Despite what you might read in investment bank research reports or the daily business newspaper, wind energy economics are presently still a touch ahead of solar. The latest power purchase agreement (PPA) signed by Origin Energy for the development of a major 100MW solar farm in north Queensland may be not quite what is claimed.
However, given that solar will attract higher spot prices during the day, and given the falling cost of debt, solar is looking a better deal than ever, both in large installations and on rooftops.
Origin advertises that solar is cheaper than wind
We thought we knew a little bit about the cost of building new solar and or wind power stations. After all, there are now 5GW of solar PV installed and about 4GW of wind across Australia.
Therefore we were intrigued, and more than a little excited, to see the largest electricity retailer in the land, Origin Energy, publish the chart below as part of its presentation to last week’s Macquarie Equities investment conference.
The exciting part of this graph was that, according to Origin, solar PPA prices were down around $80/MWh. Origin is certainly in a position to know because it has recently written two solar PPAs both with Spanish group FRV. Some investment banks got quite excited about this, one note we saw stated:
“Origin’s signing of a PPA with the first non government-backed large-scale solar project at a price below parity with wind power is an important milestone in Australia’s renewables transition. To be clear, further policy reform is needed, however this could herald the start of a renewables investment boom”
The Australian Financial Review, not previously known for showing any empathy towards renewable energy and generally taking at its kindest a “none of our business” attitude towards climate change, wrote a glowing piece calling CEO Grant King, “the Sun King”.
Your author is fully in favour of the renewable revolution – we wouldn’t be here otherwise – and if Grant King is going to become Australia’s Sun King, so much the better. However, it’s a maxim in the markets that “if something looks wrong, it probably is wrong” and these PPA prices looked wrong to us.
A broader view suggests caution. The overall industry data still supports a view that wind should be a touch cheaper than solar. The Australian Renewable Energy Agency recently released details on 70 projects that had applied for grants in relation to utility solar PV plants. That data clearly showed that wind capacity factors are about 17 per cent higher than solar and cost to build is about 8 per cent lower. Opex is probably a touch higher for wind.
Those numbers aren’t the end of the story. The timing of solar output is more predictable than wind. At the moment, the black price (wholesale price) for solar is likely to be higher than for wind, as wind output tends to be overnight when demand is low and solar output comes in the middle of the day in the high part of the daily demand curve.
Still, in ten years time when there is another 20GW of solar across Australia, solar may have its own negative pool price correlation.
Is Origin gilding the lily thanks to ARENA grants?
Neither Origin or FRV have provided any detail on either the cost or the projects or the PPA price for the 100MW Clare solar farm that attracted all the headlines. Still we put together the attached table that summarises the two projects – both Clare and Moree.
The key point:
FRV hardly put a dollar of its own money into Moree. Basically, virtually 100% of the equity in that project came from ARENA with the debt from the Clean Energy Finance Corporation.
This means that any PPA it wrote was going to be at a profit. The project is up and running and on budget so its de-risked. In turn this meant that FRV likely could afford to write an “out of the money” PPA with its Moree partner Origin.
To put it bluntly, the profit on Moree likely subsidises Clare. We put together a fairly simple net present value model for Clare and calculated the Internal rate of return (IRR). IRR is the interest rates that makes the sum of the time weighted (discounted) cash flows of the project zero.
If the IRR exceeds the weighted average cost of capital [WACC] it is good news. In this case the IRR is 4%. That’s bad news. The project only has a 13 year term so FRV is taking some risk for the back half of the project.
The cost of capital is a bit controversial. We believe most of the corporate community is used to a cost of equity of 9-10 per cent. Most management grew up when interest rates and inflation were higher and just don’t psychologically accept that returns are lower than they used to be.
Still, if we plug the numbers straight out to the textbook with the only two assumptions that the beta is 0.7 and debt weighting is 1/3 we get a WACC of 5.5 per cent. Even so Clare doesn’t cover its cost of capital.
What about wind?
For a 100MW wind farm located in, say the New England region of NSW, and getting a capacity factor of 35 per cent we estimate an IRR of around 5.6 per cent – so right on the cost of capital.
Household PV economics are fantastic at current interest rates
The cost of rooftop PV is around $1.60/watt after the SREC discount. If we go back two years to April 2014 it might be about $1.83 a watt and a year ago about $1.70 watt. The SREC benefit is about $0.78 KW which means the unsubsidised cost is presently around $2.50 watt installed. Making the following assumptions:
1. The panels last 25 years with output degrading 0.3% per year.
2. The inverter lasts the entire 25 years (this is probably not realistic)
3. Households don’t spend any money each year maintaining the panels
4. Capacity factor is about 14.5% (annual output as a percentage of stated capacity operating 24 hours a day, 365 days a year).
5. The cost of capital is equal to the investment loan bank rate or about 4.5% We will assume its not tax deductible, if it is the numbers are even better.
We then model out the required cost of solar to break even using Net present value analysis at as low as $88MWh. This is an astonishingly low figure but simply reflects that the cost of capital (the borrowing rate is very low).
The payback period is 15 years which is a long time by conventional standards. Again the message we want to emphasise here is that borrowing rates and the cost of capital are very low. In theory this means that projects with long payback periods by historic standards are still economic.
In reality the household mostly installs solar as an “avoided cost”. The self generation means that electricity doesn’t have to be paid for. Electricity purchased from the grid costs the average household about $250 MWh ($0.25 KWh).
Not all electricity can be self consumed; some has to be sold back to the grid and your friendly retailer will pay around $0.06KWh . Still, on the calculations above even if 90 per cent of the electricity was sold back to the grid (most unlikely) installing rooftop solar is still a good idea. Bottom line. It’s almost certainly worth installing rooftop PV provided you can get a decent capacity factor and can borrow at 4.5 per cent.
Some sensitivities around these numbers are shown below. The key insight is that it’s the cost of capital, and the capital cost that drive renewable economics. Not nearly enough attention is paid by the industry, or by those that set policy, to the wonderful opportunity renewable energy has because of the low cost of capital that exists all over the world.
David Leitch was a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.
David Leitch is a regular contributor to Renew Economy. He is principal at ITK, specialising in analysis of electricity, gas and decarbonisation drawn from 33 years experience in stockbroking research & analysis for UBS, JPMorgan and predecessor firms.