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The U.S. solar industry has flourished over the past decade, with annual project installations growing exponentially since 2010. One well-known reason for this growth has been the rapid drop in solar equipment costs. However, solar growth has not only been a result of supply-side factors. Since 2015, a powerful source of solar demand has emerged – the direct purchase of solar power by companies with significant electricity needs.
Why are companies interested in solar energy?
Thousands of companies across the globe are making clean energy commitments to reinforce their relationships and brand value with their own customers. Because U.S. electric utilities have generally moved towards decarbonization too slowly for many companies to meet their internal goals, these companies have taken the initiative to sign direct contracts with clean energy projects. Figure 2 below shows the rapid growth of this market, which has primarily come from large-scale solar and wind projects.
Source: Renewable Energy Buyers Alliance
Figure 2 - Annual Utility-Scale Solar and Wind Projects Supported by Corporate Contracts
How are the solar contractual agreements with corporate clients structured?
As new corporate customers entered the solar industry, the solar industry transformed to serve a new set of needs. From 2010 to 2015, most large-scale projects pursued fixed price Power Purchase Agreements (PPAs) with electric utilities. In a fixed price PPA, a project sells its output to the buyer for 20 or 25 years at a set price and the PPA itself is signed prior to construction.
A long-term fixed price contract can deliver benefits for both project and buyer. A solar project needs price certainty to be attractive for its own investors, and an energy buyer can lock in costs at an advantageous rate for the long term. A homeowner who has considered a 30-year fixed-rate mortgage versus a 5-year adjustable-rate mortgage can relate to the benefits of locking in long-term costs.
Because the general corporate market has different needs than electric utilities, solar projects had to innovate within their business model to appeal to these customers. Investor and accounting pressures on large companies (especially publicly traded companies) make it much more difficult for these entities to sign long-term PPAs compared to utilities, even if those contracts would provide savings to current and expected energy costs. However, this creates a conflict with the project’s requirements for price certainty on a long-term capital investment.
The solution to this problem was a hybrid contract: an upfront fixed price contract period that is shorter than a classic fixed price PPA with a “tail” period subject to market price fluctuations. Solar projects use the shortened fixed price period to achieve a minimal level of investor payback and then manage to fund their projects using variable cash flow projections. Figure 3 illustrates the distinction between fixed price PPAs and hybrid contracts.
Figure 3 - Example Pricing of Fixed Price and Hybrid Contacts
Fixed Price PPAs vs. Contracts with a Variable Price Component ($/MWh)
Innovative business models expected in the solar industry
Ultimately, the hybrid contracts shifted some risk to the solar project. However, because this new risk came paired with a large new marketplace, solar developers and investors figured out how to make the deals work.
Considering the bright future of solar energy adoption, there will be a need for evolving business models and innovative debt and equity financing schemes. Active cooperation with utilities and local authorities will continue to add value to the financial feasibility of solar projects.
If the U.S. power grid is to make further progress on decarbonization, Distributed Sun expects to see and help create further business model innovations in the solar markets. Only through reaching as many customers as possible will the solar industry be able to claim its rightful place on the U.S. power grid.
Written by Paul Holshouser