Inside the IRRs: The rise of South Asia

Lux Research analyst Matt Feinstein explains the ups and downs in global solar project rates of return, from Europe’s smoothed-out PV market demand to which US states have the highest paybacks — and why the future of growth is in Asia.

January 9, 2012 – Following a Lux Research report picking the top global solar markets ranked by internal rates of return (IRR), we asked the report’s lead analyst Matthew Feinstein for more details about which regions are heating up (and cooling off) and why. (IRR is basically a describer of project profitability per year.)

First of all, the methodology used to calculate these IRRs is fairly simple: system cost in year one, production value over the next 25 years (the typical lifetime), taking subsidies into account for each geography, and electric rates if needed to determine the value of electricity obtained. Subsidies are prioritized over electricity rates, but all other inputs are given equal weighting.

  1. Portugal: 62.2%
  2. Cyprus: 42.4%
  3. Hawaii: 36.9%
  4. Greece: 31.5%
  5. Israel: 27.8%

Top five locations by IRR, 1Q12. (Source: Lux Research)

Europe’s solar IRRs are overall characterized as “relatively constant,” but of course there are highs and lows at a national level. Germany’s solar star is losing luster due to market saturation and falling subsidies; see also Spain’s 2008 surge and quick flameout, and Italy’s more recent surge and quick pullback. Portugal, on the other hand, ranks consistently high thanks to an “extremely generous” feed-in tariff — although those high IRRs only apply under the country’s “quite low” installation cap, “so outside of it, returns plummet,” he notes. And all European (subsidized) markets must be viewed with a healthy dose of skepticism given the region’s ongoing financial woes. Greece is ranked in the top 5 IRRs right now under Lux’s model — but as Feinstein rhetorically asks, “if you were an investor, would you take your money to Greece?”

Another region seen picking up some of Europe’s slack lately is the US. The Lux IRR calculations broke out US states separately, with Hawaii, Massachusetts, Ohio, New Jersey, and California as the top five. (Hawaii was No.3 in global IRRs, thanks to its extremely high electricity rates and low energy market.) Massachusetts and Ohio’s new SREC programs are similar to NJ’s and tend to start off with high prices that drives up IRR, Feinstein points out; NJ ranked No.1 in Lux’s 2Q11 list with ~40% IRR thanks to its high SREC prices. There are questions, though, about bankability (for Mass. projects) and market newness (for Ohio). Others have questioned whether these SREC programs create more demand than utilities need, leaving end-users with less payback than they’d hoped.

What was surprising in updating the global IRR list, said Feinstein, was the rise of South Asian markets (e.g. Malaysia, Philippines, and Thailand), which possess a formidable combination of large demand, strong subsidies, and high solar insolation. A lack of existing domestic legal and financial project expertise will temporarily slow the MW installations. India, too, is in the top 10 IRRs, partly thanks to heavy subsidies and its National Solar Mission, Feinstein added.

It’s worth noting that these IRR lists are calculated entirely on geography, not technology — but one can make some assumptions about technology plays based on some regions’ locations and insolation. Thin-film technologies have an advantage in high insolation areas, mainly thanks to its lower production cost combined with the fact that crystalline silicon’s efficiency degrades in hot climates. No surprise that First Solar is laying its future bets on regions including India, Africa, and the Middle East instead of chasing other more established subsidy markets in a “whack-a-mole” market rush. But the relentless crash of c-Si prices — in markets absent of any subsidies — will provide no relief for FSLR’s margins, Feinstein pointed out.

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