U.K. Solar Market: The End of the Beginning

The purpose of this article is to give an objective view of the current debate in the U.K. regarding the eligibility of large-scale solar projects for FiTs. One of the major drivers for the early review has been the incumbent government’s concern over the projected growth of large-scale solar projects in the U.K.

By Ashvin Suri

The recent release of the fast track consultation document (March 18, 2011, see page 22) by Gregory Barker, Minister of State, Department of Energy and Climate Change (DECC) for the U.K. solar sector, is simply the end of the beginning of the solar sector in the U.K.

The fast track consultation comes in the aftermath of the damage caused to the industry’s confidence, post the press release by the Energy Secretary, Chris Huhne (February 7, 2011). Chris Huhne called for a comprehensive review of the U.K. Feed-in Tariffs (FiTs) originally introduced in the U.K. market on April 1, 2010.

The purpose of this article is to give an objective view of the current debate in the U.K. regarding the eligibility of large-scale solar projects for FiTs. One of the major drivers for the early review has been the incumbent government’s concern over the projected growth of large-scale solar projects in the U.K.

Current Market Status: ‘Nascent at Best’

The current status of the U.K. PV market is ‘nascent’ at best, with ‘zero’ large-scale (ground- or roof-based) projects installed or connected to the grid.

Wheal Jane, the first large-scale ground-based project to receive planning consent (Cornwall, September 2010) for a 1.55 MWp project is yet to commence construction. It is expected to receive grid connection, just in time before the proposed August 1st 2011 trigger date (reduction of FiTs). Assuming, that, this project is able to complete grid connection in time, as of August 1st 2011, the U.K. market will have only one large-scale (above 1 MWp) project established under the FiT scheme introduced in 2010.

According to the consultation document published by the DECC, as of December 31, 2010, there were ‘zero’ PV installations over 100 KWp. The majority of installations in the UK market (14,664) are sub 10 kWp, with nearly 95% below 4 kWp (as per the DECC consultation document).

The government’s argument for the need for a revision of the FiTs, because of the ‘uptake’ of large-scale projects, is both irrational and irresponsible. The government has argued that large-scale (over 50 kWp) projects were not envisioned as per the FiT legislation introduced in April 2010. This is absolutely a ludicrous statement, as it clearly stated in the April 2010 legislation, that the eligible range for installations is up to 5 MWp. It is, therefore, not surprising, that project developers, investors and industry participants have worked on the basis of the faith, trust and credibility placed in the U.K. government to develop projects up to 5 MWp. It is also clear that the U.K. government, despite being laggards in the solar sector, with every opportunity to learn from markets like Germany and Italy, have shown little evidence of such learning or understanding of the sector. A case in point is the U.K. government’s classification of projects over 50 kWp as ‘large-scalel. Large-scale projects in Germany average between 15 MWp to 25 MWp in size!

It is, therefore, very clear that the government has already pronounced the developers, investors and other stakeholders of ‘medium’ to large-scale projects as guilty, without even an iota of evidence of a crime. The only crime that has been committed is the betrayal of trust by the U.K. government and the paralysis of a sector that is yet to give birth in the U.K.

‘Greed and Robin Hood’

In the propaganda initiated and reinforced by the DECC, the message is clear. Large-scale solar developers/investors equate to greed and that these stakeholders are in fact in the path of significant wealth creation. To save the poor householders in the U.K., depending on the day, either Chris Huhne or Gregory Barker play the role of Robin Hood.

However, upon closer inspection and an educated assessment of the sector, it is profoundly clear that the propaganda is false and baseless and in fact the displacement of blame on the large-scale solar sector is irresponsible.

Fact 1: Value Distributed by Large-Scale Project across a Number of Stakeholders

It is not a one-way street with large-scale projects (as the government would like us to believe). Large-scale projects contribute significant value to the U.K. government and other stakeholders and it is a balanced two-way relationship.

Large-scale solar projects pay tax at the project SPV level, generating significant revenue stream for the U.K. government. A simplified calculation is as follows;

-Assume the average energy harvest in the U.K. for PV installation is 900,000 KWh/ KWp per MWp/ per year (regions like Cornwall and the south being higher). This results in a tax liability of over ￡1,000,000 per MWp, over the life of the project. Now for a 5 MWp project the tax earnings by the government are significant, which residential projects are not liable to pay.

Apart from the tax revenues earned by the government, the local district councils earn approx.￡25,000 to ￡40,000 in fees per application for a 5 MWp project. This is a significant stream of revenues for the local district council, under the full application fees in the U.K. The district councils will not be able to earn such application fees from projects in the residential sector.

