What are the key entry points?
The activities of the solar industry span research, manufacturing, construction, installation and maintenance.
Technological advances in solar generation, storage and smart infrastructure should give VC and private equity investors some attractive opportunities in the development stages of the value chain.
The most important entry points are:
Secondary finance for operational assets
Once operational, solar installations can be refinanced using senior debt backed by future revenues. Secured debt is the solar investment vehicle of choice for many institutions. It offers a low risk yield profile and, even if not very liquid, is relatively easy to market. The availability of secured senior debt should increase as utilities, many of which have arguably been slow to adapt to renewable energy, embrace alternatives to traditional balance sheet funding and look to raise funds or finance M&A by offloading operational assets.
Initial project finance for construction
As demand for senior debt backed by solar assets grows, yields are coming under pressure. In response major investors, including certain sovereign and pension funds, are opting to provide initial project finance at the development or construction phase of a project. This offers a higher risk-return profile and, in the case of equity investment, greater scope for capital gains.
Labeled and unlabeled “green bonds” are an alternative entry point for fixed income investors, and an increasingly popular funding option for corporates, municipalities, governments and commercial lenders. A record US$41.8b of labeled bonds was issued during 2015, with 46% dedicated to renewable energy investments.
The unlabeled green bond market is larger, at about US$500b, but offers weaker environmental safeguards. Despite the growing use of green bonds for corporate and project financing, both categories could face growing scrutiny as investors look for differentiation beyond their “green” credentials.
Institutions looking for higher returns can invest in the listed stock of utilities shifting towards solar assets, or energy companies competing with utilities in solar markets. There is no escaping the fact that incumbent utilities, and the challenger businesses now competing with them, hold a large proportion of the world’s power assets. As these players build the solar elements of their portfolios, their common equity offers upside exposure to global solar adoption.
An alternative to conventional equities, yieldcos are companies that own specific operating assets and use their predicable cash flows to pay investors an attractive dividend. Yieldcos are typically listed subsidiaries of larger energy producers.
Following an initial bubble, in recent years many yieldcos have suffered from excessive investor expectations or the financial weakness of parent companies. The next 12 to 18 months could see growing calls to restructure existing vehicles. The yieldco model is likely to survive, although unlisted vehicles may be preferred in future.
Asset-backed securities (ABS)
Securitization is giving major institutions the chance to invest in smaller-scale solar projects, which are becoming an increasingly important part of the global energy mix. Companies that install and lease rooftop solar PV assets to private individuals are packaging up revenue streams from long-term contracts to issue bonds or notes.
Residential solar ABS has been successfully issued in markets including the US, China and Kenya. Greater standardization of contracts could also hasten the securitization of mid-scale commercial and industrial solar assets.
It is important to note that solar investment opportunities span high growth and developed markets, providing a wide range of macro-economic exposure. The 10 most attractive countries for solar investment as ranked in the May 2016 edition of EY’s quarterly Renewable energy country attractiveness index (RECAI) give an illustration of the diversity of solar investment markets.
China, the world’s leading solar market, is aiming to install 100GW of new generation by 2020, tripling its current capacity. India is also targeting 100GW of new capacity — a near twenty-fold increase — while Chile, Brazil, Mexico and South Africa are launching large-scale projects backed by a mixture of private and public investment. In the first three months of 2016, solar accounted for 64% of all new electricity that came online in the USA.7
These investment opportunities are not restricted to “sunny” or high growth markets. Non-sunny markets, such as Germany (the world’s leading solar market until 2014, second to China in 2016), can be grown to have significant installed solar capacity. Australia and the US are seeing an explosion in rooftop solar investment. In addition, increasingly aggressive carbon reduction targets in Europe and North America suggest that investment opportunities will continue to multiply in these markets.
What challenges do investors face?
Despite the stunning growth of recent years, solar investment still represents less than 1% of most institutional investors’ asset allocations.
This is hardly surprising. Historic labels such as “green” or “alternative” have left many investors unsure about how renewable assets should fit into their wider strategies.
The restructuring of solar energy yieldcos has raised questions in the minds of some, while the rapid advance of solar technology has taken many observers by surprise.
Investors are one of many groups trying to get up to speed with these developments. As they seek to familiarize themselves with solar investment, newcomers need to understand a few potential obstacles to successful investment. An example is illustrated below.
In the past, solar and other renewable energy technologies relied heavily on policy-driven price subsidies or favorable regulation to compete with conventional energy sources.
More recently, unexpectedly strong demand for subsidized investments and the rapid decline in solar PV costs have led to unpredictable or sudden policy reversals, such as the UK’s 2015 decision to end rooftop subsidies a year earlier than planned. These shifts have dampened investor confidence and created boom-bust deployment cycles in some markets.
However, policy risks are declining as solar power reaches grid parity in many markets. Although the review and reduction of solar subsidies will continue to create near-term hiccups, the increasing ability of solar investments to generate sustainable, unsubsidized returns is a highly positive indicator for the future.
As already discussed, the natural variations of solar output contrast with the more constant “base load” of conventional energy sources and renewables like biomass or geothermal.
As the scale of solar deployment increases, this variability has the potential to create balancing issues for transmission networks. The good news is that technological advances have the potential to address solar variability. Battery-based and other forms of storage are helping to decouple supply and demand, and other forms of “smart infrastructure” are enhancing grid resilience. Storage costs are expected to fall rapidly over the next five years. The combination of scalable generation and scalable storage is widely expected to supercharge demand for solar capacity.
The technology and economics of solar power can appear complex to nonspecialist investors, few of which typically have in-house sector expertise. Local variations in regulations and market structures can also be a source of confusion. These factors, together with the growing choice of investment options, can make it hard for institutions to identify the most suitable opportunities.
However, these are common challenges for energy investors. An increasing number of institutions are building their solar knowledge or working with expert third parties to move up the learning curve.
Although the rapid deployment of solar has produced significant volumes of performance data, in practice much of this is fragmented, proprietary and hard to access. Fortunately, investors have increasing opportunities to work collaboratively with project developers and asset operators to gather and collate the data they require to compare projected and actual performance. The ability to generate more reliable long-term forecasts will help investors to make decisions across a range of vehicles and entry points.
The good news is that experienced investors should be able to address or mitigate most of these challenges. Few are unique to solar investing, and many will naturally resolve themselves as solar assets move into the mainstream and more institutions build their understanding and experience of the sector.