A Compelling (and Complex) Opportunity: Creating Value as a Solar Developer in 2020

A Compelling (and Complex) Opportunity: Creating Value as a Solar Developer in 2020

Letters from our CEO |
By Yuri Horwitz

When we
started Sol Systems around a dinner table in 2008, PV modules cost $3/watt –
and that was a recent breakthrough. Those same modules now cost 30-40 cents/watt
and they are significantly more efficient. As we noted last
, solar energy technology continues its path to global dominance. Costs have
fallen by 89% in the last decade, even as modules and balance of systems (BOS)
increase in efficiency, and solar is now the least expensive source of electricity in two-thirds of the world.

Solar pricing
will further fall in the next five years as multi-busbar modules increase
harvest and reliability, wafers get both thinner and larger and drive
efficiency, raw silicon declines in value, silver use falls by 40%, and
manufacturing facilities become more efficient. Our previous
annual letters
described many of these changes in more technical detail. All
of these changes are occurring at a time when natural gas exploration and
production firms are beginning to stabilize their businesses and focus more on
cash flow to meet large amounts of debt and focus less on growth. When natural
gas prices go up as a result, so too will the price of electricity, since
natural gas is the primary source for electricity in the United States (38% in 2020), further driving demand for cheap solar power.

As a result,
the U.S. and global solar markets will continue to scale. Solar composed around
40% of all new capacity in the United States in 2019 and it will
compose an estimated 32% in 2020. Wind will provide 44%. Solar
generation is projected to expand globally from 571 TWh in 2018 to an estimated 1,263 TWh
in 2022. Bloomberg New Energy Outlook estimates that solar and wind will
provide 50% of the world’s electricity by 2050. Couple these changes with an
electric car fleet that is 30x what it is today, utilizing around 10% of the
world’s electricity, and a very interesting picture of the future emerges. The
times, they are a changing.

These changes
are dramatic, and they are impactful for our industry. Their impact is at the
heart of why so many of us got into this business to begin with and we all have
much to be proud of. But good changes can be challenging too. Running a solar
company has always been a bit like competing in the World Series on a shifting
field a la the ‘89 Giants. It’s either fun or crazy, or both. Your call. 2020
arrives with its own unique opportunities and dynamic market changes for solar

Large Developers + Institutional Investment =
Even Larger Developers

2019 served
up a super-sized array of mergers and acquisitions as the solar industry looks
increasingly like the more consolidated wind industry. Recent examples include
Canada Pension Plan Investment Board’s acquisition of Pattern Energy,
BlackRock’s majority investment in GE’s renewable energy platform, Ares Management
Corporation’s majority investment in Heelstone Energy, TerraForm
Power/Brookfield’s acquisition of the Washington Gas/AltaGas portfolio (platform), and
Green Investment Group’s acquisition of Tradewind Energy. And it’s not just developers that
are consolidating; asset management platforms like AlsoEnergy and Power Factors
are growing through acquisitions, and oil majors Ørsted, Shell and BP are all
doubling down on investing in renewables via acquisitions in the United States.

That drumbeat
will continue in 2020. Institutional investors like pension, insurance and
infrastructure funds will increasingly invest in renewable energy development
platforms (not just projects). They will make these investments because the
infrastructure market is increasingly crowded and competitive and project
returns are historically thin (generally hovering at 6-6.5% unlevered after-tax
internal rate of return, with some merchant tail risk thrown in for good
measure). These institutional investors don’t necessarily want to run a
development company; they want a project pipeline and potentially a partner to
help them. The more creative buyers can structure their platform investments or
acquisitions to mimic a pipeline acquisition.

institutional investment and scale enable developers to offer differentiated
customer products. Investor demand for yield is also forcing developers to get
more creative in how they structure projects. An estimated 20% of all new
utility builds in the United States will be offsite PPAs. The traditional
contract for differences (CFD) is a financial swap that avoids some of the
complexity of physically delivering electricity to customers. It’s rather
elegant in design, but sometimes less elegant in practice. Locational and
temporal basis risk mean that customers or project owners (and sometimes both)
aren’t swapping electricity at the same price or buying electricity at a price
that corresponds with what they contracted for.

