southern California desert. Stirling Energy Systems has been developing its Stirling solar dish technology for the last ten years. Six 25kW units are being operated and tested at Sandia National Labs and the developer says that sales of its system outside the US are likely to be concentrated in Spain, the Mediterranean region, and Australia.
Anticipated to drive sales in the US is a combination of federal production tax incentives ($0.018 per kWh) and the state renewable portfolio standards (RPS), which are already in place in nearly 20 states including Arizona, California, Nevada and Texas. In California, where 12% of the state's energy comes from renewables already, the goal for 2010 is 20%
California utilities are responding by signing power purchase agreements that will count toward their renewable portfolio standard requirements. SES has signed, for example, a 20-year power purchase agreement with Southern California Edison that was approved by the California Public Utilities Commission in October 2005. The agreement would lead to an 500MW solar project in the Mojave Desert northeast of Los Angeles, with an option to expand the project by 350MW. Another power purchase agreement was signed with San Diego Gas & Electric (SDG&E) for a 300MW facility that could be expanded to 900MW. The stated initial project online date for the Southern California Edison project is January 2009 - only 30 months away.
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