Italy is the new Spain in terms of solar power development. Under a 2007 decree, the Italian government set attractive 20-year tariffs for photovoltaic solar projects, which fall by 2% per year from 2008 to 2010. The tariff in 2009 is set at around Eu350/MWh ($523/MWh) for large ground-based systems, which are favoured in the sunnier southern areas of Italy.

When 1,200MW of solar power is built, expected next year, the tariff will apply for projects brought online during a period of 14 months following this point. But the market now expects the government to introduce lower tariffs for 2011-2012, following a trend in Europe of reducing state subsidies for solar power as component prices fall and units become more efficient.

Since large solar projects under development could see start-up dates slipping into 2011, financiers are eager to know the extent of the drop in tariffs. There is some scepticism as to whether the government will publish the new tariffs this year, but one source close to the matter says a draft decree is already on the table, and a decision is to be made in 2009.

Government ministries have differing views on how much the tariff should fall. One view is that the solar industry should be heavily subsidised to boost employment in the sector, whilst another is that the tariffs should fairly reflect the large falls in cost seen in the last two years.

Some industry sources claim a drop of around 30% would be in line with the lowering in PV plant costs. But a 30% cut in PV tariffs in Spain last year had an unforeseen effect on the market – the booming PV development sector stalled and when asset prices dropped following the downturn, activity in the secondary market for solar projects jumped.

Attention in the Spanish market ha now veered towards solar thermal plants. Thermal project developers were given more regulatory certainty on November 13 when the Spanish government reportedly authorised some 2.4GW of solar thermal projects, to be commissioned in separate stages over the next three years.

When Spain made its tariff change, the solar market was more developed than Italy's, which could influence the extent to which the Italian government intervenes on prices. "The common understanding is that the reduction could be in the range of 15-20% for plants with capacity higher than 1MW" says Calyon's Sergio Alcini, head of Calyon's project finance in Italy.

"The current cost of PV equipment justifies a material cut in the Italian tariff: the proof is that projects are still being built in Spain under the new, lower incentive system. An excessively high tariff in Italy is likely to result in distortions such as speculative markets for licenses (or pseudo-licenses), abnormally high development premia and above market profits for manufacturers," adds Luigi Pettinicchio, Associate at HG Capital.

The sluggish permitting process in Italy must also be factored into cost estimates, says Calyon's Alcini. "The development costs are quite high in Italy because the lead time to get authorisations is quite long ... the lower costs of the plant (materials) may be partially offset by the development costs."

Italy's permitting process can drag on project schedules, and lenders nearly always want all authorisations in place before any financial closure takes place. The country's regional governments have the power to create new regulation, and there have been moves to streamline the authorisation process, but this regionality has caused further complication for investors.

The regions of Lazio, Puglia, and Sicily are the most active areas for solar projects, but there remains many administrative hurdles to overcome, partly due to an earlier inundation of low quality or badly structured projects clouding the authorisations process, participants say.

Following national legislation in December 2008, a project must be connected to the grid within 20 working days of its completion, and this has appeased some concerns over grid connection speeds.

But for projects potentially starting up towards the end of 2010, there is no legislation that ensures compensation if the grid operator cannot handle the volume of connections needed at the end of 2010 and start up slips into the following year. It is a 'grey area' that will undoubtedly be a money-spinner for legal counsel in 2011.

Supply cost slump

Prices of solar components have slumped in the last two years, on the back of recession-hit demand combined with an upturn in product flow from Europe and Asia. According to some estimates, supply costs may have fallen by around 40% from their peak.

The bruised banking interest in project finance has also seen lenders and developers seeking higher quality product, which has held back sales of less established components. In the current risk-sensitive environment, projects are keen to buy modules from suppliers with high levels of output as well as quality, says Sean Murphy, Chief Technology Strategist at developer Sunray.

"There are literally dozens of module producers with targets, and capacity already in place, to produce at least 500MW per year, and the new credibility threshold looks to be moving to 1GW per year," he says. "There are lots of existing players looking to expand and new players looking to enter this market. The available supply is still rising sharply," Murphy adds.

Asian suppliers have been offering modules at lower prices than some European counterparts and some Asian firms are responding to higher quality requirements of developers.

The quality and warranties of products from relatively new suppliers from the East must be heavily scrutinised, but their appearance in the market has caused a reaction from their European competitors, and put downward pressure on component prices, sources say.

The warranties offered for Asian product can be a sticking point, as the quality of the warranty drafting by Asian suppliers can be out of line with European expectations, and there is also some caution over the perceived longevity of the legal entities behind the documents, says John Dunlop, head of the London Energy Team at HSH Nordbank. "The enforceability of the guarantees is uncertain," he adds. Looking forward, pricing competition could see some suppliers fall out of the market. Sunray's Sean Murphy says he expects component prices to continue to fall in 2010, if perhaps at a slower rate.