As a result,
some customers are asking for a firmed and/or shaped product that matches some
or part of their load, and sometimes requesting that developers combine solar
projects with batteries or other technologies and market the ancillary services
and capacity associated with production and storage. For example, a customer
may request physical delivery of a firm on-peak block of 200 MW to be delivered
at a Dominion hub starting in January 2021 for a 12-year PPA. The customer may
even want to swap the RECs and has no interest in the capacity, which means the
owner needs to manage this asset.

A solar
developer that wants to meet that demand may need a license to market
electricity, additional thermal generation to firm and shape the block it is
delivering, an environmental commodity team that can manage SREC and REC
exposure, and an active electricity trading team that can hedge, block, and
deliver into PJM. Or they need a partner. For those retail energy suppliers
that have this capability (our friends at Calpine, NRG, Direct, or Tenaska to
name a few) there is tremendous opportunity to collaborate with the solar
industry and serve their customers. What has been less successful for some of
these businesses is offering these products directly without partnering with a
solar developer. In short, we all need one another to build the industry we all
want to build. Which is why this is not only an opportunity for retail
electricity suppliers, but solar developers and project owners as well.

But Wait Up…Local Developers Still Create
Much of Our Industry’s Value

While the
industry is both scaling and consolidating, skilled regional developers will
continue to play a critical role creating value in 2020 and beyond. As they

development platforms that scale will rely upon these more regional developers
to aggregate pipeline and achieve scale. Large institutional funds take razor
thin economics and are incentivized (required) to deploy capital in hundred
million-dollar chunks.

That may be a
perverse incentive, but it is a real one. One primary value differentiator for
smaller developers is their deep understanding of local political conditions,
sensitivities and knowledge around land acquisition and land use, and a
connection to local communities and customers. There are therefore tremendous
opportunities to create value on the ground with market-specific strategies for
highly focused developers. 

disclosure: this changing landscape does require significant discipline and
planning. Last
we urged caution around packing
and filling pipelines with non-tenable assets. We reiterate that
caution here. Because many markets are saturated with projects, creating
differentiated value is mission critical. It is imperative that before grabbing
a bourbon at the local well with a perspective landowner, a development team
first evaluates congestion risk and locational marginal pricing and monitors
the queue to understand where other projects are coming online. It is also
imperative that developers are mindful of historical land use and work closely
with communities. As solar scales, the relative attractiveness of another 20,
50, or 100 MW project in a nearby field goes down for many communities.
Coordination with environmental non-profits and community interests is key.

Stay Focused

All of these
moving pieces are specific to one geography. Although scaling from a regional
developer to a national development platform and fully integrating both appeal
to our innate sense of purpose and mission (“hey look, it’s awesome, we’re 100
people!”), it’s a path fraught with challenge. That’s a lesson many have
learned the hard way (we certainly have).

As developers
move from one market to another, they must adjust to different incentives,
different timelines and very different regulatory regimes. These new markets
mean significant changes to individual project and portfolio development
timelines. These changes can also magnify risk implicit in one asset across a
dozen assets, fundamentally altering the risk-adjusted return for a developer
and its capital sources. In a simple example, a development financial model in
the Massachusetts SMART program does not translate into Maine given the vast
differences in interconnection. And vice versa.

New markets
also often mean different customers, which mean different sales strategies,
which mean fundamental corporate organizational changes and maybe even new
corporate funding sources. Community solar in Minnesota is not community solar
in Maryland. EPC in the Southeast is not EPC in the Northeast. O&M in the
Southwest is not O&M in the Midwest. We all endeavor to grow, but we urge
you to harness your ambition incrementally…don’t let it harness you.

