In the past, most of the growth in large renewable energy installations was carried out by independent developers. Today, the typical developer’s business model is based on capturing the yield arbitrage between early stage projects and operating assets (or a middle point in the development process) due to different risk profiles. But the collapse of SunEdison seems like the nail in the coffin for this business model.
Developers have benefitted in the last 15 years from a significant reduction in development risks: wind and solar technologies (as well as their respective supply chains) have matured, standardized procedures and contracts have appeared, and capital has become easily accessible. At the same time, government policies — such as feed-in tariffs (FiTs) and guaranteed grid access — designed to support a high-risk industry have remained in place. Such policies increase the yield arbitrage between the development stages.
This policy scheme works well for wind developments, as they are complex endeavors, but solar developments face different barriers. In solar, resource variability within the same region is not significant; projects can be deployed following land ownership or local authority limits, and the build complexity of projects is low. This paradigm means that a significant number of developments can quickly arise in the same market simultaneously.
The first victims of solar were FiTs — when solar costs were low enough to benefit from these policies, projects boomed. Governments tried to respond by lowering the FiTs, but by then, the costs of solar were even lower. The only way to stop the cost spiral created by FiTs is to eliminate them — and with them, a profitable business model.
In an attempt to continue to support the renewable energy sector, several governments have implemented a tender system in which projects have to compete for a guaranteed long-term contract. For some time, independent developers with strong links to financial markets were competitive. However, markets were flooded with projects fighting for the same contracts, all using the same technology and located in the same region.
As a result, projects with the lowest capital cost structure, access to cheaper PV modules, and better electricity yields have an advantage. In the most recent tenders, developers have been outbid by large energy corporations like Enel Green Power and ENGIE or manufacturers like SunPower (backed by Total), JinkoSolar, and Recurrent Energy (backed by Canadian Solar).
Chasing Opportunities: Moving All the Way Down the Value Chain
From the start of the industry in the ’90s until now, independent developers have mostly excelled at securing and managing supply, financing engineering procurement construction contracts, and mitigating technological and regulatory risk. The demand side of the equation was more or less straightforward — get a FiT if developing in Europe or sign a power purchase agreement (PPA) with the local utility if developing somewhere else. To successfully move forward in 2016, independent developers will have to reach out to the end consumer directly and work to understand consumers’ energy needs.
Developers could follow the following three strategies:
1. Develop relationships with large end users to sign corporate PPAs
2. Move into community solar
3. Move into electricity retail
Signing PPAs with large end users is perhaps the simplest option for independent developers. This approach mimics a current business model, simply replacing a large off-taker — the utility — for another large off-taker — a corporation. Corporate PPAs are increasingly common. This area has grown from around 600 MW in 2013 to more than 3 GW in 2015 globally. Initially, companies signed corporate PPAs and used them as an image and hedging tool, but now economics is the main driver.
This business model also has weaknesses. Corporations at least have some resources available to analyze offers from developers and shop around for the lowest cost for the quality of service needed. Developers not only have to be better than other developers, but also better compared to the local utility. To be successful, developers will have to develop the skills to match their customers’ energy needs.
Another area in which independent developers can play a major role — especially in the U.S. — is community solar programs. Although these programs are usually developed, financed, and run by the utility, programs also can be outsourced to a one-stop-shop third party.
The third-party model is popular with electric cooperatives but is less so with investor-owned utilities (IOUs). IOUs prefer to own assets and seek a return on investment. Independent developers have also successfully worked with utilities to develop community solar projects. For example, the Clean Energy Collective has been co-developing projects with local utilities in Colorado and Massachusetts that do not want to have the full risk of the development.
Some states, like Minnesota, allow third-party developments to benefit from virtual net metering. According to Mike Taylor, Principal of Knowledge at Solar Electric Power Association, over 900 MW of solar projects have been proposed in Minnesota, although not all of them are expected to reach completion.
Finally, some developers operating in liberalized markets have also opted to become retailers. In countries like Germany and the United Kingdom, FIT prices are well below those of residential and commercial electricity. By becoming retailers, developers can achieve higher margins.
An example of a developer turned retailer is Octopus Energy, the largest developer of solar plants in the United Kingdom. The company began as an independent developer in 2011, when it built its first solar generation plant. Since then, Octopus Energy has built 154 solar farms in the United Kingdom and another 66 projects in France.
The farms financed by the company generate 40 percent of the United Kingdom’s large-scale solar. It has also invested in wind generation and anaerobic digestion plants to offer gas services to clients. In addition, the company offers rapid response gas generation, which is crucial for balancing supply when there is no wind and sun. Octopus Energy’s retail arm began operating in 2016; so far, it is too soon to assess its success.
Playing an Active Role
These are just a few examples that show opportunities still exist in renewables for independent developers. However, developers will have to take a more active role in securing off-takers for their electricity and in understanding their customers’ demand profiles in order to maximize arbitrage opportunities.
Lead image credit: Oregon Department of Transportation | Flickr