Solar Investing: Where Politics & Finance Come Together
Most solar sector watchers will remember the second half of May 2008, when the solar world collective held its breath awaiting to find out what German policy-makers were going to decide about solar subsidies in that country. All this commotion was caused by the fact that Germany, despite lacking favorable physical conditions in the form of ample sunshine, had become the world's largest solar market on the back of a very aggressive incentive program. Germany alone is in fact so critical to sales growth in the solar sector that the mere announcement of a review of the subsidy caused solar stocks to fall and analysts to issue rating cuts. In the end, German politicians decided to take it easy on subsidy cutting, to the delight of investors.
This episode brought home the fact that, while debates among pundits about when solar will reach grid parity are often very informative, this very much remains a sector that survives - and even thrives - on government support. Even when solar does reach grid parity in jurisdictions where electricity prices are elevated, large-scale deployment must still be supported by some form of state policy (e.g. net metering, transmission facilitation, coordination with dispachable supply, etc.)
The Policy Dimension: Key to Understanding Risk
Having a thorough understanding of the policy dimension for solar investors can therefore be very useful in assessing market potential, as none of the much-touted potential of this sector will occur without government intervention over least the next five years. More importantly, however, understanding the political and policy-making processes can be key to managing risk.
One good example of policy-induced volatility is the infamous US Production Tax Credit (PTC) for renewable power. The volatile "on again-off again" nature of this policy, and the fact that the situation was allowed to endure for years, is the principal reason why a healthy wind turbine manufacturing sector never emerged in the US as it did in Europe.
The Ontario Example
Besides Germany, the most recent embodiment of this risk is the province of Ontario, one of North America's largest electricity markets with an output of around 140 TWh in 2007. In November 2006, the province unveiled its Standard Offer Program (SOP), a feed-in tariff offering C$0.42/kWh ($0.41/kWh) for solar, and C$0.11/kWh ($0.108/kWh) for wind, biomass and hydro. With such as generous subsidy, the reaction to the announcement was almost immediate with a number of commercial solar developers rushing in to Ontario. Although the program's rules limited individual project sizes to 10MW, developers found a way around this by submitting several adjacent 10MW projects as different bids.
But there was a rub. Buried somewhere on some website is a document called the Integrated Power System Plan (IPSP), which lays out the province's target long-term electricity supply mix. Reading through this document, one finds out that policy-makers only ever expected there to be about 88MW of solar feeding into the Ontario grid, with another roughly 130MW as distributed generation to offset peak demand. Moreover, provincial officials expected that 218 MW target to be realized over a period of 10 years. Contracts for large-scale (ie. >10MW) renewable generation were to be awarded through a different competitive bidding process favoring wind over solar.
One and 1/2 year into the program, there were already 420MW of solar contracts awarded. Between January, 2007, when the first contracts at C$0.42/kWh were handed out, and the end of April, 2008, committed solar capacity in Ontario grew at a compound monthly growth rate of around 45%. Moreover, while the Standard Offer Program was initially intended to foster small, community-based projects, commercial developers ended up owning the vast majority of committed MWs, seizing all available transmission capacity in the process.
On May 13, 2008, the province abruptly put an end to the program in its current form (PDF document), citing transmission bottlenecks in certain areas (wind also grew very rapidly under the SOP, adding to the problem). Things are currently under review, but from the look of it it seems as though loopholes will be closed so that commercial solar developers and large projects are completely excluded. Needless to say, this will slow down installations dramatically.
Besides transmission problems, it's probably logical to speculate that cost was becoming an issue. The weighted average cost of the power contracted under the SOP (weighted by installed capacity and not production, so likely an overestimate) is around C0.22/kWh. Cut that to $0.15/kWh to make up for the solar capacity factor in actual production, and this electricity is still costing roughly 194% more than the weighted average spot electricity price in Ontario in 2007, which was C$0.051/kWh.
Luckily for solar panel makers and their shareholders, Ontario never got the chance to become a global solar heavyweight, although with the growth rates it was registering the potential was certainly there This was evidenced by announcements of major panel makers opening offices in Toronto. I say luckily because the effects of this policy turnaround could have been much more pronounced had Ontario established itself as an important solar growth center like Germany.
But the main lesson here is that the project developers who spent money on bids and were later caught empty-handed when the program shut down quite clearly never bothered to read the policy fine print, because if they had they would have realized that the power market regulatory authorities never intended for Ontario to become a global solar hotspot (no pun intended). They would have realized that the SOP was being far too successful for its own good and that something was going to give.
The same could happen elsewhere. Electricity remains one of the most politicized commodities there is because, unlike food and fuel, every day citizens believe politicians have the power to reign in soaring prices through regulation. When a new hot solar market emerges through policy, as is the case with Spain at the moment, investors have to be sure they understand not only the incentive part of the policy, but also how the incentive fits in the jurisdiction's overall long-term energy plans. The last thing one wants to do is invest in a stock as a play on a particular region, only to have that region change its mind.
Another thing to watch out for are residential electricity rates. Bringing a large amount of solar into the grid raises electricity prices, and it's really the percentage increase, rather then the absolute, that matters. In places where power is cheap and abundant, forget too much solar in the near-term - the rate-payer won't go for it, especially when gas prices are rising the way they are at the moment.
Finally, transmission, transmission, transmission. We've said it before, and will repeat it again - the power grid needs massive capacity upgrades and additions if all that renewable energy is to come on stream. Aggressive incentive programs without the transmission capacity to accommodate growth will lend you where it did Ontario, namely nowhere.