We offer
similar advice around vertical integration. In the early years of Sol
(2008-2012) the industry grappled with determining the best means to create
value, to maintain control and certainty, and to select where to invest to
enable success. Almost every large developer has gone through one or more
gyrations of vertical integration and then specialization, either to capture
margin or because they were concerned about relying on third parties (or both).
Recently, many developers that made large investments in building out
construction teams are paring those teams down, or in some cases splitting them
into two different businesses and forcing them to compete on market terms.

module companies that were focused on both production and
development/construction are changing their strategies as they realize that
they don’t need to develop proprietary pipeline in order to maintain market
share. In 2019, First Solar downsized its EPC and development efforts. Meanwhile, Sunpower split its company in two so that its module business (now
Maxeon) could focus on module production and its development business (which
maintains the brand) can focus on customers.

Instead of
attempting to vertically integrate, developers can use their resources to
identify new markets or market niches and create value within these markets.
Developers can actually build new markets (like Maine, Virginia or
Pennsylvania) through policy intervention. And developers can build stronger
and more integrated relationships with key customers. Further, early-stage
developers can narrow their focus on where they maximize risk-adjusted value
for their balance sheet and capital partners. Developing early-stage assets is
both incredibly challenging and critical for the solar industry. These assets
are the seeds that our industry will eventually harvest in the next decade.

these market changes de-risk the development cycle for the industry, which
leads to a lower cost of capital, which in turn leads to a more competitive
product for the customer, which leads to scale for the industry. So while
they’re sometimes challenging, they’re generally good.

So…Where to Play?

This industry
transformation means making a very purposeful decision about where to play in
the development, aggregation and ownership cycle.

The earlier
in the market and the development cycle and the more localized the effort, and
the greater the advantage of a local or regional player. A localized presence
is a differentiator when speaking to a city council. This development strategy
may lend itself to an early-stage “flip” model where developers focus on
getting the project papered with a lease option, feasibility studies, and maybe
an interconnection study. Focus local, create a solid team, build a reputation,
then sell your assets to a developer partner or long-term owner you can trust.
Then scale responsibly. And while this is a good place to start as a new
developer, it’s not just small companies that pursue this business model. Some
of the most successful developers in the country do this. If done correctly,
it’s highly capital efficient.

For those
developers that are aiming to commercialize their assets by securing a PPA,
there are not only the long-standing financial barriers of development spend
between initial development and securing offtake; there is now an additional
challenge of creating and shaping the financial and energy product customers
are demanding for offsite projects. The combination is a potential barrier to
entry that will increasingly drive the solar industry towards consolidation. If
developers can dedicate the resources to become sophisticated players here,
there is certainly an opportunity.  On
the other hand, those resources may also be a significant distraction.

And for those developers or funds that are aiming to own semi-merchant, community solar, CFD, physically hedged, or other complex assets long-term, the challenges are perhaps more myriad. Evaluating and managing environmental commodity and electricity risk long-term requires a significant investment and deep knowledge of policy, electricity demand, technical trading, and fundamental trading. Consider what these assets look like post-PPA as you strive to create value.

If you have questions around corporate offtake, financing semi-merchant assets, managing environmental commodities, or building your development business give us a shout. We’re always happy to help the industry grow and a rising tide lifts all boats. Thanks to all of you for building this incredible industry with us these last 11+ years. We’re excited to build the future with you


Systems is a leading national solar energy firm with an established reputation
for integrity and reliability across its development, infrastructure and
environmental commodity businesses.To date, Sol has developed and/or
financed over 850 MW of solar projects valued at more than $1 billion for
Fortune 100 companies, municipalities, counties, utilities, universities and
schools. The company also actively shapes and trades in environmental commodity
and electricity markets throughout the United States. The company was founded
in 2008, is based in Washington D.C, and is led by its founder. Sol Systems
works with its team, partners, and clients to create a more sustainable future
we can all believe in. For more information: www.solsystems.com

Recent Articles...