Solar investment advisory

Quarterly essay

Quarterly essay Q2 10

Is there a market for small and midsized power producers in renewable energy?

By Javier Herrero*

The renewable energy market is no doubt a very attractive one as it is in a high growth phase and all accounts point to its continuing to be so for decades. But are the capital gains and cash flows just in development and technology, leaving ownership for utilities and large funds, or is there a model for small to midsized power producers? Is the business model limited to just PV and wind or are other technology plays also possible?


Market conditions

While many large utilities and multinational energy companies have joined the rush into this lucrative market including the likes of British Petroleum, Iberdrola and Florida Light and Power the field is still open for many new entrants into becoming Independent Power Producers (IPP). PV ownership nevertheless has remained fragmented among investors and developers, but utilities and other “PV Power Producers” are beginning to evolve their strategies. A growing number of European utilities are looking to add solar PV to their renewable portfolios Including Enel, Electrabel, and EDF EN.
A recent report by Emerging Energy Research in a new market study shows clearly that the leading incumbents are slow to pick up on new business models for the production of energy and smaller, faster and more innovative companies are gaining the leading positions as IPPs. This fact is characterized by the global ranking of photovoltaic IPPs at of the end of 2009.
 It is clear that with a few exceptions the photovoltaic IPP market is dominated by European companies. At the same time, solar PV development in Europe has become the center of activity for global developers, PV suppliers and utilities. And the current amount of installed MW capacity by IPP by no means excludes new entrants. There are many new IPPs sprouting up especially as new markets and technologies continue to change and expand the market.
In the US however, and according to Dr. Chris Constantine Director of New Technologies Oerlikon Solar in an interview with the SEMI PV Group, a global trade association, "the fastest growing PV segment will be the distributed generation utility segment (under 20MW) with new utility project models, growing financing support, and growing public policy support to help accelerate growth. Total US demand could reach as high as 4GW in 2012, dramatically up from the 2009 level of less than 700MW."
It is apparent that governments and administrations around the world are enacting legislation targeted to promote small and midsized renewable energy power plants in an effort to localize the generation of electricity or production of energy sources and in the process are creating a positive environment for small to midsized power producers.
Again in the US, key short term growth drivers include the Investment Tax Credit grants that provide a 30% refund (not tax credit) through 2010, the DOE energy loan guarantee program, expanded utility financing, and accelerated depreciation schedules The clearly optimistic 4GW upside scenario assumes continuation and expansion of state-level incentives, national Renewal Portfolio Standards (RPS) and accelerated investment recovery. In California, which comprises 60% of the US grid-connected solar PV market, market drivers include the California Solar Initiative for systems less than 1MW in size, an increase in the RPS to 33%, expanded state FIT programs, and provisions that allow utility ownership and accelerated depreciation for solar. Constantine said that 29 states also have RPS, 16 with explicit targets or "multipliers" for solar and small-scale distributed renewables. Several states are considering additional RPS increases and FIT legislation to stimulate the development of small scale energy production plants.
This is also very much the case with wind energy as it is the leading renewable power producing technology due to its more efficient production capacity and many wind farms of 10-20 MW are being built for local energy use. The only setback for IPP companies focused on wind is the long development cycle but this is offset by a growing number of promoters that have initiated the wind studies early on and are willing to sell the licenses to developers or IPPs. There are also new models for IPPs in bio gas generating facilities which allow for small scale installations of 500 kW to 2 MW. Generating electricity locally is generally one of the strong points of renewable energy and biogas related power plants are probably the best example of generating power, which can be stored, while at the same time producing useful products such as energy, heat and fertilizers from waste.  An enormous opportunity for IPPs owning and operating a large number of these small plants is becoming a reality.


Working models

The main hurdle for incipient IPP companies is of course the financial model. In a capital intensive activity such as energy production the trick is not only being able to adequately finance each new operating asset but to get to positive cash flow as quickly as possible and also turn over some of the assets for a capital gain to finance further growth.
Finding and acquiring new operating assets, licenses or projects in the promotional phase that meet investment grade objectives is not easy either and many are turning to specialized M&A firms that lower the costs and provide efficiency gains in this task. Typically, emerging IPPs are looking for projects which have all the licenses and permits in place with a FIT or PPA securely in place. The size range that these operators are looking for is normally between 4 and 10 MWp in solar, between 10 and 30 MW for wind operators whereas biogas energy generating facilities fall into a smaller range of 0.5 to 2 MW class. The competitive operators may have to pay a premium for picking up projects at this stage but it is well worth it as it brings them much closer to generating the much needed positive cash flows or capital gains. Many IPPs have a strategic alliance with a developer where they share the costs of building the plant and then disinvest some of the assets for a capital gain. The flow then of capital from operations to fund the growth of IPPs can come from two sources, cash flows of operating assets held and capital gains from selling off non strategic turnkey builds.


*Javier Herrero is cofounder and managing partner at Bauhaus Capital Partners.

Visit Javier Herrero’s blog: http://jherrerosdc.typepad.com/jhsdc/

And Bauhaus Capital Partners website: http://www.bauhauscapitalpartners.com