Energy spotlight: Solar
The benefits of solar power are obvious; along with wind, it presents a carbon-free, fuel-free (if you ignore the impact of manufacturing solar modules) and increasingly low-cost form of energy generation
The absence of carbon emissions makes it consistent with the UK's low-carbon agenda, and solar production has scaled-up in tandem with broader UK government efforts to achieve carbon neutrality.
The UK's commitment under the EU's first Renewables Energy Directive (RED I) in 2009 was to generate 15% of its energy from renewable sources by 2020. Under the second Renewable Energy Directive (RED II) in 2016, the UK upped its goal to 32% renewables generation by 2030.
In domestic legislation, under the UK's Climate Change Act 2008 (unamended), there was a binding commitment to decrease greenhouse gas emissions by 80% of 1990 levels by 2050.
Following the adoption of the UK's Committee on Climate Change's (CCC) latest advice, the UK has become the first major economy to legislate for net zero greenhouse gas emissions by 2050, which has given a further boost to the British renewables sector.
Solar has several advantages over other forms of renewable energy generation. It does not have the noise implications of wind turbines and can be delivered on a concentrated (i.e. solar farms) or distributed (e.g. rooftop) basis.
Its downsides are land-use impact (solar farms require reasonably large surface areas, roughly six acres per megawatt of installed panels), construction costs and intermittency (because, of course, it is not always sunny).
The extent to which energy storage can address the issue of intermittency remains to be seen, but it is hoped that the development of stationary, high-density batteries will offer a solution.
Co-location of energy storage with renewable generation will play an increasingly important role in the renewables industry's development, as technological improvements enhance storage capacity and the role of storage is expressly recognised in UK grid codes.
Development: Brighter prospects?
Solar is generally regarded as having high capital costs, but low "rest of life" operation and maintenance (O&M costs).
Most solar farms can be operated remotely from an asset management perspective. The capital cost is largely associated with the cost of components (solar modules, inverters and balance of plant), as farms have short build times and can be deployed at scale on a relatively non-bespoke basis (for an extreme comparison, consider the difficulties in site variations in nuclear reactor designs).
Solar construction costs have come down rapidly since the technology was first deployed on a significant commercial scale in the 1990s, with a notable acceleration in the last decade.
This has led to the winding down of subsidy support for solar in the UK.
Total solar PV installation cost in the UK decreased from ~£2.5 million/MW installed in 2011, to ~£800,000/MW at the end of 2016 (according to analysis by infrastructure and private equity investment firm, Foresight Group).
The cost of solar modules, which account for 35-40% of the total installation cost, has been eroded by growing demand (allowing economies of scale) and production efficiencies.
Protectionist import and antidumping agendas in relation to solar modules by different jurisdictions across the world have arguably constrained further cost reductions, but the overall trend has been towards solar becoming a cheaper and more accessible technology.
Once constructed, solar farms typically generate power for 25-30 years, providing an attractive low-risk, high-yield return to investors.
Despite that stability, investors can still optimise their investment strategy (risk appetite) by investing or refinancing at any of the three main phases: development, construction or operation.
Grid connection and stranded assets
Connection arrangements form a key part of solar projects.
Solar farms are generally connected to the distribution system (i.e., they are a form of embedded generation and require a connection offer from the relevant Distribution Network Operator (DNO)).
The location of the connection point, the anticipated site loads, the extent of connection works (contestable and non-contestable) and the integrity of the local grid supply will all be important in determining the nature and cost of the connection offer.
Connection arrangements are particularly important in the context of "private wire" or "behind the fence" power purchase agreements (PPAs), where the generator will often need to be connected directly to the offtaker's premises.
Where the generator makes use of the offtaker's existing grid connection, the PPA will need to ensure the generator's connection rights are robust and that the offtaker is obliged to maintain that connection and comply with the DNO's connection requirements.
Particular care needs to be taken to avoid the solar farm becoming a "stranded asset" once the PPA has expired at the end of the agreement or terminated (e.g., for material breach by either party), as the solar farm will still need to connect to the distribution network, even without the PPA in place.
A typical provision in a PPA might allow the generator to install its own direct connection over the offtaker's land (with the offtaker's reasonable cooperation), with the party at fault under the PPA paying the construction costs of connection separately to (or as part of) the liquidated PPA termination amount.
Much like onshore wind, the favourable subsidy regime in the last 10 years has led to a massive increase in installed solar capacity, from just 80 MW in 2010 to 12.8 GW by the end of 2017.
Improvements in solar technology (particularly in efficiencies in UK typical temperatures) and a fall in panel costs (and to a lesser extent, inverters, transformers and balance of plant) has also played a significant part in that expansion.
As with other forms of generation, the subsidy available to solar depends both on the installed capacity and the proposed commissioning date.
However, subsidies are now only really relevant in the context of the acquisition and disposal of existing sites (where they are still a key component of project value).
