Shorter construction lead times, given that many solar installations can be deployed in months compared to years for comparable scale wind projects.
The unique scalability of solar is another attractive investment feature, both in terms of the asset itself, but also the potential levels of investment and profit.
Solar assets can be sited on ground or rooftop, at utility, commercial or residential scale. That means they can be located near to where energy is required, reducing the costs of transmission and distribution infrastructure maintenance. Planning restrictions are often less onerous than for other renewables, since solar installations are often added to existing infrastructure. These factors create a wide range of “off-grid” investment opportunities, such as the commercial use of solar to power factories, offices or datacenters.
Solar has significant scope for technological improvements. This is in addition to the further reductions in PV module costs already predicted by analysts.
- Continuing investment in R&D by PV manufacturers will result in enhancements to the efficiency, durability and flexibility of PV technology.
- The natural variability of solar output is stimulating the development of ‘smart’ infrastructure such as microgrids and intelligent energy management systems. Innovations like these are creating new investment opportunities. A recent EY paper suggested that microgrids could allow commercial users in twenty countries to achieve total annual energy savings of US$64b-US$171b by 2020.5
- Developments in battery technology, and lithium ion (LI) batteries in particular, could give an additional boost to solar PV capacity growth. Technology companies’ investments in R&D and large-scale manufacturing is widely expected to drive LI costs down a PV-like curve over the next five years.
The significant volume of capital already flowing into solar investments provides the most compelling evidence that solar is no longer just a niche market. Recent years have seen around US$750b of investment, creating more than 200GW of solar capacity. A growing number of pension funds, sovereign wealth funds, local authorities and insurers are getting comfortable with solar assets. Investment managers are setting up their own infrastructure funds and even investing directly in specific projects. In the UK alone, the first quarter of 2016 has seen solar installations acquired by a Danish pension fund, a German insurer and a global investment manager.
The march towards grid parity and the investment features we have outlined are galvanizing ever-increasing investment. BNEF forecasts US$3.7t of investment in solar energy alone between 2015 and 2040, with the resulting capacity of around 3,500GW — equivalent to as much as 35% of all new global generation capacity during the period — split evenly between utility-scale and small-scale installations.
Historic performance data shows that these characteristics can deliver attractive returns, with key renewable and solar indices outperforming broader market and traditional energy stocks over the past four years (see Figure 3). Meanwhile, recent research suggests that solar investments have the potential to generate average annual expected returns on investment of between 6.6% and 10.1% over the next 35 years, depending on the scenario, ranging from transformation (ambitious climate change mitigation action) to fragmentation (limited climate action).
Recent research suggests that renewable investment has the potential to generate average annual expected returns on investment of between 6.6% and 10.1%.
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 venture capital 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.
Labelled and unlabelled “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 labelled bonds was issued during 2015, with 46% dedicated to renewable energy investments. The unlabelled 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 12-18 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)
Securitisation 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 standardisation of contracts could also hasten the securitisation 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 ten 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 (see Figure 4).
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.
Nor are these investment opportunities 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.
Figure 4: EY RECAI solar indices rankings, May 2016
Source: EY RECAI, May 2016
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 how renewable assets should fit into their wider strategies.
The restructuring of solar energy yieldcos has raised questions in the minds of some, whilst 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 familiarise themselves with solar investment, newcomers need to understand a few potential obstacles to successful investment. For example:
In the past, solar and other renewable energy technologies relied heavily on policy-driven price subsidies or favourable regulation to compete with conventional energy sources. More recently, unexpectedly strong demand for subsidised 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 non-specialist 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.
An increasing number of institutions are building their solar knowledge or working with expert third parties to move up the learning curve.
Is now the time to invest?
Solar PV is a rapidly growing asset, with plummeting costs and constantly improving technology.
This, alongside the minimal operational requirements (compared to traditional energy sources), vast potential for scale and proven fi nancial returns make it one of the most attractive assets for investors in the short, medium and especially long terms. In addition, the added benefi t is the environmental argument, one which is quickly growing in importance for regulators and investors, particularly millennials (due to inherit US$30t in the coming decades), alike.
For these reasons, groups as diverse as pension funds, sovereign wealth funds, national green banks, mutual fund investors and crowdfunding investors are increasingly interested in solar, with investors fi nding themselves competing for the best deals.
At the same time, companies seeking capital for solar assets need to ensure they are doing all they can to package those assets in ways that meet the needs of investors. That includes making a greater effort to engage with potential investors and educate them about the solar industry.
Overcoming misconceptions that solar assets are immature, specialised or particularly complex is a key challenge. The unique potential of solar to deliver stable long-term cash flows, comparatively low risk profiles and scalability across a worldwide range of markets — even in the least sunny regions — shows that investors need to consider solar investments as a mainstream asset class in their own right.
Today, solar investments represent a drop in the ocean of global asset allocations. Fast forward to 2040, and solar power is estimated to represent almost a third of installed global generating capacity.8 It seems obvious that a significant ramping up is required to refl ect this weighting in energy portfolios, demonstrating that investors failing to engage with the solar market are overlooking attractive opportunities. Even oil and gas companies are moving towards renewables, with the largest global IPO in the first half of 2016 being a renewable energy company. DONG Energy, originally Danish Oil and Gas, now has 75% of its capital going into renewables.
There is a vital need for investors — especially large institutions able to provide the lowest costs of capital — to recognize that an energy sector in transformation is also an energy sector in need of capital. A willingness to understand the unique and highly promising solar investment market could offer some equally unique long-term returns.
"I’d put my money on the sun and solar energy. What a source of power! I hope we don’t have to wait until oil and coal run out before we tackle that."
Thomas Edison, 1931