When we started Sol Systems around a dinner table in 2008, PV modules cost $3/watt — and even that was a recent breakthrough. Those same modules now cost 30-40 cents/watt, and they are significantly more efficient.
As we noted last year, solar energy technology continues its path to global dominance. Costs have fallen by 89 percent in the last decade, even as modules and balance-of-system technologies increase in efficiency. Solar is now the least expensive source of electricity in two-thirds of the world.
Solar pricing will further fall in the next five years as multi-busbar modules increase harvest and reliability, wafers get both thinner and larger and drive efficiency improvements, raw silicon declines in value, silver use falls by 40 percent, and manufacturing facilities become more efficient. The U.S. and global solar markets will continue to scale.
Solar was on track to account for around 40 percent of all new generating capacity in the United States in 2019. Solar and wind will provide around half of the world's electricity by 2050, according to Bloomberg's New Energy Outlook. Couple these changes with an electric car fleet that is 30 times larger than it is today, using around 10 percent of the world’s electricity, and a very interesting picture of the future emerges. The times, they are a-changing.
These changes are dramatic, and they are impactful for our industry. Their impact is at the heart of why so many of us got into this business to begin with, and we all have much to be proud of. But good changes can be challenging too. Running a solar company has always been a bit like competing in the World Series on a shifting field a la the ‘89 Giants.
This article (hopefully) provides some insight to help in navigating those challenges.
A recent flurry of M&A (and more to come)
2019 served up a super-sized array of mergers and acquisitions as the solar industry looks increasingly like the more-consolidated wind industry.
Recent examples include Canada Pension Plan Investment Board’s acquisition of Pattern Energy, BlackRock’s majority investment in GE’s renewable energy platform, Ares Management Corporation’s majority investment in Heelstone Energy, TerraForm Power/Brookfield’s acquisition of the Washington Gas/AltaGas portfolio (platform), and Green Investment Group’s acquisition of Tradewind Energy's solar and storage unit.
The M&A drumbeat will continue in 2020. Institutional investors including pension, insurance and infrastructure funds will increasingly invest in renewable energy development platforms (not just projects). They will make these investments because the infrastructure market is getting more crowded and competitive, and project returns are historically thin (generally hovering at 6 to 6.5 percent unlevered after-tax internal rate of return, with some merchant tail risk thrown in for good measure).
These institutional investors don’t necessarily want to run a development company; they want a project pipeline and potentially a partner to help them. The more creative buyers can structure their platform investments or acquisitions to mimic a pipeline acquisition.
Investor demand for yield is also forcing developers to get more creative in how they structure projects. An estimated 20 percent of all new utility builds in the U.S. will be offsite power-purchase agreements. The traditional contract for differences is a financial swap that avoids some of the complexity of physically delivering electricity to customers. It’s rather elegant in design — but sometimes less elegant in practice. Locational and temporal basis risk mean that customers or project owners (and sometimes both) aren’t swapping electricity at the same price or buying electricity at a price that corresponds with what they contracted for.
As a result, some customers are asking for a firmed and/or shaped product that matches some or part of their load; sometimes they are requesting that developers combine solar projects with batteries or other technologies and market the ancillary services and capacity associated with production and storage. For example, a customer may request physical delivery of a firm on-peak block of 200 megawatts to be delivered at a Dominion hub starting in January 2021 for a 12-year PPA. The customer may even want to swap the RECs and have no interest in the capacity, which means the owner needs to manage this asset.
A solar developer that wants to meet that demand may need a license to market electricity, additional thermal generation to firm and shape the block it is delivering, an environmental commodity team that can manage SREC and REC exposure, and an active electricity trading team that can hedge, block and deliver into PJM. Or they need a partner.
The importance of local developers
While the industry is both scaling and consolidating, skilled regional developers will continue to play a critical role in creating value in 2020 and beyond. As they should.
Institutional-backed development platforms that scale will rely upon these more regional developers to aggregate pipeline and achieve scale. Large institutional funds take razor-thin economics and are incentivized (or required) to deploy capital in hundred-million-dollar chunks.
That may be a perverse incentive, but it is a real one. One primary value differentiator for smaller developers is their deep understanding of local political conditions, sensitivities and knowledge around land acquisition and land use, and a connection to local communities and customers. There are therefore tremendous opportunities to create value on the ground with market-specific strategies for highly focused developers.