"There is at least 100% spare capacity – the module companies could collectively manufacture twice as much volume as they did last year. When you also throw in some new entrants just beginning to come into this market with highly efficient modern plants, oversupply is going to remain for all of 2010, and probably much of 2011," Murphy says.

Debt pricing and tariffs

Debt pricing for solar projects has stabilised in recent months, and lending starts at upwards of 250bp above base rate. Base rates remain low as economies recover, and there is little expectations of much movement on solar debt pricing this winter.

"I would say that the over the last two to three months it has broadly stabilised in that 250bps to 300bps range," says Tim Corfield, Head of Project Finance at Sunray.

"We may see a slight compression in spreads, I'm talking maybe five or 10 basis points ... what I am seeing is more banks coming back to the table which will ultimately create competition and spreads will react to this," Corfield adds.

HSH Nordbank's John Dunlop says there is a lot of credit rationing occurring and that is reflected in the pricing. "We're still seeing general market pricing at 280-300 bps, with lower and higher margins depending on geography. Pricing is becoming fragmented across Europe," Dunlop adds.

Corfield also sees growth in lease financing and capital market financing on solar projects and this could lead to more "risk based" debt pricing, rather than the current levels steered by banking market liquidity. Smaller projects costing less than Eu20 million might achieve lease financing and those above Eu100 million could be financed through capital markets, Corfield says. "From a borrower's point of view that should naturally lead to a reaction from the banking market, and hopefully we will see some price compression, though at the moment banks are very much sticking to their pricing."

Sunray is planning solar plants of 9MW and 53MW adjacent to its 24MW Montalto di Castro project in Italy, currently under construction. The developer is looking at capital and banking market options for the new plants and intends to start construction on the new projects later this year.

Sunray aims to have its new Montalto di Castro plants online well before January 2011, when Italian tariffs are expected to fall.

The expected Italian tariff change in 2011 means that participants negotiating terms on the larger, lengthier solar projects are targeting start-up dates several months before the end of 2010, in case there are any delays in the construction phase.
Project parties do not want to get caught out by a sluggish grid connection process late next year if there is a flurry of projects jockeying for a 2010 start-up. And lenders are not comfortable with start dates after October 2010, with some requiring a commissioning date before the autumn to be comfortable with the project.

The risk of tariff-slip is carefully built into project structures, and some players are learning from their experience in Spain's solar rush. "Clearly the vast majority of the delay risk will fall on the contractor, and it would need to cover that in liquidated damages," says Sunray's Corfield.

The developer is looking at using an "early start" mechanism with its contractor for the expansion at Montalto di Castro, as it is in both the developer's and contractors' interest to be online well before 2011, Corfield adds.

Other measures to mitigate the tariff-slip might include a corporate guarantee to cover sponsor liability, and some lenders require contingent equity to cover overruns. Risk of construction delays through force majeure scenarios, like several months of rain, may be mitigated by insurance cover.

France and Greece next?

The PV markets of Greece and France are potential growth areas to follow the burst of Italian activity. Spain's tariff reduction means a more steady flow of PV projects is expected there after the boom period in 2007-2008.

The Greek government has set a target of 700MW of PV capacity by 2020, and whilst a PV tariff of over Eu400/MWh for 20 years may look attractive on paper, the long drawn-out permitting process in Greece is holding back growth. Many developers are waiting 18 months or more to get permits authorised, whereas in Germany, for example, it can take two or three months.

However, the sector has started to show signs of growth this year, and installed PV capacity has reportedly doubled from 14MW in January to 30MW in July. Greece's new Socialist government is to reveal in November a new set of incentives and improve permitting procedures for solar and wind energy projects, as it pushes towards more ambitious green targets.

There is also new legislation expected in France. The government has proposed new PV tariffs from January 2010, which would offer a higher rate for plants in areas of the country with less sun intensity.

The French state already offers tariffs for wind farms which vary with wind intensity, but the variable tariff for solar would be the first of its kind for the sector, and likely boost the amount of applications in France's solar market.

French power grid operator RTE announced in July that installed PV capacity should reach 1,400MW by 2015, in line with the French government's aims of 5,400MW by 2020. Towards the start of 2010, installed capacity is 175MW.

Up until now, France's flat rate tariff has meant that only a small area has looked attractive for solar projects, says Sunray's Murphy. "At current prices, you would say most of the south of Italy looks attractive, but only the south-east corner of France looks attractive. You end up getting pushed into a quarter of the country."