According to Davis at Infra-Energy, investors are “going to be lucky if they get their capital back in the contract period,” and will most likely be relying on the post-contract period for returns.

WoodMac’s Honeyman said residual value used to be “the gravy” on top of existing returns. It’s now being treated as a primary revenue stream.

Davis said investors are “pricing operating assets to perfection” to make sure projects pencil out economically.

“Everything has got to line up in order to achieve…somewhat modest returns, which doesn’t give you a lot of room for problems,” he said.

And the market, which is still maturing, is likely to change in the next two decades.

“Personally, I think these assumptions that are being made are far more aggressive than what the investors think they are getting from a risk standpoint,” Davis added.

Today’s gambles

Project finance experts say the market dynamics have pushed project sponsors to bank on returns that may be overly reliant on forward electricity price curves which may not come to pass.

Katherine Ryzhaya, chief commercial officer at solar developer Lightsource BP, said that, because merchant prices may not meet expectations, her team is more careful in dealing with projects that may rely on residual value.

She said Lightsource has continued to focus on 20- and 25-year deals. “That’s still our view that those are the better deals, rather than putting all our chips in the merchant market.”

“Our general market view is that the merchant curves are aggressive,” she added. “Do we [cut] merchant exposure here for our internal models? Yes, we do. And we’ll give a more substantive [cut] to projects that have longer merchant exposure.”

Several firms create the electricity price forecasts that developers and investors use, including Wood Mackenzie (the parent company of Greentech Media). WoodMac’s current model shows prices remaining mostly flat through the 2020s; the firm projects price growth in the 2030s.

But Robert Whaley, a principal analyst in North American power and renewables for WoodMac, said those curves rely on the assumption of a carbon price starting in the late 2020s. That, along with WoodMac’s gas price assumption, is the most significant variable in its pricing model. But if Congress doesn’t pass a carbon price in the next decade — and tangible federal momentum is currently severely lacking — Whaley said prices over the next 20 years remain “much flatter.”

Because of those variables, Whaley said the firm provides several high and low cases, with a price spread.

“It’s quite wide, looking at all the variables. That’s why we try to provide sensitivities so people can get a sense of how volatile these forward projections are,” he said. “The model itself is based in reality as much as we can make it.”

But Whaley also noted that developers seem so eager to get into the market before the projected price growth kicks off that they may be willing to take a loss on near-term contracts to crowd out the competition.

“They’re making some gambles today off of project price growth in the future,” he said. “Obviously, it’s risky, because of all the variables we talked about.”

Though Whaley presented the price curves as a range that’s subject to change, many said the sponsors that use the price projections are relying on growth.

“The market is behaving as if that’s gospel truth,” said Matsui at kWh Analytics.

The fallout

When working in tandem, the themes now shaping the market have created challenges and uncertainty for utility-scale solar. But Davis suggests any potential “bubble” may just be par for the course.

“Potentially, there is a bubble, and you can say that about many markets over time,” he said. “If you look at the renewables sector, you’ve had…a favorable regulatory environment in terms of incentives. You’ve had a declining cost curve that has been supportive of continued penetration in the markets. You’re starting to see a little bit of an evolution toward becoming more merchant-like.”

Some view the current environment as more of a maturation of the industry than an atmosphere of pressure that could lead to a burst bubble. But however one characterizes the current environment, several in the industry say growing pains are coming.

“I would expect, somewhere along the line, some fallout in the industry,” said Davis. “It’s just like an engine: It can’t run-red hot forever.”

Looking ahead, Davis said industry players “need to instill some discipline back into the market.”

Ryzhaya at Lightsource agreed that the market will need to find a way to modulate. She said it needs a strong market signal from investors that the lower cost of capital will also go to longer PPAs. At the same time, she said it’s up to the entire industry to innovate for a new array of counterparties and to get comfortable with the current risk profile for projects.

“It seems that, hopefully, it is a temporary phenomenon, but it also seems like developers whose business model it is to sell into the froth are doing that at extraordinary levels,” said Ryzhaya. “Developers and long-term capital providers need to find a balance between shorter-term contracts and merchant exposure.”

Archer at Macquarie said that in the long-term, the conditions don’t necessarily equate to a threat to the industry, but they do mean change.

“It’s like anything: It’ll take some kind of shock to sort it out,” he said. “There was a bubble in U.S. housing in 2004. It took until 2008 for it to actually burst.”

Source: greentechmedia