How Small & Mid-Sized Developers (SMDs) Could Compete & Win in Highly Competitive Solar PPAs, Auctions & Bids

We have started eDGe Renewable Partners with a mission to help SMDs find the right financing, technology and development partners; we believe that SMDs are the key to the world’s successful transition into a green, low-carbon and sustainable economy. (To learn more about us, follow us on Linkedin).

Over the next few articles, we will talk about the main drivers for pricing and how to build effective financial models. We will also cover financial modeling for resource assessments, construction costs, operating costs, PPA dynamics & risk analysis. 

1- Cost of Capital (Equity & Debt)

We will start our discussions with the cost of capital since it is one of the most important drivers of bid prices. Cost of capital is also a significant competitive disadvantage for SMDs.

Cost of capital could be calculated as follows:

Cost of Debt (Interest) x Weight of debt x (1 - Tax Rate) + Cost of Equity (Required Rate of Return) x Weight of Equity

First: The cost of debt (interest) for any specific project/auction should be equal among all competitors because most (if not all) risks are fixed (off-taker, technology, interconnection, land, process, scale, regulatory, etc).

It is worth mentioning that some developers/equity sponsors could elect to provide corporate guarantees backed by their own balance sheets, which could significantly lower the cost of debt, however, this is rather a rare case, as most developers typically choose non-recourse project finance.

Second: The cost of equity, similar to debt, there are no fundamental, project specific, risks that could give an advantage to a large developer over a smaller developer, balance sheets aside. 

Think about an operating solar project, you will usually find a widely accepted market price (IRR), so why do developers have varying cost of capital, and consequently uncompetitive PPA pricing, pre-operations?

We believe the following issues might be the reason:

Issue 1: Mismatch of Capital: 

The major issue we typically find is that developers match with the wrong investor.

This is usually an investor who overestimates the risk of the local market, or project, and charges a high IRR resulting in an uncompetitive bid.

Equity sponsors typically charge a premium over the risk-free rate (or they will charge their opportunity cost which is the return they would have made on an alternative investment). This premium is usually a subjective percentage that differs widely from one investor to the other.

It also depends significantly on the investor’s own research, experiences, forecasts, analysis and most importantly, other investment options they have, how flexible they are, or in other terms, how much they need to win this bid/project. 

Issue 2: Terms and Structure:

It is also very important to focus on the terms of the equity and debt per-bidding (not jus the price). These terms are rarely discussed in details pre-bid and is left to when the bid is won or progressing.

Some regions/countries for example have a wide number of development banks offering more relaxed terms (grants, concession financing, grace periods, etc.). DSCR and LTV ratios could also make a big difference. Financing and transaction costs are also an important aspect to consider, with higher significance for smaller projects. 

Issue 3: Scale, track record, balance sheet, etc

These are more fundamental issues for SMDs. For example, investors could be more flexible with their premiums if there is an opportunity to partner with the developer in the future. That being said, with the right strategy, these hurdles could also be mitigated.

Some recommendations that could help: 

1-    Pricing your Equity:

With a combination of benchmarks and scenario analysis, you could determine and negotiate the cost of equity with your potential partners. An example is below:

2- Search for your Capital Partner:

While you could negotiate the cost of capital with your investment partner, it is definitely much easier to find (by aggressively searching) the investor who believes in the economics of market and has the right appetite for the project.

The larger the number of qualified investors you speak with, the more likely you will find the one partner with the lowest cost of capital. At least, you won’t be in a competitive disadvantage knowing that you are in the same position as your competitors (after you have done your research) with regards to the cost of capital.

3- Start with the end in mind

Using various tools such as financial models, and market intelligence, identify the price (or cost of capital) you think will make you win the bid, then start talking and negotiating with potential investment partners. This will help put you in a better negotiating position and will also help the investor understand what is needed to win the project.

4- Start as soon as possible

Most developers improve & become more competitive over time, as they learn more about pricing and build better relationships with investors. It is really important to start the pricing discussions as early as possibly, especially with potential investment partners.

Recent Auction Prices

In recent weeks, there have been several news about PPA auction results that showed record low prices in different parts of the world.

Europe:

The last auction in Portugal resulted in PPA prices ranging from U$16/MWh to U$36/MWh with an average price of U$22/MWh for a 15-year fixed price PPA. Germany latest solar tender saw winning PPA prices of $63/MWh. Hungary finished an auction of 15-year CFDs. 348MW of solar project have been awarded with prices coming in around $67/MWh. Poland recently concluded a solar RFP for 42MW under a 15-year CFD scheme with winning prices ranging from $70-85/MWh.

Asia:

Malaysia announced results of its third solar auction. 490MW were awarded in that auction with the lowest solar price being $42/MWh. The fixed price was for 21 years. Saudia Arabia’s previous rounds of tenders have attracted over 250 bids and seen low 25 year-PPA price bids as low as $16/MWh and a winning bid of $23/MWh.

Africa:

Tunisia just concluded its tender with the winners receiving a PPA price of around $28/MWh for 20 years with the lowest being $24/MWh.

To learn more about how eDGe Renewable Partners helps SMDs find the right financing, technology and development partners, follow us on LinkedIn or connect with us via email at samy@edgerp.ca