When people talk about Germany these days, it is to commend its─relatively─stellar economic performance and, for many, its success in developing renewable energies─and solar PV in particular, at a very large scale: over 25 GW of solar installed, out of which 3 GW in December 2011 alone.

The Chaotic End of a Government-Run System

Yet a closer inspection hints at a different reality: the demise of a system which has served the solar industry so well, in Germany and globally, over the last decade, the Feed-in Tariff (FiT) system. Talks are indeed under way within the German government to fully revise the system─and forcefully bring down the German solar market from 7.5 GW in 2011 to 3 GW per annum until 2020, possibly even less than 1 GW, paradoxically at the very same time when grid parity is in sight.

The German situation is just the last episode in a string of FiT system collapses: Spain (2008), Czech Republic (2010), France (2011), Australia (2011), Italy (2011), Britain (2012). What is going on?

Imagine an economy where a government agency fixes the price of a product, its shape and desired quantity, acts as a sole buyer (or mandates other buyers for that), and ultimately delivers the product to millions of consumers in exchange for a quasi-tax.

Is this the Gosplan that, in the heydays of Soviet rule, planned and supervised the annual production of millions of pairs of shoes and other consumer products, usually with an unwieldy shape and bad value for money ─that people had no choice but to buy? Well, maybe. That’s also the system that has ruled solar power generation in Europe (80% of the global market in 2011) over the last decade.

And just as surely as the Gosplan was good enough in its early days but quickly found its limitations, the intermediation of bureaucracy between sellers (power producers in our case) and buyers (power distributors or consumers) is ultimately a losing proposition, as seen in the ultimate fall of centrally-planned government-run economies.

A mechanism which was necessary to support a desirable, small and uncompetitive form of energy in its early days, has now gone astray as costs have sunk and volumes ballooned. According to some estimates, the actual premium on power prices needed to fund existing solar feed-in contracts in Europe could exceed 300 billion euros over the next 20 years…The system has run its course.

What we are witnessing is the chaotic transition from an unsustainable government-run system to a real market economy. The consequence for industry is steep: when the old system goes bust, so do most of the companies that had based their business models onto it (remember the Treuhand?). In the case of solar today, that unfortunately means most players, both upstream and downstream. Just look at the Spanish, Czech and French solar industries.

Back to Economics 101

Why did this come about? Three flaws inherent to government-run economic systems were bound to make the European solar mechanisms unsustainable:

-Obstructing price signals: Functioning markets allow prices to go up or down according to supply and demand, and to reflect shifts in cost structures. If prices are set arbitrarily, then volumes skyrocket (if they are too high) or go to zero (if they are too low);

-Open and permanent subsidizing: Subsidies work if they are either limited in time or in volume. Permanent, massive, uncapped subsidies lead to unsustainable economic behaviors, and possibly bankruptcy;

-Impeding the direct confrontation of supply and demand, power generators and consumer by the regulatory intermediation of an administrative body: Service offers are minimized, innovation is stifled, and most importantly in the case of electricity, systemic factors and costs (such as the overall balance of the grid) are disregarded.

These built-in flaws account for the massive and repeated inflation of photovoltaic installations ahead of feed-in tariff cuts, the unchecked and unsustainable explosion of support system costs, the growing disruption of wholesale power prices and, last but not least, the lack of sustainable business models for the supply of solar power to consumers.

Incidentally, what is true of solar is also true for other sources of energy: government meddling in power prices on the account of so-called ‘cheap coal’ was the direct cause for the South African power collapse in 2008, and France’s nuclear subsidies are bound to bring ugly surprises when the real bill for decommissioning nuclear power plants and waste storage comes due (over 200 billion euros according to some estimates).

Jumping into the World of Real Energy ─with Market Rules and New Allies

Should all solar industry players be scared of the transition from a government-run system to a market economy? Actually, if one takes some distance from the daily flow of negative announcements, the news is incredibly good.

Photovoltaic system price cuts (modules and now balance-of-system), one of the immediate causes of the demise of the FiT system, have now reached such a level that makes is possible, for the most efficient industry players in reasonably irradiated geographies, to generate solar power at or below 10 euro cents per kWh, and most likely 7 euro cents by 2014─at least that’s our roadmap at Solairedirect.

This is not grid parity, this is better: solar power at or below wholesale power prices, cheaper than all the alternatives for new generation, whether fossil, nuclear or renewables (with the possible exception of gas near the well). These are the guys who should be scared!

This disruption in relative prices means two things: First, solar power has definitely exited the tree-hugging ghetto and jumped into the giant pool of mainstream energy (where there are admittedly lots of sharks) and second, market economics are not solar’s foe, they are its best friend. How can that be?

The basic tool for integrating solar power into mainstream energy is the Power Purchase Agreement (PPA)─although merchant sales to the wholesale power markets can also be an option, yet not as strong in terms of bankability.

PPAs, if they are market-based (with or without tenders)─and provided they do not come with huge tax and other benefits (such as in the U.S.), are a very efficient way to massively cut the cost of solar incentives; with a view to eliminating them altogether very quickly.

Such market-based PPAs, like the ones Solairedirect just signed with 2 local utilities in Western France and a Chilean mining company for a total of 121 MW, provide the basis for a direct relationship between power generators and distributors/consumers, taking the cues from price signals to optimize the value of the solar kWh for all the parties involved, focusing project locations on the substations with the highest need for power and actual grid feeding on the highest value hourly slots.

More value can also be created for power off-takers by offering them long-term hedges against potential surges in power prices.

The PPAs also open the door for the delivery of a whole range of innovative services: long term asset development (for instance through repowering), smart grid services (to better integrate intermittent solar power generation to the off-takers’ load profile), marketing support (to promote solar-based power offers to power consumers), community ownership programs.

Perhaps, the most important benefit is the systemic benefit. Price signals and service contracts bring the responsibility onto the solar power generator to share the responsibility in grid stability, which is the absolute pre-condition for such an intermittent, distributed form of energy as solar to go beyond a few percentage points in the energy mix.

Combining solar power generation with demand response, other sources of energies and ultimately storage should not only be left to grid operators, but is a task which solar power generators should embrace, for instance through aggregation with other power generators.

In the end, the solar industry should see power distributors and consumers, and the market in general, as its best allies, to help improve itself and grow, and quickly become what it should be: a major, fully competitive yet distinct (distributed and ubiquitous) part of the energy mix

In the new world of market-based solar power, not all existing business models are called upon to flourish and the transition will be too steep for many existing players. New models and innovative new entrants are bound to emerge, local and/or global: The opportunity is up to everyone to seize!

Thierry Lepercq, Chairman of Solairedirect (www.solairedirect.fr/en), France’s second largest producer of solar power and a pioneer of the solar IPP (Independent Power Producer) model. Previously Lepercq had a 20-year carrier in technology finance, first with Banker’s Trust in New York, and later with Banque Arjil (Lagardere Group) and Oddo & Cie. In 1999, he founded NetsCapital, a boutique investment bank focused on information technology (software, semiconductors, telecommunications) which structured 40 transactions for a total of 400 million euros. In 2004, he set up Reseau Innovation Energie, a think tank with such participants as Caisse des Depots, Suez, EDF and Gaz de France.the leading company in the sector, now Honeywell Analytics.

For more information, please send your e-mails to pved@infothe.com.