Merchant Solar Projects Rise as Contract Prices Fall to Record Lows

The costs of deploying large-scale solar and solar-storage power plants have come down to a level where growing numbers of developers are willing, and able, to take the risks associated with developing “merchant” projects that rely on selling electricity via spot and forward electricity markets rather than long-term power purchase agreements (PPAs).

The drop in solar PPA sales and auction tender prices has picked up momentum, and fueled the rise. For a mere US$0.033 per kilowatt-hour (kWh), the Los Angeles Department of Water and Power (LADWP) in early September signed a contract to buy enough solar energy capacity from the Eland solar-storage project to be developed, owned and operated by 8minute Solar Energy to meet 6–7% of the city’s electricity needs , for instance. That’s well below the national average of US$0.108/kWh the U.S. Energy Information Administration (EIA) published for June this year.

Some industry insiders have been questioning just how low utility-scale solar power sales prices can go, as well as position themselves to take advantage of opportunities to buy distressed assets on the cheap. “I would agree, generally speaking, that long-term PPAs are being bid down to some very low levels,” Dan Balaban, CEO and founder of Alberta, Canada-based Greengate Power, told Solar Magazine.

That’s putting pressure on returns, and making merchant solar more attractive.

The Travers merchant solar project in Alberta

Greengate Power recently achieved a project milestone when it received regulatory approval from the Alberta Utilities Commission (AUC) to proceed with its Travers Solar project, a 600 megawatt, C$500 million (~US$376 million), clean energy plant to be built on 4700 acres (1902 hectares) in Vulcan County near Calgary, Alberta.

Designed to incorporate some 1.5 million PV panels with enough capacity to deliver reliable, low-cost, emissions-free energy to power an average 100,000 homes, upon completion the Travers Solar project would be the largest of its kind in operation in Canada, and one of the largest in the world .

All goes well, Greengate expects to begin project construction next year and complete it in 2021. The project developer expects Travers will offset more than 472,000 metric tons of greenhouse gas emissions each year, as well as create hundreds of jobs over the course of its two-year development, add significantly to provincial tax revenues and boost the economy locally and well beyond.

“We’re planning on financing Travers on a merchant basis,” Balaban explained in an interview. Alberta runs the only electricity market and grid among Canadian provinces where merchant power projects can be undertaken, he noted.

“There’s a strong case for merchant solar, and there’s little on our grid today. It produces on peak, when power demand is highest. We’re selling into the spot market and earning revenue based on whatever spot prices are at the time.”

Greengate is also selling the environmental attributes of the project, Balaban added. “There’s an industrial carbon emissions regulation in Alberta, a carbon price on large, industrial emitters. In order to comply, they pay a price per ton for their emissions or they can buy offsets from renewable energy facilities. We’re doing that with Travers.”

Getting a firm grasp of and managing merchant solar financial risk

As financial rates of return vary with the time periods over which loans are made—solar project lenders typically require higher returns the longer they approve loans in order to compensate for the extra risk. Merchant solar power generation owners take on something yield curve risk by borrowing capital medium and long-term. They also assume basis risk, the differences in rates associated with hedging in an instrument at rate that differs from that of the asset itself.

Balaban says Greengate has a firm grasp of this, along with the other risks associated with Travers’ development. “You don’t know with certainty what prices will be throughout the life of a project, but you can get a good idea of the range of prices and expected returns you’ll see.”

Power prices on Alberta’s grid change by the hour, Balaban explained. Inflation-adjusted, annual averages go up and down over time but grid sales prices on average have consistently sold for around C$60 (~US$45)/MWh. Solar energy typically commands a premium given it produces electricity during traditional periods of peak demand, he noted.

You can take advantage of high market prices at times, but if you look at the downside scenario, the low end of the range, you’ll see prices roughly equivalent to what PPA prices would be in an auction.

In sum: “You can earn substantially better returns with merchant solar power and have downside protection similar to fully contracted projects,” he said.

Regulatory de-risking

AUC’s regulatory approval clears the way for Greengate to step up its efforts to raise the capital needed to complete the project. “This is a very important milestone—the regulatory de-risking of the project. With this approval in place, we’re now driving hard to close project financing by the end of the year,” Balaban said.

Phasing out of government subsidies and a sea change in energy policies has reached the point where subsidy-free solar is fast becoming the norm in leading solar markets around the world. That’s spurring growth of merchant solar power project development, as well.

A major energy policy shift that included the removal of solar and renewable energy incentives instituted by the previous New Democratic Party government in Alberta made the new government’s intention to take a purely market-based approach clear. “Given where renewables have matured to—costs coming down, efficiency improving—it now makes sense on a subsidy-free, market basis,” Balaban said. “We believe there will be a significant amount of growth in Alberta in coming years.”

Merchant solar on the rise—there will be risk

Merchant solar power projects are on the rise in a growing number of markets worldwide, particularly those where grid integration of renewables is approaching levels that give grid operators and regulators pause for concern and leads them to reform policies so as to wean solar power developers and owners off subsidies. That’s taking place in China, the EU and the US, among others. In the European Union (EU), Portugal’s latest solar tender yielded a new, record low price of €14.76 (US$16.31)/MWh; and in the U.S. states, such as California and Hawaii, there’re high and growing amounts of renewable energy coursing on to power grids.

Furthermore, insufficient transmission and distribution infrastructure, which results in the curtailment of power production from wind farms and solar power plants, and regulatory barriers are increasing pressure on returns on investment. A growing number of owners are looking to sell out as a result.

The recent, nearly 6,000% spike in real-time spot electricity prices on ERCOT’s Texas grid served as an illustration, according to David Scaysbrook, managing partner and co-founder of Quinbrook Infrastructure Partners, which is developing the 690-MW/380-MW-ac Gemini Solar + Battery Storage project on approximately 7,100 acres of federally-owned 25 miles northeast of Las Vegas, Nevada.

A stealthily growing market in distressed assets?

We have some big concerns regarding project risk profiles, particularly to the degree that there’s generally too much optimism regarding the merchant component of future cash flows in particular.

—Scaysbrook told Solar Magazine.

Quinbrook has done well for itself and its backers thus far in part by buying utility-scale solar and wind power projects when they were being offered at low prices on the market. “When we’re referring to distressed assets, we mean it in the sense that either some or all of the assumptions baked in have been too aggressive,” Scaysbrook said in an interview.

In addition, there are markets, such as in Texas, where significant levels of basis risk due to curtailment exist, he added. “It’s not a pandemic or contagion, but the mix of tax equity financing and the pace of the rollout makes for a risk cocktail,” Quinbrook elaborated. “There already is a lot in the way of distressed assets in certain U.S. markets where revenue streams are subject to volatility. It isn’t being talked about, but it exists. It’s inevitable that some of these assets will change hands and there’s going to be some value destruction along the way,” Scaysbrook said.

All this isn’t, or shouldn’t, come as too much of a surprise, given the nature of capitalism and the rapid rise of wind and solar power plants as an asset class, Scaysbrook pointed out. “You have a lot of new entrants, and certainly a lot of new money coming into the sector. I wouldn’t call it a bubble, but it’s certainly a boom, and like any new sector it sometimes takes some time before mistakes are revealed. Why should renewables be immune?” he concluded. comment↓