Is Merchant Solar the Future: When and How Could Utility-Scale PV Enter the Wholesale Energy Market?

22 Jan 2013

by Josh Garrett for Sol Systems

As the drop in the federal Investment Tax Credit (ITC) from 30 to 10 percent in 2016 approaches, solar financiers, solar installers, and other solar partners are wondering if the industry can overcome its current dependence on federal tax credits by entering wholesale markets. Solar PV-generated electricity from utility-scale projects could be sold on one or more of the U.S. regional markets along with electricity from conventional generation sources and take the form of “merchant solar.”

Following the deregulation of many state energy markets in the 1990s, six major trading hubs managed by Regional Transmission Operators (RTOs) have emerged. On these markets, Independent Power Producers (IPPs) make deals with electric utilities to supply electricity. The liberalization of power markets has without question made the wholesale energy industry more competitive, though its effects on wholesale and retail electricity prices have been mixed. While much of the continental U.S. trades wholesale power on RTO markets, there are still many states that produce, sell, and distribute electricity under the pre-1990s model characterized by vertically integrated utilities, making for a patchwork of regulated and deregulated distribution zones across the country.

When considering how utility-scale solar power might fit into existing deregulated wholesale markets, it is worth noting that the most promising and fastest-growing solar PV markets lie within deregulated regions: the Mid-Atlantic, New England, California, and Texas. At first glance, this geographical overlap provides support for hopes of merchant solar entering wholesale markets in the near future. But such an industry shift relies on a host of other important factors, namely production costs, market liquidity, and prices.

Currently, those factors are not aligned in such a way that favors merchant solar. But the looming expiration of the wind industry’s Production Tax Credit at the end of this year has led merchant wind to blaze a renewable energy trail into wholesale markets.  As Lincoln Renewable Energy COO Dan Foley explained to Greentech Media in November of last year, one funding model that has worked for the wind industry and could be applied to merchant solar is the synthetic power purchase agreement (PPA). Technically, synthetic PPAs are not “merchant” deals, though they are similar, as they are based in transactions made on wholesale electricity markets.

According to Foley, the synthetic PPA is the result of a long-term agreement between IPPs and power marketers to sell electricity to purchasers on the market, known as load-serving entities (LSEs). Through synthetic PPAs, independent power producers can establish swaps with power marketers in which payments are made based on the difference between the hourly clearing prices for wholesale electricity and a fixed price previously agreed upon by both parties. The swap deals between IPPs and marketers work parallel to LSEs purchasing electricity from the market at the clearing price. Under these swap agreements, the IPP pays the marketer the difference between the fixed and clearing price when the clearing price is higher; when the clearing price is lower than the fixed price, the marketer pays the IPP the difference.  These contract-settling payments take place every hour as the clearing price fluctuates.  See the table below for a simplified example of how a synthetic PPA between a power producer and a power marketer would work:

Sample Synthetic Power Purchase Agreement

Agreed-upon fixed price: $50 per megawatt-hour

Time Market clearing price (per mwh) LSE pays market (per mwh) IPP pays marketer (per mwh) Marketer pays IPP
Hour 1 $45 $45 0 $5
Hour 2 $57 $57 $7 0

Such agreements, Foley explained, provide IPPs with price certainty that can be used to attract solar tax equity financing for a given project.

For now, however, the market conditions for solar to follow wind’s example in the wholesale space aren’t quite right, but many factors are trending in the right direction: solar panel costs are declining, panel efficiency is improving, and the price of natural gas is on the rise after bottoming out in early 2012.

Looking more closely at wholesale electricity prices along the East Coast, the New England (ISONE), New York (NYISO), and Mid-Atlantic (PJM) markets are relatively pricey.  According to the Energy Information Administration’s November Electricity Monthly Update, from September 2011 to September 2012, wholesale prices ranged from about $20 to $150 per MWh in New England, from $25 to $180 per MWh in New York, and from $25 to $125 per MWh in the Mid-Atlantic (see chart for additional information).  These high prices, as compared to prices in other regional markets, provide a slightly lower barrier to entering wholesale markets for developers along the eastern seaboard.

Is merchant solar the future of the utility-scale PV?  Given the rapid growth and streamlining of the U.S. solar energy in recent years, it appears to be a strong possibility. The state of the industry at the ITC expiration three years from now will likely hold the definitive answer.

About Sol Systems

Sol Systems is a solar finance firm and a leader in financial innovation in the renewable energy industry. Since its inception in 2008, Sol Systems has partnered with 350 solar installers and developers to bring over 3,000 solar projects from conception to completion by offering innovative financing solutions for residential, commercial, and utility-scale projects.

Sol Systems’ financing programs catalyze investments for a broad set of solar projects by simplifying their origination, diligence, and financing processes. Developers seeking financing for solar projects can access over $2.5 billion in capital through the Sol Systems investor network.

In addition to providing financing, Sol Systems also offers project due diligence, deal structuring, and asset management services – all designed to reduce overhead and transaction costs and quicken project development timelines.

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Josh Garrett

Josh Garrett