Solar Is Powering Up, On The Roof or Over The Grid: Primary Credit Analysts

Solar Is Powering Up, On The Roof Or Over The Grid
Primary Credit Analysts: Trevor J D'Olier-Lees, New York (1) 212-438-7985; trevor.dolier-lees@standardandpoors.com Winston W Chang, New York (1) 212-438-8123; winston.chang@standardandpoors.com Steven J Dreyer, Washington D.C. (1) 202-383-2487; steven.dreyer@standardandpoors.com Secondary Contacts: Hiroki Shibata, Tokyo (81) 3-4550-8437; hiroki.shibata@standardandpoors.com Michael Wilkins, London (44) 20-7176-3528; mike.wilkins@standardandpoors.com Jeong-A Kim, New York (1) 212-438-1211; jeonga.kim@standardandpoors.com Research Contributor: Stephen Coscia, New York (1) 212-438-3183; stephen.coscia@standardandpoors.com
Table Of Contents
Competitiveness Of Solar Power Versus Other Types of Electrical Power Generation Capital Markets Now Open For Utility Scale Projects Japanese Solar Boom Europe Still Has A Gleam For Solar Efficient Capital Market Financing For Distributed Solar Generation Is A Tough Nut To Crack Let The Sunshine In Related Criteria And Research
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Harnessing the power of the sun has increasingly become a cheaper, cleaner, and more widespread alternative to electricity generated by fossil fuels. Several factors account for the growing role of solar power. Among them are the sharp decline in photovoltaic (PV) cell prices over the past few years, growing comfort level of capital markets when it comes to funding solar projects, government assistance and subsidies, and, in most U.S. states, renewable portfolio standards, which direct utilities to obtain a share of their power from renewable sources. Still, solar has a long way to go before it can be considered a mainstay: It currently generates less than 1% of all electricity, although that figure varies by country and locality. The U.S. by itself had about an 11% share of global PV solar energy production in 2012, according to GTM Research and the Solar Energy Industries Association (SEIA). Overview Solar-generated power will likely show significant growth in coming years, both in distributed (i.e., rooftop) and utility-scale projects. Financing for solar projects may increasingly move to the capital markets as standardization of distributed solar power financing improves. Policy decisions regarding the price of solar energy and the extent of federal tax subsidies will influence the degree and speed of its spread.
When someone flicks a switch and turns on a light powered by solar, it's only the end of a long process that included planning, financing, manufacturing, siting, construction, and transmission of that power. Solar power can be generated from large arrays of PV cells that collect sunlight, sometimes from millions of panels on "solar farms," convert it to electricity, and send it to local utilities. Or, more directly, it can be generated from solar panels installed on-site at individual homes and businesses. The former is called utility-scale power, and the latter is distributed generation. Although there were more utility-scale than residential or commercial installations in 2012 (see chart 1), Standard & Poor's Ratings Services sees further growth in all segments of the solar power industry, and we expect distributed solar to become more common as financing for it becomes standardized and routine.
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Chart 1
Competitiveness Of Solar Power Versus Other Types of Electrical Power Generation

