The cost of solar energy is plummeting at blistering speeds, making the technology increasingly affordable and popular. A record 98 gigawatts (GW) of new solar capacity was installed globally last year alone, according to the United Nations. “Solar power also attracted far more investment than any other technology, at USD 160.8 billion, up 18 %,” according to the UN.
Governments, bank and many global corporations are putting significant funds toward solar energy, but how secure is banking on the sun for the average investor?The answer depends on the kind of purchase you want to make, because there are many ways to get involved in the industry. You could buy shares in solar panel or battery manufacturers or even lithium mining companies that deliver the material needed for energy storage. You could also purchase green bonds or buy into funds and ETFs that invest in solar projects.
If you are really motivated and have the required startup capital, you could even launch your own small-scale solar farm and sell electricity into the grid or to a local company. So there are many different options and your returns, and risks, depend on what you choose. Some of these investments are highly dependent on external factors, for example, like international competition and government policy. Solar panel manufacturers are exposed to a highly competitive environment where technological advances lead to ever-cheaper products.
Meanwhile an operating solar farm pretty much just sits there and sells the power it produces for the next few decades, so these two investments are very different. But of course, even solar farms can make a loss.To understand what goes into assessing the quality of a solar farm investment, let’s look at some of the key factors that go into projecting future returns.
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As with any company you would consider buying a stake in, you want to know whether you’ll likely make or lose cash, right? It’s no different with a solar farm.
One man who looks very closely at the viability of projects is Transcendence Network Chief Investment Officer Kevin Chen. Mr Chen joined Transcendence from Macquarie Group, where he worked within the investment banking arm.
According to him, the three most important aspects when evaluating a solar project are the market price forecast, the market loss factor and the cost of capital, meaning your funding costs.
The market price forecast indicates the cost of electricity over the next two or three decades, and thereby how much income you will generate.“The standard operating life of a solar project is now extending from anywhere between 25 years to 35 years. The market benchmark is probably hovering around 30 years at the moment,” Mr Chen says.
The problem is that with costs falling as quickly as they are, forecasting the price of electricity for 30 years can be a little tricky. In its New Energy Outlook 2018 report, Bloomberg New Energy Finance forecasts a 71 % reduction in the cost of an average PV plant by 2050. “Wind and solar are set to surge to almost “50 by 50” – 50% of world generation by 2050 – on the back of precipitous reductions in cost, and the advent of cheaper and cheaper batteries that will enable electricity to be stored and discharged to meet shifts in demand and supply,” the report says.
“In scenarios with as much as 44% VRE (post-curtailment), average annual hourly wholesale energy prices decrease by USD 5 to USD 16/ megawatt hour (MWh),” the study states. This makes it difficult to gauge a solar plant’s income 20 years down the track. So if you are building a solar project, the best way to know exactly what you’ll be getting for your electricity is through a solar power purchase agreement (PPA), where a party agrees to buy your electricity at a certain price for the next decade or two.
On the other hand, if you are a power purchaser and you are aware of how quickly the cost of solar is falling, why would you want to lock yourself into a contract for 20 years? If prices keep declining significantly, you might be stuck with a higher charges compared to the contract you could have signed just a couple of years later.
Mr Chen from Transcendence says that some of these decisions are policy driven. For example, when state governments commit to a renewable energy target, they are keen to sign long-term contracts to demonstrate that they are on track to reach their goal. The same is true for companies or institutions like universities that have committed to reducing carbon emissions. Signing PPAs can be good PR. The University of New South Wales, for instance, put out a press release in January 2018, saying it is the world’s first university to sign an agreement that will see all of its energy requirements met by photovoltaic solar.
That sounds a lot better than announcing that you’ve signed a one-year contract, because who knows what happens after that. So despite falling power prices, PPAs are still a popular way to secure long-term electricity supply.
The future price of electricity is not all that matters when assessing a solar project, though. Power cables have a certain amount of resistance and that means that not all of the electricity produced arrives at the destination.“The losses are equivalent to approximately 10% of the total electricity transported between power stations and market customers,” according to the Australian Energy Market Operator (AEMO).
However, this percentage is not static. The longer the electricity has to travel, the higher the loss. Earlier in 2018, the AEMO changed its calculations and lifted the loss factor for plants that are further away from power hubs, such as those in western New South Wales or Northern Queensland.
