The aim of the European solar energy incentive programs has always been to bring solar technology to the point where photovoltaic (PV)-generated electricity becomes competitive with the retail rate of grid power, a situation known as “grid parity”. In most of Europe, grid parity is expected to be reached by 2017, but is already nearly a reality in certain southern European countries with high levels of sunshine and high electricity prices.
The recent cuts to incentives in many European markets are both a cause and an effect of this near-parity, and as such are not necessarily bad news. Achieving competitive cost structures for solar power plants is expected to eliminate the market distortion resulting from subsidies, which until now were the driving force of the European PV market.
Feed-in Tariffs on a Constant Decline
Fol lowing ef forts by the European Commission to promote renewable energy, most EU Member States have introduced incentive schemes awarding direct payments, generally known as feed-in tariffs (FiT), for the production of or injection into the grid of electricity produced by PV facilities. As a strategy to boost the development of technology and bring down component prices, these incentive schemes were a great success. At the same time, the costs of such programs (whether financed through taxes or an extra charge on electricity bills) have become unsustainable for national budgets or consumers and many governments have made substantial reductions to their FiT. The two biggest PV markets in Europe— Italy and Germany—are typical of this development.
In March 2012, the German Parliament agreed to a significant reduction of FiT. Pursuant to the initial draft, the FiT for PV plants exceeding 10 megawatts (MW) will be abolished completely. Plants between 1 MW and 10 MW will receive only €135 per megawatt hour (MWh), while smaller plants will receive €165 per MWh or €195 per MWh. These numbers will only apply to plants completed in April 2012, the FiT for plants completed later will be subject to a monthly reduction of up to 2.8 per cent, depending on the total newly installed capacity in Germany, for which the law defines certain targets. In addition, it is envisaged that only 90 per cent of the electricity produced will be remunerated through the FiT and the remaining 10 per cent must be self-consumed or sold to the market. While this is meant to encourage direct distribution of electricity, the immediate effect is another reduction of the feed-in tariff of up to 10 per cent. Although some details of the new FiT regulation may be expected to change during the legislative process, it is likely that the FiT will effectively drop below €100 per MWh in 2013 or 2014.
The direct distribution of electricity to small utilities or large industrial electricity consumers will consequently become a serious alternative to the FiT. In this respect, the interplay with the German direct distribution regime is interesting, as it allows an operator to maintain the applicable FiT as a fall-back for the first 20 years of operation. The worst case scenarios for project finance lenders can still be based on the FiT.
In Italy, incentives for the production of electricity through PV facilities were first introduced in 2005 by Ministerial Decree (the Conto Energia). The incentive system was modified several times, each time with cuts to incentives. The draft of a fifth version of the Conto Energia is currently under discussion and is expected to enter into force in autumn 2012.
The fifth Conto Energia will replace the feed-in premium, which was paid on top of the price for the sale of the electricity, by a true feedin tariff, i.e., an overall incentive including both the price for the sale of the electricity and the production premium. As currently proposed, the all-inclusive FiT relevant for industry-scale PV plants exceeding 5 MW will be initially €128 per MWh (or €135 per MWh for rooftop PV plants) with half yearly decreases arriving at €108 per MWh (or €104 per MWh for rooftop PV plants) after two years. Furthermore, the current draft provides for the introduction of annual budgets and caps for all PV plants exceeding 12 kW that do not allow for serious investments in utility-scale PV plants on the basis of the FiT system. Considering also that in 2011 the price for the sale of electricity in many areas of Italy ranged from €90 to €100 per MWh, and is only expected to increase in the future, it becomes obvious that the benefit of the FiT becomes less and less relevant, and it becomes increasingly viable to self-consume the electricity or sell it directly to large end-consumers or utilities.
Power Purchase Agreements
These developments in Germany and Italy are only two examples of a trend that can be seen in many European countries. The industry is moving away from FiT towards PPA markets, which are markets where PV facilities generate their return exclusively through long-term power purchase agreements (PPA). This market does not necessarily require full grid parity, as large utilities and industrial customers are prepared to agree on power prices that are higher than current electricity prices, if they are guaranteed for a sufficiently long period of time.
PPAs will have to satisfy the needs of lenders, sponsors (the sellers) and customers (the purchasers), address technical and commercial risks, and take into account the specific requirements and restrictions imposed by the national regulation of the production, transport and sale of electricity. Typically, the following key issues should be addressed in a well-drafted PPA.
- Construction and Commercial Operation: The PPA will have to deal with and limit the purchaser’s (often excessive) requests to exercise control over the construction process. The consequences of a delay to commercial operations must be negotiated carefully.
- Term: The term needs to be long enough to recover the investment and to offer the purchaser long-term security on the power price. Early termination needs to be limited as far as permissible to certain defined cases. Force majeure needs to be defined carefully.
- Exclusivity: Generally, the purchaser must buy all the energy produced by the facility and the seller will be in default if the energy is sold to a third party. Exclusivity arrangements must, of course, be compliant with local laws and regulations and should provide for some necessary flexibility, such as during any period of curtailment.
- Price: Normally, PPAs provide for a fixed and flat price over the full term. But a soft indexation may also be attractive for purchasers that expect conventional power prices will increase faster than inflation.
- Benefits: The parties need to define who will be entitled to the benefits associated with the PV power production, such as renewable energy certificates or levy exemptions. These associated benefits need to be transferred in accordance with the relevant regulations.
- Metering and Invoicing: The process needs to be defined clearly. Electricity meters might be temporarily unavailable or produce uncertain readings, necessitating a fall-back solution.
- Availability: Despite the natural unpredictability of the electricity output of a PV plant, availability forecasts and availability guarantees are often required by the purchaser.
- Counterparty Risk: The seller needs to be comfortable with the long-term creditworthiness of the purchaser. Termination and enforcement rights must be coordinated with the applicable insolvency legislation.