This changing landscape does require significant discipline and planning. Last year we urged caution around "packing peanuts" and filling pipelines with non-tenable assets. We reiterate that caution here. Because many markets are saturated with projects, creating differentiated value is mission-critical. It is imperative that before grabbing a bourbon at the local well with a prospective landowner, a development team first evaluates congestion risk and locational marginal pricing and monitors the queue to understand where other projects are coming online.
It is also imperative that developers are mindful of historical land use and work closely with communities. As solar scales, the relative attractiveness of another 20-, 50- or 100-megawatt project in a nearby field goes down for many communities. Coordination with environmental nonprofits and community interests is of vital importance.
No two markets are the same
All of these moving pieces are specific to one geography. Although scaling from a regional developer to a national development platform and fully integrating both appeal to our innate sense of purpose and mission, it’s a path fraught with challenges. That’s a lesson many have learned the hard way (we certainly have).
As developers move from one market to another, they must adjust to different incentives, different timelines and very different regulatory regimes. These new markets mean significant changes to individual project and portfolio development timelines. These changes can also magnify risk implicit in one asset across a dozen assets, fundamentally altering the risk-adjusted return for a developer and its capital sources. In a simple example, a financial model for development applied in the Massachusetts SMART program does not translate into Maine given the vast differences in interconnection processes, and vice versa.
New markets also often mean different customers, which means different sales strategies, which means fundamental corporate organizational changes and maybe even new corporate funding sources. Community solar in Minnesota is not community solar in Maryland. Engineering, procurement and construction in the Southeast is not EPC in the Northeast. Operations and maintenance in the Southwest is not O&M in the Midwest. We all endeavor to grow, but we urge you to harness your ambition incrementally — don’t let it harness you.
The same is true for vertical integration. Almost every large developer has gone through one or more gyrations of vertical integration and then specialization, either to capture margin or because it was concerned about relying on third parties (or both). Recently, many developers that made large investments in building out construction teams are paring down those teams, or in some cases splitting them into two different businesses and forcing them to compete on market terms.
Similarly, module companies that were focused on both production and development/construction are changing their strategies as they realize that they don’t need to develop proprietary pipeline in order to maintain market share. In 2019, First Solar downsized its EPC and development efforts. Meanwhile, SunPower split its company in two so that its module business (now Maxeon) could focus on module production and its development business (which maintains the brand) can focus on customers.
Instead of attempting to vertically integrate, developers can use their resources to identify new markets or market niches and create value within these markets. Developers can actually build new markets (like Maine, Virginia or Pennsylvania) through policy intervention. And developers can build stronger and more integrated relationships with key customers and narrow their focus on where they maximize risk-adjusted value for their balance sheet and capital partners.
So… where and how to play?
This industry transformation means making a very purposeful decision about where to play in the development, aggregation and ownership cycle. The earlier in the market and the development cycle and the more localized the effort, and the greater the advantage of a local or regional player.
A localized presence is a differentiator when speaking to a city council. This development strategy may lend itself to an early-stage “flip” model in which developers focus on getting the project papered with a lease option, feasibility studies and maybe an interconnection study. Focus local, create a solid team, build a reputation, then sell your assets to a developer partner or long-term owner you can trust. Then scale responsibly. Some of the most successful developers in the country do this, and if done correctly, it’s highly capital-efficient.
For those developers that are aiming to commercialize their assets by securing a PPA, there are not only the longstanding financial barriers of development spend between initial development and securing offtake (take those seriously); there is an additional challenge of creating and shaping the financial and energy product customers are demanding for offsite projects. Generally speaking, most successful developers in this market segment have partnered with private equity firms or long-term buyers to help capitalize on this effort.
For those developers or funds that are aiming to own semi-merchant, community solar, contracts for differences, physically hedged or other complex assets over the long term, there are perhaps even more challenges. Evaluating and managing long-term environmental commodity and electricity risk requires a significant investment and deep knowledge of policy, electricity demand, technical trading and fundamental trading. Consider what these assets look like post-PPA as you strive to create value.
In short, there are multiple areas to create value in the solar industry in 2020. A thoughtful and strategic approach is mission-critical for all of us.
Yuri Horwitz is CEO at Sol Systems, a national solar finance and development company.