“Many projects have suffered cuts of between 10 and 22 %,” an article in Renew Economy said about the AEMO’s changes. Taking a 22 % cut in forecast income is fairly hefty and can change how viable a solar farm is. That is why the market loss factor is so important.
The third important aspect when evaluating a solar farm is the cost of capital. For large projects in the hundreds of millions of dollars, developers need to borrow funds, and the higher the interest rate, the lower the profit margin. If you have ever bought a property, you know from experience that your lender’s interest rate can make a big difference in how much money you have left for other things in your life.
The three ways of accessing traditional capital are senior debt financing, subordinated debt financing, and the project owner’s equity contribution. Senior debt has priority over other forms of debt. That means that if the borrower goes broke, senior debt creditors have to be repaid before everyone else. This lowers the risk for the lender and typically makes senior debt the cheapest form of capital.
“Usually in the solar space, depending on your final contractual arrangement, you should be able to get AUD 6 to AUD 8 out of every AUD 10 to be funded by a senior lender or a group of senior lenders,” says Mr Chen. To access this kind of funding, your numbers have to stack up. Providers of senior debt tend to be major banks that require a lot of security.
Remember how we talked about PPAs and the security they provide in terms of income? Banks will not lend you money if you don’t have a PPA. On the open market, electricity prices can fluctuate heavily, and banks don’t like that kind of uncertainty.“Some hours could be extremely high and some hours could be extremely low, and when you are exposed to that level of volatility, the revenue you can expect to make over a 30-year period becomes highly uncertain,” explains Mr Chen.
Let’s assume you numbers convinced senior lenders and have your senior debt locked in. Now you need to either come up with the entire remainder of the capital yourself, or find another entity that wants to invest in your project. No bank will fund your entire solar farm, because lenders want to see you taking sufficient risk in your own endeavour. If you aren’t willing to invest, why should they? Depending on the size of the overall project, that remaining amount to be financed may still be quite a lot of money though. Maoneng Group’s 255-megawatt (MW) Sunraysia project, for instance, cost around AUD 275 million.
Here is where mezzanine investors come in. Capital from such investors is called subordinated debt. Subordinated debt means that if a borrower runs into trouble, lenders only get paid back after the senior debt has been settled. If no money is left by that stage, they receive nothing. Therefore such lenders run a higher risk. While mezzanine investors tend to be more flexible than banks, they also charge a higher percentage to make up for the risk they take.
What’s important to remember is that your financing terms can make or break your project. “The cost of capital, depending on how cheap or expensive it is, can fundamentally drive the value of the project, in term of how much money you will make, or whether you even make money after accounting for the development and construction cost of the project,” says Mr Chen from Transcendence.
If you’ve ever read through analyst notes about solar stocks, you might be excused for thinking that investing your hard-earned cash in this technology is a bit of a gamble. The CNBC’s Mitch Goldberg even compared it to buying bitcoin, because of the extreme volatility of some solar stocks. He attributes this to the following factors:
“Competition from China, where the government has heavily subsidized renewable manufacturers; uncertainty over government subsidies in many nations; and a lot of attention from hedge-fund shorts.”
Take US photovoltaic manufacturer and PV power plant provider First Solar, for example. Its share price jumped to nearly USD 78 in late April, only to dwindle to around USD 37 in October. These changes were largely driven by external factors. Earlier this year, US President Trump introduced a 30 % tariff on some imported solar equipment. Luckily for First Solar, its cadmium-telluride solar technology was excluded from the tariff, which gave it a big advantage over competitors.
As financial information provider MarketWatch reported, First Solar’s share price jumped 8 % when news of Trump’s tariff plans spread. But just a few months later, China suddenly decided to slash solar power incentives in the giant country, resulting in lower demand.“That drop in demand is resulting in falling prices for commodity solar panels, which First Solar's panels compete directly against,” notes Travis Holum from US financial services provide The Motely Fool.
“If we don't see a big increase in demand and prices for commodity solar panels in the next few quarters, First Solar could face some serious pressure on margins and profitability,” Mr Holum adds. “Unfortunately, falling margins and profitability will probably be a common story in solar over the next year.”
All this has little to do with First Solar’s operations, and is all about factors it cannot control. And the US company isn’t the only panel manufacturer who is struggling with policy changes. SolarWorld, for example, filed for insolvency not once, but twice. After being saved by an investor in 2017, the German solar panel manufacturer went bankrupt for the second time in March this year, citing competition from China, as well as EU plans to phase out protective measures against cheaper imports.
