A Solar Power Energy installation has a product shelf life of 20-25 years; a typical Solar Energy installation will factor in several variables and assumptions to determine output over the next 25 years of the asset life – built into these assumptions are several “known knowns and some known unknowns”
Cost of Risk
In finance we qualify and capture all RISKS (variance from the mean) in a single variable i.e. ‘Cost of Capital’ which is the risk adjusted rate of return. For all the risks involved in a Solar Investment financiers demand a weighted average risk return on their investments of 8%-9%. This in today’s time when the risk free rate is hovering around 2%; a cool premium of 600-700 bps over the risk free rate.
Solar Power Energy Installation Risks
A Solar Energy project shoulders several risks, and these risks are split among the project stakeholders – the Developer, the EPC and the Financier/Equity + Debt investors. Typical project risks include:
• PV • Technical • Performance • Site Construction • Operations & Maintenance • PPA Offtake • Financing • Regulatory Policy; (the risk criteria mentioned here are only indicative and by no means exhaustive)
An SMB installer on the other hand doing residential and small commercial installations underwrite a limited set of risks;
• System Performance Risk • Technology Risk • Warranties Risk • Pricing Risk. (the risk criteria mentioned here are only indicative and by no means exhaustive).
It behooves to analyse the risk of the contractual obligations to your customer over the system life of 20-25 years and ensure that your pricing and margin factor in potential claims that may arise due to:
System Performance Risk:
There is a limited amount of historical PV Performance Data in the public domain. There is also a tendency by current players to guard their system performance data as proprietary.
Installers need to model system performance over a 25 year period to evaluate project ROIs, good quality of data has emerged only in the recent years as almost three-fourths of total PV capacity was installed in the last four years.
Installers are accountable for the output that they guarantee to their customers!
Technology Risk & Vendor Selection:
An industry-wide compression of profit margins and an oversupply of panels has led to some 24 PV manufacturer insolvencies or bankruptcies in the United States and Europe (at least 4 were U.S. companies) and over 50 in China.
Are you using a ‘Tier 1’ or ‘bankable Tier 2’ vendor – will your vendor be around to support you over the 25 year system life of your installation.
Installers are bound to service the equipment supplied by them; but what if your vendor is not around to back you up?
Typical PV manufacturer warranties include a 5–10-year workmanship and materials guarantee (which warranties the physical product), and a 25-year performance guarantee (which warranties the energy produced). The performance guarantee usually stipulates that the modules will operate at 90% of their optimal output for the first 10 years and 80% for the remaining 15 years (there are of course variations to this theme).
Almost all major manufacturers offer a long-dated performance guarantee in the warranty, but questions remain about its effectiveness. If the manufacturer goes out of business before the sunset of its warranties, then there is no entity left to backstop customer claims—the policy is essentially rendered null and void.
Installers are bound to provide a free replacement to customers during the warranty period; but what will you do when your vendor with whom you probably have a back-to-back has folded up?
Utility Rate Assumptions:
Any forecast of utility rates requires an in-depth understanding of the relevant utility’s operational strategy to establish acceptable base case and stress case scenarios for that particular region. The region’s regulatory environment is also a critical factor to consider. Other factors to consider are the source and reliability of the data, the type of data (residential retail rate, usage assumptions, etc.), and assumptions for competitive versus regulated markets and municipal versus investor-owned and retail marketers.
Most ROI models assume a 3%-4% annual growth in Electric Utility rates while making their financial case to customers – we know how dangerously wrong it is to work on rules of thumb; the 2008 financial crises was predicated on the premise that US Home prices will continue to rise into the foreseeable future based on historic trends!
Solar Investment ROI is based on the premise of Utility Rate inflation out into the future; but what if these trends were to stall or be reversed?
Risk Mitigation Strategies in Solar Power Energy Installation
Insurance is a transfer of risk away from the project and onto a carrier’s balance sheet in exchange for the payment of a premium that represents the probability and size of losses that could arise from that risk. This is an expensive method for managing project risks, and as such, it serves as a “last line of defense” for contingencies that have not been captured through the process of mitigation and allocation. Moreover, insurance coverage has to be renewed at short intervals of one-two years; the insurance premiums are volatile and could effect project economics.
Pricing your Service Right
Running scenarios, planning for eventualities is a useful exercise in mitigating risk, pricing your product/service with adequate margin buffers, setting aside a contingency reserve to address any claims in the future is the right way forward.
An SMB installer is in a competitive place; there are limited barriers to entry and most installers operate on gross margins ranging between 15% to 30%. (Forbes article http://www.forbes.com/sites/tomkonrad/2011/05/31/is-the-solar-installation-industry-ripe-for-consolidation/)
For a young nascent and fast growing industry it should not turn out to be a situation of BUYER BEWARE!