Other individuals/organizations to benefit are the local planning consultants and the sub consultants, who earn significant fees for all the documentation/studies to be completed for such projects (in the range of ￡50,000 per 5 MWp application, if not more). Benefits for local employment and local sourcing run in the hundreds of thousands for such projects. It is, therefore, amply clear, that even at a basic level of analysis, the economic contribution to the U.K. sector from large-scale solar projects are significant.

Fact 2: Returns Are not over the Top

There remains an unfortunate misunderstanding, that the returns made by the large-scale projects are disproportionate to the risk of these projects.

This cannot be further from the truth. Firstly, the returns made from U.K. ground-based projects are at best fair, if not below the returns achieved for similar projects in other European markets. Assume a project SPV gearing of 80% (as is in the case of most projects), the geared average IRR in the U.K. is around 11% to 12%. This is far lower than the return achievable for similar levels of capital employed in markets like Italy. However, given the credibility and low political risk of the U.K. legislative framework, the lower IRR’s were deemed acceptable by investors. Clearly, given the recent behavior of the U.K. government and the amplification of the U.K. legislative risk, the expected returns from U.K. projects will now be deemed as unattractive!

For the proponents of lower returns to large-scale projects, it will be worth their time, if they go back to the development life cycle of any industry over the past 100 years. The glue holding the fabric of the success of the development and maturity of industries are directly correlated to the incentive available to the pioneers of the sector. By no means is even an 11% IRR return a risk commensurate of the tremendous effort of entrepreneurs and other early movers in the U.K. solar sector!

Homework Should Be Done on Project Costs

Now, if the U.K. government had done their homework, they would have realized that the argument of the ‘significant’ drop in prices (installation costs) and the resultant higher project SPV returns are anything, but true for the short term.

Yes, there is no doubt that the pricing curve for solar projects has been decreasing, but the argument is not as simplified as the government would like the wider community to believe. Yes, module prices have fallen and yes, if governments across the world support robust FiT schemes for solar, the prices will continue to reduce. However, this reduction of prices historically and current price levels are driven by a number of complex factors to include, global demand, costs of raw materials, expansion of manufacturing capacity and further investments in research and development. This dynamic complex scenario does not automatically translate into a sharp downward ‘curve’ on pricing. Reductions in module prices will continue, but at a more modest rate of decline. Indeed, there have been period of price increase in module prices in the recent past.

Though the reduction in other components, and labor costs have witnessed price declines, it has been at a more modest pace. It is only through sustained, medium and long-term stability in the legislative framework, will the price reductions result in grid parity. Grid parity will be achieved and will be one of the most significant events in the next 100 years in regards to climate change, energy security and a low carbon world. It is worth every dollar and minute invested, to support solar technology up to grid parity.

Proposed Changes to the FiT Scheme: ‘Ill-Conceived, Immature and Disastrous‘

The proposed changes to the FiT scheme as per the consultation document released on March 18, 2011 (8.5 pence per KWh for projects over 250 KWp), reflect, once again, the lack of understanding at the government level of the economics of renewable energy and of solar sector in particular. It is indeed shocking that the U.K. government does not have access to widely available data on costs and financial modelling tools to come to a more informed decision.

Or is it the case that the government has a more perverse reason for the suggested 8.5 pence. I believe it does, and that is simply to expedite the end of the U.K. solar sector as a sacrifice to the government’s ambitions for other forms of energy to include nuclear.

I believe that there should be a balance of energy technologies, as we move into a new world of low carbon generating assets. It is too early today to judge which particular type of technology will be the most beneficial to humankind for the next 100 to 200 years. But, one thing is for certain, that, prudent and responsible government actions should foster, encourage and develop in equal measure all forms of low carbon technologies, that are expected to lead us to a low carbon future.

By displacing the balance today, as has been done by the U.K. government, the profound negative implications on the future of a balanced energy portfolio of low carbon generating assets is incalculable.

A lack of confidence in stable legislations leads to lower confidence in investments in research and development and capacity expansion, leading to a further delay in the maturity of the industry. Eventually, delaying the benefits to economies achieved through grid parity. The implications of the actions of the government in regards to the solar sector will also spill over to other sectors and technologies and will result in a systematic failure in the adoption of low carbon technologies in the U.K. Sadly, the dent in investor and industry confidence may be too late to fix!

AshvinSuri is Co-Founder of AlphaWatt Limited (www.alphawatt.co.uk), a solar developer active in the European and U.K. Market. Ashvin has been an investment banker with JPMorgan, Flemings and Lehman Brothers. He has been involved with a number of start-up ventures to include fund management and renewable energy. He holds an MBA from the London Business School.

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