Big changes are causing a rethink of the financials for solar projects. Debt finance has become difficult to find. Solar feed-in tariffs are stepping down to a materially new low level in the market-leading countries. However, module prices measured on a cost per MW basis are expected to drop significantly and new technologies are becoming commercially available that are superior to existing technologies in certain applications.

These new market conditions are in stark contrast to the frenzied build-out of solar projects over the past couple of years. In Spain, for example, there was a race to get projects built under the REPE Definitivo before 29 September 2008 to qualify for the high feed-in tariff. Speed of execution mattered most. Optimising project economics mattered less. Project finance was plentiful and long as project developers could procure photovoltaic modules, which became increasingly difficult, the projects were almost always profitable.

In the new lending market developers will be affected most. Unlike equity investors, who simply calculate whatever price is necessary to achieve a certain IRR, developer's margins are the balancing item between the cost of the project and the sale price of the project. Developers will need to quickly reconsider the countries they develop in, the variant of solar technology they decide to use most, and make bets on when to lock in the prices for their key components. Most importantly, they will need to maximise the chances of their projects getting project finance.

Effects of the credit crisis on Solar

Accessibility to debt finance will be the overwhelming determining factor of whether projects get built in 2009 – unlike the determinant in 2008, which was module availability. The total interest rate that projects pay will not change a great deal – margin expansion over the past year has been largely offset by contracting swap rates. However, the volume of debt finance available is down dramatically from 2008. Some estimates put the supply of renewable energy project finance at up to 40% less than last year. There will be a lot of competition among projects for a limited amount of funding. The lowest risk projects will stand out from the others when competing for funds, given the massive amount of risk aversion in the credit markets.

The world is rapidly de-leveraging. This can be seen everywhere: Companies are issuing equity to pay down debt, debt is being swapped for equity, loan-to-value ratios are compressing, over-leveraged companies are going bust, and asset values are falling. There's no reason to believe that renewable energy projects are immune to this. For example, many large solar trough projects may get shelved or have to live with low levels of gearing if bank club sizes do not reach expected levels.

Developer margins may reduce or disappear entirely if debt finance cannot be found. Debt and equity investors will differentiate more between good projects and bad projects and credit spreads will widen. Second tier and third tier projects will struggle to get funding. To ensure a project is bankable and to maintain margins, developers will need to pay more attention to the details of the projects. Developers will need to ensure that they are developing bankable projects by engaging with financiers that can advise them on what kinds of deals are being accepted by the market and which are not. Developers will substantially increase the value of their projects by arranging staple financing, i.e. arranging the project finance for their project before they sell it to private equity investors. Projects that secure debt finance will be worth substantially more than equivalent projects without debt finance.

Sunbelt countries stepping down feed-in tariffs

The Spanish market has been the price setter in the solar industry for the past couple of years. The 30% drop of the Spanish PV feed-in tariff from Eu459/MWh in 2008 to Eu320/MWh in 2009 will have an enormous impact on the pricing power of solar module suppliers. Italy and Greece have legislated similarly low levels of feed-in tariffs as the new Spanish tariff.

Lower inflation indexing and shorter duration of the new feed-in tariffs will also squeeze project economics – the inflation indexation in Spain contrasts with no indexation in Italy and the 25-year tariff life in Spain contrasts with only 20 years in Italy. Inflation indexation increases the debt capacity of these projects – we often incorporate inflation swaps into the projects we finance to guarantee inflation uplift. This is important given that Spanish inflation is forecast to be negative in 2009, i.e. the 2009 indexed Spanish feed in tariff may fall rather than rise for those projects without inflation hedges.

Anecdotal evidence suggests that the new feed-in tariffs are squeezing the economics of projects in at least one area – Spain's first convocatoria was undersubscribed for rooftop solar. Only 43MW of rooftop projects "Tipo 1.2" applied for preliminary registration for the feed-in tariff (Registro de Pre-asignación de Retributión) out of a maximum of 67MW.

The volume of build-out is shifting rapidly from Spain towards Italy. Spain's previous feed-in tariff under Real Decreto 661 has been tremendously successful and will most likely result in a final count of about 1,500MW of solar projects. However, under the new tariff, the Spanish market is capped at a much lower 560MW. The Italian market is capped at a much higher 1,200MW limit.

Will Solar module prices fall far enough?

Two factors will affect module prices in 2009 – anticipated lower production costs and unanticipated oversupply. Module prices have been long forecast to fall as new amounts of production capacity are scheduled to come online and volume-driven productivity gains move production costs down the cost curve. However, the unanticipated severity of the credit crunch will have an additional heavy effect in pushing down prices as fewer projects get financed and the module market moves into oversupply.

Some are predicting module costs to fall by one-third or more over the next year. Wholesale module prices were reportedly trading around Eu2.75/Watt in March 2008 and are now trading at around Eu2.35/Watt (March 2009). A price of Eu2.00/Watt by the end of 2009 is expected by some of our clients.

More differentiation with new technologies

A wider variety of solar technologies will be used in 2009-10 than in the past, which has been dominated by large grid-connected crystalline PV projects. Increasing site and regulatory constraints combined with commercial availability of new technologies is leading to a more differentiated approach.

The competitive advantages of the various technologies will matter much more than they have in the past. A "horses for courses" approach will become more prevalent, with the key solar performance metric differing according to the constraint. Today's solar technologies have different efficiency rates, different power to weight ratios, different cost/MW and cost/MWh ratios. Some are bankable, whilst others may need more prototyping and reference projects before they are able to achieve their optimal levels of debt finance. The benchmark will continue to be crystalline photovoltaic modules given this is where the industry has most knowledge.

