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Investing in Solar Energy, Not Technology
Considering the implications of the fact that solar is really an energy industry, not a technology industry


Solar Energy, Not Technology

Great expectations and even greater hopes surround the solar industry in the United States, and we share this vision of a solar future in this country. However, transforming that potential into reality requires more than simply viewing the world through green-colored lenses. It requires realistic expectations, understanding the true nature of this industry, and a frame-shift in the mindset of solar companies. Foremost, to realize the potential of solar in the United States, the industry must come to terms with the fact that it is a part of the energy complex.

As proven by Google and Facebook, technology companies are most successful when they can easily alter consumer tastes and demands. Those changes catalyze the evolution of operating platforms (killer apps) and hardware requirements (processing power). Yet, despite all of the tech money that has flooded into solar in recent years, technological advances have not lived up to expectations. In fact, most of the "technology" that is being funded in solar projects is relatively old. Crystalline-silicon (c-Si) cells were invented at Bell Labs in 1954 and since c-Si efficiencies hit 14% in the 1960s, not very much has changed with the technology. Likewise, the other pieces (balance of systems) that go into a solar generating system involve fairly uncomplicated electrical work and few moving parts. These well-known and reliable generating assets, not an elusive magic technology bullet, are what energy and project investors will fund.

Put simply, the technology roller-coaster is not a path to success that capital-intensive commodity companies should travel. At the least, this kind of technology risk is not something that project investors can tolerate. After all, an electron is an electron is an electron. Or, to paraphrase one partner of a major venture capital group, "VCs should be very careful when investing in solar, and should stay out of the downstream."

So, why should anyone invest in solar if there is no technology element to make it cost-competitive? Because cost-competitive solar is here today; it's just a matter of pricing it correctly, effectively capturing incentives, and being realistic about the cost of peak power over the next 25 years.

Technology-Induced Problems in the U.S. Solar Industry

At the root of the U.S. solar industry's problems are unrealistic growth expectations and the misguided strategies used to try to capture market share. "Network effects" and the drive to establish new industry standards don't apply in the energy sector. In fact, the two biggest problems impeding the growth of the U.S. solar industry are overvaluation of project pipelines (development activities) and "pretend" PPAs (power purchase agreements).

Since 2006-2007, when the sky was the limit for the sector, most solar development companies have significantly underperformed. This is because project lenders require that developers provide some equity in their projects, much like a bank requires 20% equity from a homeowner. This is not something that the VC community -- which had never invested in project development companies -- can provide. Nonetheless, the drumbeat for growth continues to be sounded loudly, and solar development companies have begun to build "pipelines" of projects for someone else to own.

Fundamentals of Solar Development and Pipeline Overvaluation

Because we can site solar nearly anywhere the sun shines -- solar resources at any given location have been studied for decades by NASA and the National Weather Service -- our projects are much easier to develop than other energy projects. Whereas wind projects require two years of meteorological tower data, complicated, site-specific land negotiations, and significant transmission hurdles, solar projects require none of those. Given this disparity, why would solar developers expect to be compensated on the same level as wind developers? Why would property owners expect to charge significant premiums for land if the sunlight is the same 50 miles down a transmission line?

Pretend PPAs

Most solar developers, in their rush to grow development pipelines, underestimate the cost of capital and subsequently provide unbankable solar PPA prices. How many lenders are willing to charge only 6% for 80% of the money that goes into a project? Notwithstanding the intricacies of the tax equity market, how many equity investors have return expectations that fall under 10%? (If you know of any, please put them in touch with us.) Given the inability of most developers to put someone else's money where their mouth is, we don't assign much credibility to their PPA quotes.

For example, if we assume a "winning" PPA price of $0.11/kWh to $0.13/kWh (2.5% annual escalator) in Arizona, and we assume very low capital costs (6% debt, 10% equity), we arrive at a total system cost of only $2.40/watt to $3.00/watt. With prevailing panel prices of $1.75/watt, this leaves only $0.65/watt to $1.25/watt for BOS, which currently costs about $1.50/watt at a minimum. That said, a panel manufacturer hell-bent on growth could always sell panels at a loss into a low-priced project; however, such activities are clearly unsustainable in the very large energy market. As far as we know, the only group that has come close to controlling energy prices is OPEC.

Therefore, we are dubious of the feasibility of most solar PPAs, including those that have been approved by the CPUC. As of August 2010, the CPUC reported that 789 megawatts of RPS-related power projects had failed to come online when expected (some projects are more than a year overdue), with another 574 megawatts being completely terminated. Over the last five years, about half of California's RPS-related projects have been solar. Furthermore, according to GTM, only 172MW of the 2.7GW of proposed grid-tied PV projects in the U.S. (with signed PPAs) have been completed (the percentage of completion is lower in areas without feed-in tariffs). This is not the kind of growth that technology investors were expecting.

Execute Projects and Stop the Greenwashing

We are bullish on solar, but only with realistic energy expectations. Unlike any other asset in the world, solar does not really deplete (80% output warranty for 25 years). This allows us to provide long-term, locally generated, clean, peak, and fixed power, which we believe is extremely appealing to consumers. But without realistic expectations, the solar industry will remain a sideshow to the conventional energy sector.

Cost-competitive solar is here today, and it's time for the solar industry, utilities, and regulators to get serious about completing projects. Otherwise, we're just greenwashing ourselves.

Below are some best practices that we recommend for solar energy industry participants:

Developers and other solar companies: Stop writing checks that nobody is willing to cash
Get to know your bankers and be respectful of their underwriting criteria.
Be realistic about the cost of materials and work that go into a solar project.
Stop overpaying for pipeline.
Utilities and regulators: Increase and enforce penalties on non-fulfillment of projects
Shorten execution time frames (at least for PV).
Enforce stiffer penalties on projects that are late.
Require bigger proposal deposits.
Expedite the interconnection process.
Investors: Understand full-cycle project and corporate economics
Get out of your investment if management can't explain cash-on-cash returns.
Do not make the assumption that size and high growth make right (e.g., Calpine, AES, Enron, Conergy).

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Tuan Pham is President of PowerFin Partners, a manager of institutional funds for solar projects throughout North America. Tuan was previously a research analyst covering energy and industrial companies at Morgan Stanley, Banc of America Securities, and Strategic Value Partners. He also has spent time at the Austin Clean Energy Incubator and at HelioVolt Corporation, a CIGS panel manufacturer. PowerFin approaches solar from a conventional energy perspective. Other members of the PowerFin team have extensive experience in wind development, regulatory and legal affairs, and conventional energy. Please see the company's website for more information (www.powerfinpartners.com).


Eric D. Schwerin
Rosemont Seneca Partners, LLC
1010 Wisconsin Ave., NW
Suite 705
Washington, DC 20007
(202) 333-1880
eschwerin@rosemontseneca.com
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