Although the technology involved in either distributed or utility-scale solar power is constantly improving, the wholesale cost per unit remains higher than established technologies (see chart 2). The U.S. Energy Information Administration estimated in early 2013 that for plants that come on line in 2018, the levelized cost of energy--which includes construction, operational, and fuel costs--for a megawatt-hour of solar PV power will be $144.30 and $261.50 for more complicated solar thermal plants. In solar PV plants, sunlight is transformed in the PV cell directly into electricity. In a typical solar thermal plant, sunlight is concentrated through mirrors or lenses to produce heat, which boils water or another liquid to create steam that drives turbines.
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Chart 2
By comparison, costs for a conventional coal-burning plant and a combined-cycle natural-gas-fired plant run $100.10 and $67.10, respectively (see table 2). Similar cost differentials exist in the rest of the world. The higher cost of solar power explains why even though it's desirable from an environmental point of view, it's likely to need some form of subsidy until costs reach parity with conventional power sources at the wholesale level. These U.S. government estimates, however, don't include the possibility of lower total costs that result from targeted domestic tax credits. New solar plants that come on line before the end of 2016, for instance, are eligible for a 30% investment tax credit on capital spending. Whereas, solar projects that come on line after that are eligible for a 10% tax credit. Nor do those estimates reflect any changes that might occur in the relatively low current price of natural gas, now the fuel of choice in the U.S. for new utility scale electric power. Material changes in the cost of any conventional fuel could help or dampen prospects for more solar power growth. Solar power costs do have a bright side, and that's the fall in prices of PV material resulting from increased production (principally in China) and oversupply. That price decline was apparent in 2012, when the price of polysilicon, the principal raw material for most solar PV cells, declined 37% to $19.88 per kilo in the last quarter of that year, from $31.62 per kilo in the first, according to GTM/SEIA (see chart 3). The cells and wafers made of this material also showed similar price declines (see chart 3).
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Chart 3
The reduction in PV system installed and related costs, such as customer acquisition and financing has led to a reduction in stalled prices (see chart 4).
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Chart 4
We believe that PV system installed and related costs, such as customer acquisition and financing, and system component costs will continue to fall leading to the greater penetration of solar generation. However, given the capital intensive nature of the industry a challenge to future growth is the need for long term efficient capital.
Capital Markets Now Open For Utility Scale Projects

Institutional investors are becoming more aware of the technologies and financial arrangements with utilities that solar power producers use. Moreover, in the wake of the financial crisis and new regulations, some banks have become less interested or less able to provide long term financing for the larger utility scale solar projects, opening the door for new backers. Standard & Poor's recently rated the world's largest PV utility scale solar project, Solar Star Funding LLC, in addition to ratings on CSolar IV South LLC, which we rated in October 2013, and Topaz Solar Farms LLC, rated in September 2012 and upgraded in April 2013. Thanks in part to the renewable portfolio standards, such projects often have a ready buyer for the electricity they generate through power purchase agreements (PPA) with local utilities. These privately negotiated long-term PPAs are key to a project's creditworthiness and are supportive of investment-grade ratings we
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have assigned in this sector. In parts of Europe, utility-scale solar projects benefit similarly from feed-in tariffs (FIT), where regulated utilities buy renewable energy at a government-set price. FITs and PPAs reduce the financial risk for solar producers and help make their projects viable.
Japanese Solar Boom

Internationally, construction of utility-scale solar plants is often a function of growing demand for electricity. However, two broad factors may temper this: economic viability and environmental concerns. Ongoing problems at Japan's Fukushima nuclear plant following the 2011 Tohoku earthquake and tsunami have heightened that country's interest in alternative power sources, solar among them. The Japanese government in July 2012 enacted a law for a new FIT system that directs the country's electric utilities to purchase clean energy at mandated, above-market prices guaranteed for 15 to 20 years. We expect that power coming from renewable sources in Japan will ultimately move from 1% to 2% of the total to perhaps 5% in 20 years, and that large-scale solar PV operations are the most likely form to benefit. In fact, around 90% of new investment in renewable power projects following implementation of the new FIT went to solar power, far exceeding our expectations a year ago. Even though the government plans to correct the imbalance with an increase in guaranteed fixed prices for offshore wind power from April 2014, new technology requirements and environmental concerns lead us to take a conservative view of growth potential for offshore wind power. Even if the guaranteed fixed price for solar power declines, we think the asset type will remain attractive to investors due to falling costs for solar panels, and therefore the solar power market will continue to grow in Japan over the next one to two years.
Europe Still Has A Gleam For Solar