However, there are many ways to invest in solar and not all of them are as reliant on external factors.
Transcendence Chief Marketing Officer Milton Zhou says there are several reasons why solar farms are a more stable investment than solar panel manufacturers. With a solar project that does not sell electricity on the open market,
- a PPA is in place, guaranteeing secure returns for one, two or even three decades,
- providers of senior debt, usually major banks, require thorough vetting of a project’s profitability before committing their money to it, and
- solar plants have insurance in place that covers the rebuilding of the plant and loss of income in case of a natural disaster, like a cyclone.
One example of a fund that invests in solar farms is Australian-based New Energy Solar, which acquires and manages solar farms in Australia and the US. According to the Australian stock exchange, the ASX, the fund’s 52-week high was AUD 1.65 while the low sat at AUD 1.35 as of 14 November 2018. That’s still an 18 % drop from the top, but not as crazy as the rollercoaster First Solar’s share price has been through.
Also, New Energy Solar only launched last year and volatility has mellowed after some initial upheaval. The company has been paying a bi-annual dividend, with the most recent one yielding over 5 % if you take the share price at around the record date in June 2018.
Other forms of comparatively secure solar investments are bonds. Utility company Duke Energy Carolinas in the US recently issued USD 1 billion in green bonds that focus on solar and energy storage facilities, and have a weighted average coupon of 3.74%.Major Swiss bank UBS is also launching a green bond that finances the construction and operation of US solar projects.
And the Australian state government of New South Wales just issued its own record AUD 1.8 billion in green bonds, with a yield of 3.235 %. So you see, not all solar investments are like buying bitcoin. You won’t see 1,000 % increases, but it is also unlikely that you end up with a fraction of what you put in. However, what you can do is use bitcoin to buy shares in solar power plants.
Buying shares, bonds or ETFs isn’t the only way to invest in solar projects. Blockchain technology is also becoming a player in the renewables industry. The Maoneng Group’s blockchain arm, the Transcendence Network (TSD), wants to facilitate investments in solar farms and other renewable energy projects through tokens, which work a bit like traditional shares.
However, these TSD tokens aren’t traded on a stock exchange but on the blockchain, and purchased with cryptocurrency. Instead of dividends, they pay bi-annual rewards in the form of non-tradable tokens, called IRF tokens, which can be redeemed for either cash or services, such as electricity. Given that TSD tokens are tradable, they will be subject to volatility. If a lot of people sell, the price will drop. At the same time though, the yield will rise.
Just think of a dividend stock. If you invest in shares that cost AUD 10 a piece and pay a dividend of AUD 0.50 per share, the yield would be 5 %. Were the share price to drop to AUD 7, new investors would now get a return of over 7 % on their investment if dividend levels remained steady. Transcendence says it is committed to maintaining its IRF payout level for decades to come.
However, the Transcendence blockchain platform is designed to be more than an investment platform. It wants to become a community hub for skills and knowledge sharing, and bring stakeholders together to develop renewable energy projects around the world. Transcendence Chief Executive Qiao Nan Han says that blockchain technology can open up renewables to a wider group of people.
“The renewable sector has predominantly been controlled by a small group of institutional investors and more recently some emerging developers,” Mr Han says, adding that this has led to lack of medium-sized projects in the solar sector. “There is a gap in the market that sits between your typical rooftop panels that are in the order of, say, 2 to 5 megawatts (MW) and a minimum utility sized power plant, which is say, for example, 20 MW or 30 MW,” says Mr Han.
“It is more beneficial for communities to develop a greater number of smaller assets in that in between range than for a handful of people to focus on larger power plants,” the Transcendence CEO adds. Local solar projects can facility jobs growth, income and cheaper electricity.
In the US, for example, the solar industry employs over a quarter of a million people, according to the Solar Foundation’s National Solar Jobs Census 2017. But in order to get involved, budding developers need access to funding, skills and knowledge in the sector, as well as PPAs. Going through all the approval procedures is complicated, and communities don’t necessarily have the required funding. The Transcendence platform wants to change that by standardising the process and matching potential developers with investors as well as providing guidance in the process.
“The platform is a market place where projects are being constantly exhibited for investment or stakeholder participation,” Qiao Nan Han says. “It will draw upon our collective experience in developing infrastructure assets to guide stakeholders into being able to determine what the risk spectrum would look like for their project offering.” Transcendence is expecting to complete the fundraising stage for the platform in the third quarter of 2019.