The main support mechanism for solar farms was the Feed-in Tariff (FiT), which offered generators a predictable revenue stream in the form of a per unit tariff for all electricity generated over a 25-year period.
This tariff was paid in addition to the wholesale market price for projects of up to 5 MW.
The early closure of FiTs was forecast in the Autumn 2017 budget (when the Control for Low Carbon Levies replaced the Levy Control Framework) and the government indicated no new FiTS would be awarded after 1 April 2019.
The Department for Business, Energy and Industrial Strategy (BEIS) subsequently consulted on, and then confirmed, the April 2019 closure date.
The FiT regime has now been replaced with the Smart Export Guarantee (SEG), although many commentators are concerned by the lack of revenue certainty offered by the SEG regime.
The second relevant subsidy arises through the Renewable Obligation (RO) on licensed suppliers.
The RO gave rise to a tradable market in registered certificates (ROCs), which licensed suppliers could buy from accredited generators (or the market) to satisfy their RO quota. ROCs were awarded to accredited generators (on a banded system) in accordance with the amount of renewable power they generated.
However, ROCs became unavailable to all new solar projects from April 2017 (they had already become unavailable to solar farms of over 5 MW from April 2015), subject to grace periods.
The third relevant support mechanism is the Contract for Difference (CfD) regime, which gives CfD holders a guaranteed top-up if the relevant market reference price dips beneath the applicable strike price (the converse holds for any excess over the strike price).
The CfD was perceived to be more appropriate than outright tariff subsidy, as it promotes competition between generators to secure a CfD contract.
However, solar has not had a happy CfD experience. In the first round (results announced in February 2015), 27 contracts (worth up to £315 million) were offered to a combined 2 GW of renewable projects.
Solar projects only claimed five of these contracts and accounted for 72 MW – with onshore wind the standout winner.
However, only two of the five solar projects to receive contracts were commissioned, as the low strike price did not stack-up well against anticipated installation costs.
The position then worsened, as the second auction (in 2017) and third auction (in 2019) excluded solar (and onshore wind) from participation, as BEIS took the view that both forms of generation were viable without the support of incentive mechanisms.
In terms of the Capacity Market (CM), BEIS recently published its response to the question of participation by non-subsidised renewable generation in the CM.
This has largely been a question of producing a satisfactory answer to the problem of intermittency, which means formulating an appropriate de-rating methodology for non-dispatchable technology.
BEIS has confirmed the replacement T-3 auction in early 2020 (for delivery in 2022/23) will allow certain renewable technologies to participate.
This will be on the basis of the application of an equivalent firm capacity de-rating methodology, to reflect their intermittent nature.
Addressing the question of intermittency, BEIS commented that allowing the participation of (appropriately de-rated) renewable technology does not increase the security of supply risks, it simply alters where and how their contribution to security of supply is accounted for. BEIS also noted that "remunerating this contribution is a key principle of the technology neutral framework of the CM, and a de-rating methodology has been developed to accurately account for that contribution."
It will now be possible for subsidy-free renewable forms of generation to participate in the rescheduled 2020 T-3 auction, although the de-rating methodology and increasingly low clearing prices means this opportunity will not come close to replacing the lost subsidy regimes.
Subsidy-free solar farms already operate in the UK.
The first to operate without an outright support mechanism was Clayhill solar farm near Milton Keynes in Buckinghamshire in September 2017, which was able to exploit the falling cost of solar panels and to achieve efficiencies through co-locating battery storage.
Clayhill consequently became something of a trophy for the UK government, held up in the face of criticism from industry about the timing, and speed of, the closure of the ROC regime.
In a subsidy-free context, the continued growth of the solar market relies on the following factors:
Corporate PPAs and "within the fence", or "direct wire" PPAs, are likely to remain popular, where a price can be secured, which is above the wholesale market price but still cheaper to the offtaker than a licensed supplier price for grid-provided electricity.
This is because the direct wire PPA price would not have the grid charges and non-energy costs an offtaker would pay to a licensed supplier.
As subsidies are phased out, the energy price in the PPA becomes far more important.
Lower finance costs
Driving down the cost of capital at the development stage, through corporate loans, third party debt, equity or local funding campaigns (in each case using the reliable yield of solar farms to decrease the investment or loan risk profile).
Reducing capital component, installation and operation costs
Achieved through continued R&D and competition in the solar panel supply market, achieving economies of scale in portfolio development, standardising installation costs in the construction phase, achieving lower rents in the land lease and lower asset management and O&M costs (perhaps through efficiencies arising through aggregating portfolios of sites).
These factors have all been key to the government decision to remove first ROCs then FiTs and the CfD from solar support, so future projects will no doubt prove subsidy-free solar as the new norm.
The more interesting challenge remains the development of co-located solar and significant on-site battery storage capacity.
Hugo Lidbetter is a partner specialising in energy and natural resources at European law firm, Fieldfisher. For more information on our renewables and wider energy expertise, please visit the relevant pages of the Fieldfisher website.