Lightweight solar technologies with high power to weight ratios will be best for rooftop applications (kg/kWp). Amorphous thin film photovoltaic technology on flexible substrates (not glass) will be the likely winner over heavier crystalline PV given it is cheap and light. Nevertheless, thin film has lower efficiency rates than crystalline PV and a wider range of module quality across manufacturers, therefore good technical due diligence is important when financing thin film.

Solar technologies with high power densities (MWp/m2) will be best for projects with space constraints. Crystalline silicon modules will be the winners using this metric given they tend to have module efficiencies of around 13% compared to 7-8% for thin film. Crystalline silicon will most likely continue to be paired with trackers given trackers generally boost the annual production by about 30% and the cost of trackers remains below the cost of an additional 30% of crystalline modules.

Low cost, scalable technologies that result in low levelised costs (cost/MWh) will be important for utilities that have large MW volume requirements to satisfy renewable portfolio standards at the lowest cost possible. Thin film technologies using glass substrates including amorphous silicon, Cadmium Telluride and CIGS (Copper Indium Gallium Selenide) are the price leaders for relatively small projects. However, solar thermal technologies such as solar troughs and power towers are the likely winners of "utility scale" requirements that can be easily paired with storage. These technologies are able to achieve economies of scale and drive higher efficiencies rather than a modular approach that achieves no economies of scale other than purchasing power. At a 50MW scale, solar troughs are much cheaper than solar-photovoltaic technologies.

Storage technologies such as molten salt and high pressure steam can drive significant improvements in the levelised costs of solar thermal technologies. The plants can operate for up to 24 hours per day instead of only when the sun shines. The plants can also operate at higher load factors given that the solar energy can be spread out over a 24-hour period and fewer MW of steam turbine capacity is required. This plant can also shift more electricity production to higher-priced peak periods, resulting in better economics for the project given revenues per MWh can be improved.

The race for feed-in tariff eligibility

Most solar support legislation is poorly drafted and incomplete – ambiguity and unanswered questions are common. This leads to job security for expensive lawyers but economic insecurity for projects. For example, in Spain and Italy developers are faced with a situation where the expiration date for qualifying for the feed-in tariff depends on when a certain total capacity of projects has been built. This implies that your competitors set the expiration date and you are in a race to beat them to that date. Failure has high penalties – most solar projects couldn't hope to survive on market prices for their electricity. Taking a decision to pour money into a capital-intensive two-year project construction programme without tariff certainty is a big gamble. Projects at the end of the queue and without a robust tariff guarantee are unlikely to get project finance.

Government risk is increasingly something to think about – can governments afford to subsidise these projects by up to eight times the electricity market price for the next 20-25 years? For example, Spain has a large government deficit and an economy in recession. Given the solar feed-in tariff is ultimately paid from the Spanish treasury, there could be pressure to find ways to reduce this cost.

Another example is Greece, which Standard and Poor's recently downgraded to A–, in contrast to the AAA rating of France and Germany. Whilst we would not expect Western governments to default on their formal payment obligations, officious government administrators may look for reasons to disqualify the projects from receiving the feed-in tariff. For example, the Comisión Nacional de Energía is investigating a large number of the PV projects in Spain that received the feed-in tariff before October 2008 to audit their feed-in tariff eligibility.

Qualification for the feed-in tariff is paramount to the value of a project. From a collateral point of view, modules are not worth much, unlike wind turbines, which tend to hold their value well. Modules suffer from moving rapidly down a cost curve. Whilst modules do not obsolesce as quickly as computers, there are new production technologies coming out every year. Furthermore, there is not much of an alternative market for solar modules. If today's government subsidies disappeared then the modules would have little value. The value is in the feed-in tariff eligibility, not in the modules

Recognise that fundamentals have changed and adapt

Solar developers are experiencing large shifts in the basic financial building blocks of their projects. First, feed-in tariffs have dropped by about one-third and the high-volume market is shifting from Spain to Italy. Second, module prices are expected to drop dramatically but may not drop far enough? Third, the range of commercially available solar technologies is expanding fast and coinciding with more constrained development parameters such as roof-top only tariffs and solar-thermal-only tariffs. Developers will have to ask themselves if they are developing the right type of solar projects that results in the best overall economics given the offered feed-in tariff versus technology costs and potential volumes.

The overwhelming shift is the reduction in availability of project finance. Project finance will dramatically affect the levels of development fees, which could potentially be wiped out if project finance cannot be found for a project. A flight to high quality deals by banks and investors means that developers should focus on high component quality and low commercial risk to get their projects financed.

Known, reputable manufacturers of key components should be used and questions asked throughout the development process: Are your EPC contractors assuming enough risk? Are you using experienced, low risk EPC contractors with relevant track records?

Developers should also be prepared to temporarily all-equity finance the project or sell it on just in case the project cannot compete with other projects for liquidity. Finally, it is crucial to begin working with the right project financiers – sector specialists that can get the project to financial close in today's tight markets, especially when you are in a race against other projects for the feed-in tariff.

John Dunlop heads up the London Energy Team at HSH Nordbank AG, which advises, arranges and underwrites finance for wind and solar projects across Europe. The opinions expressed in this article are those of its author and may differ from those of HSH Nordbank.
Contact: John.Dunlop@hsh-nordbank.co.uk