Credit Crunch 2008: The Impact on Solar Project Finance

Project finance within renewables – solar in particular – has made great progress over the past few years with the introduction of the solar PPA, and with financiers developing longer term operating data from which to base their financial models. Educated guesses are more educated and less of a guess, and big money has entered the space as the financial model has become more credible.

Enter the 2008 financial crisis. Surely, the world’s worst financial crisis (and tightest credit market) since the Great Depression will impact renewable energy project development, which is an inherently capital-intensive industry. The question is, who will it affect, and how badly? I think it’s too early to know for sure, but without a doubt, investors will likely demand higher returns for both debt and tax equity (a special form of equity designed to maximize use of tax credits) due to a general scarcity of capital. However, I don’t think funding will dry up, as solar projects boast a very different risk-return profile than do other investments given that government subsidies constitute a large slice of the project’s value and project cash flows aren’t particularly risky.

Assuming the power price (thus project cash flows) remain the same, an increase in debt or tax equity yield requirements would put a squeeze on those upstream, namely the panel manufacturers and/or those developing projects. Who is the likely winner in that battle? Ultimately the law of supply and demand will dictate who has the upper hand in negotiations, but if solar panels are entering a period of overcapacity, which is likely the case given industry forecasts showing a 60-70% increase in manufacturing capacity in 2009 without a requisite increase in demand, then project developers/financiers are likely to drive a hard bargain on panels, putting pressure on panel prices. Will this be sustainable? Probably. Panel manufacturers currently enjoy healthy margins (First Solar’s gross margin in 2007 was 49.9%), and commodity prices are on the decline. Thus manufacturers have some room to cut prices.

If overcapacity turns out not to be the case (an unlikely scenario – especially given the current financial crisis), panel pricing may not decline as much and the squeeze would then be on project developers. However, demand for panels from developers is likely to be far more elastic than panel supply – if the price of panels were too high, developers would simply mothball projects until a better financing or panel pricing environment came along. Panel manufacturers have less flexibility given their physical infrastructure requirements and fixed costs. So panel manufacturers would still be forced to either decrease supply (which, due to their fixed costs, would hurt margins) or decrease prices.

Like the broader economy, solar project finance and development will feel the impact of the credit crisis. Some projects won’t be built – perhaps those with unproven technologies, or perhaps those with the most marginal returns. But I think panel manufacturers have some breathing room, and project developers have flexibility. The silver lining for the sector is that as part of the federal bailout package passed in recent weeks, the ITC – a 30% federal subsidy – was extended to 2016. In the United States, this means an end to federal policy uncertainty – the biggest bugaboo the industry faced in 2008. Moreover, declines in panel prices will help make solar competitive with other forms of renewable energy, and when fossil fuel prices resume their inevitable upward march, solar will be much closer to that fabled thing called grid parity.

Mark Higgins is a Deal Associate for MMA Renewable Ventures – a San Francisco and Baltimore based private equity firm that invests in renewable energy power projects.

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