1.3 Cents/kWh is now the lowest solar tariff, are these tariffs promoting the industry and the fight against climate change?

You must have been surprised to see the record low prices announced in the Portuguese auction on Wednesday. After all, how could you achieve any return/IRR with those exceptionally low tariffs? The answer probably is that you could not. Even with low EPC/Capex prices (assuming strong purchasing power of larger players), the payback period on a similar tariff will be close to the 15 years tenor (or even beyond) of the PPA contract offered. This implies a zero or negative return on the 15 years tenor.

Think about the recently announced 2GW Solar project in the UAE that have achieved $0.0135/kWh, only 3 months ago. UAE has significantly higher irradiation potential (solar resource) and a higher credit rating (AA compared to BBB in Portugal).

Larger players are assumed to have access to sophisticated tools for assessing/pricing of projects, better information, or relationships. However, the aggressiveness of the assumptions the developer/investor underwrites in their financial model is the real driver of those low tariffs. This implies an increased level of risk appetite (or exuberance) but not sophistication or any unique competitive advantages.

This increased risk appetite could be in the form of 1) a longer view on the market beyond the 15 years contract (i.e. assuming a 35-40 years life for the project and a merchant price/curve 2) assuming interest rates at almost 0% over the long term. 3) Assuming a further decrease in modules/equipment prices and 4) assuming operational perfection or future sources of revenues.

This leaves us with the main questions, do these prices/tariffs help promote and advance the renewables industry and fight against climate change (supposedly this is the main driver for the industry)? I cannot stop thinking about the negative impacts and limited positive impacts of those ever-decreasing tariffs.

First, smaller developers and investors who can’t take those similar – very long term - risks (mainly because they do not have the balance sheet or appetite) will be out-competed and off the market sooner or later as they won’t be able to compete on the utility scale level and the corporate PPA market will look for references/guidance from the utility market.

Second, assuming risks today that could only be understood 15-20 years later (i.e. taking significant risks today that will only be unwind in 15 years) would generally lead to a stressed industry in the present, as most projects won’t be profitable on hopes that after 15-20 years, profits would be possible. This strategy of market share acquisition at all costs have previously resulted in module manufacturers going bankrupt, causing stress in the industry and investors questioning the viability of solar/renewables.

Third, very few investors could sustain those levels of risk and returns, causing investors exiting the market.

On the positive side, we have yet to see the positive impact of the additional savings from the lower electricity prices, either directly on customers or generally on the economy (i.e. does cheap or free electricity lead to growth in economic activity?).

The good news is, smaller developers/players could still compete (although it is getting harder) if they are able to provide unique value propositions to their clients (better local relationships that larger players can’t do) and ensure that they have the right capital structure, partners and inputs/information in their assumptions.