Ambitions for more solar power are high in Europe as well, but in some countries hopes have been tempered by strains stemming from lingering banking or sovereign credit issues. The willingness to generate more renewable power hasn't abated, but costs have risen. Spain has had a generous FIT to encourage the use of renewable power and is among Europe's leaders in promoting solar energy. But the FIT has proven a gross mismatch between what renewable power costs to produce and what users pay for it. In the past dozen years this has led in part to a 26 billion tariff deficit. In July 2013, the Spanish government announced a measure that would essentially require the government and consumers to pay more for electricity to whittle down this deficit. Solar producers will now sell electricity on the open market and the industry estimates that its revenues could fall by as much as 40% under Spain's new measures. Arguably, solar is in a better situation in nations with a stronger economy (see chart 5). The European leader in solar PV is Germany. According to the Federal Solar Industry Association, a German trade group, PV solar power will increase from 4.7% of all German electricity production in 2010 to 10% in 2020. Germany supports its renewable sector with a generous FIT that has reduced the risk of construction, something that's more feasible in a nation with Europe's strongest economy.
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Chart 5
Efficient Capital Market Financing For Distributed Solar Generation Is A Tough Nut To Crack
Distributed solar power has proven popular in many regions of the world, but understanding and structuring its financing is more difficult. In the U.S., capital for distributed generation is scarce and largely limited to major players. Like financing a single large power project--a dam, a gas-fired power plant, or a utility-scale solar PV sun farm--financing distributed solar generation assets can be complex and the due diligence for each asset time consuming. Until very recently the funding of distributed generation came from high net worth individuals, tax equity players and banks' lending typically on a project finance pool basis. With the advent of the SolarCity LMC Series I LLC financing, momentum towards efficient financing is building. Financing thousands of panels on homes or bundling multiple commercial and industrial installations in one transaction can benefit from pooling in a project financing or through securitization. Either, in our view, can potentially deliver the scale, structure, and homogeneity that investors seek. Further efforts continue to support the path to efficient financing. This includes industry groups such as the Solar
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Access to Public Capital (SAPC) working group, led by National Renewable Energy Laboratory and truSolar. SAPC is striving to create more homogeneity among contracts and data; truSolar is seeking to create standards in credit risk measurement. Another major issue associated with utility-scale and distributed solar generation is simply the quality of the manufacture of the panels and other components and the quality of their installation and maintenance. Given these are expected to be long-term operating assets, lower standards of quality can lead to reduced power generation and commensurate cash flows to support financings. So this is a factor in our credit analysis of both solar project financings and securitization. Efforts are under way to improve quality through standardization and other risk mitigation techniques such as quality assurance programs at factories, quality testing, and insurance. "The ultimate challenge for the industry is to standardize," said Lars Norell, a managing partner at Altus Power Management, speaking at the International Project Finance Association's Sept. 18, 2013, conference, "Distributed Solar: Key Credit Concerns and Financing Options," hosted by Standard & Poor's. Federal and state governments are also keen to support the path to efficient financing. For example, New York State recently launched a billion-dollar "green bank." Speaking at the conference, Richard Kaufman, chairman of energy and finance for the state, explained that the "green bank can help in accelerating the evolution of solar financing to capital markets." But the industry is still young and how these different financing mechanisms and mitigants will ultimately play out remains to be seen. Net metering has caused tension between the PV developer industry and the utilities. From the consumers' perspective, the current net metering regime creates an economic incentive to install a PV system. This is more so for residential customers than for commercial entities because they have different consumption profiles. Given that the average residential consumer uses more electricity in the evening when the PV system generation is low to zero and the majority of the day's generation would be exported to the grid at the retail rate, this credit generally reduces the consumer's monthly bill.
Let The Sunshine In

Perhaps the brightest expectation in the near term for solar power in the U.S. is that in the aggregate we see the growth in solar generation continuing to increase even beyond what government policies such as state renewable portfolio standards mandate. How this expansion gets divided between utility-scale and distributed solar power, however, will depend on a number of variables, including the outcome of net-metering regulatory decisions in the states, the extension or elimination of federal tax credits for solar, the development of standardized financing for distributed solar projects, and innovation in solar technology. The day will come, in our view, when turning sunlight into electricity will be as natural as sunlight itself. Writer: Robert McNatt
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Related Criteria And Research

Why U.S. Electric Utilities' Credit Quality Can Withstand The Rise Of Rooftop Solar, Nov. 15, 2013 Rapid Growth Is Expected In Rooftop Solar In The U.S., Nov. 15, 2013
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