Risk Assumptions for Investing in Solar Power

Published by firstgreen on

1. Introduction

It is vitally important that developers and financiers of solar energy projects follow best practices in developing, constructing, operating and financing projects. Prior to investing, investors should consider the risks involved in investing in the Solar Business and whether it is appropriate for investment objectives, needs and financial circumstances.

The risks affect solar projects throughout the entire project lifetime, but vary greatly in character & circumstances. The immediate impact of the presence of any of these risk factors is uncertainty around the revenue and profitability projections for the project and thus the financial viability of the project.

However, many of the risks can be managed through financial instruments and insurance products. For example, Solar Modules have 25 Years performance warranty, but there is no ascertained that manufacturer will be live till 25 years. In this case the bankable manufacturer modules can be preferred to reduce the risks. Further, weather risks can be mitigated through weather futures and technology risks can be offset through warranties.

Investors and developers should satisfy themselves that the level of risk attached with any development is appropriate to their investment criteria. Developers and investors should make every effort to mitigate the risks where possible

For any Investment in Solar projects the investment risks outlines cannot be for any defined period since solar projects and respected investment undergoes in many phases. So each phase should have its separate risk assessment. For example, to assess the technology risk of components which generating less electricity over time than expected. So to get the exact generations over the year the derating factor of the plant components must be take into account.

Each phase is its risk assessment measures and while calculating the ROI of the investment. These measures should have counted whether they are regulatory risk, Technology risk, construction risk, operational risk, Electricity market risk and Financial Risk.

2. Categorization of Investment Risks in Solar Power

2.1  Risks Specific to Business

2.1.1  Interest Rate

The Business has debt facilities in place which have both fixed and floating interest rates. Future debt facilities may have fixed or floating interest rates. As such, changes in interest rates may have a positive or negative impact directly on the Business’ net income. Changes in interest rates may also affect the market more broadly and positively or negatively impact the value of the Business’ underlying assets.

Interest rate risk (variability in rates) is the risk borne by an interest-bearing loan. It can be beneficial to finance projects on long term fixed interest rate loans, as opposed to variable rate loans. A fixed rate loan is a long term loan that carries a predetermined interest rate with a tenure usually of 15-20 years. Ideally, the plant should pay back the loan in 10 to 12 years. But spreading the loan over a longer period allows for smaller annual payments. This allows the developer the scope to build a reserve and to return a profit in the first years.

2.1.2   Leverage

In cases where projects are to be financed through a mixture of equity and non-recourse debt finance, leverage may potentially increase the total return of the equity investors. But it may also lead to increasing losses in adverse market conditions.

2.1.3  New Business Start-up

As the solar PV industry is fairly new, very few companies have a long history in operating in this renewable energy sector. A possible way to tackle this problem is to have key contractor and strategic partners that have experience in constructing and operating solar power plants.

2.2   Technical Risks

2.2.1  Solar Module

It is important to consider the quality of modules (for example, checking whether degradation will occur faster than expected) and the strength of the module manufacturer’s warranties. Any problems in the installation are usually identified within the first year and corrected under EPC (construction) warranties. Later, problems can be rectified under manufacturer’s warranties. But as far as possible, it is preferable to avoid any interruptions to production.

Given the long term nature of the project, choosing the right technology is essential in achieving consistent results and maximising power output over the life of the project. A productive and viable PV power plant will automatically become an attractive proposition to potential buyers in the future.

2.2.2  Inverters and Cabling

Besides considering quality and warranties, the overall configuration of the PV power plant must be designed correctly. This will ensure that the maximum power reaches the grid based on the gross irradiance reaching the modules.

The technology and manufacturer choice for the inverters is also important for ensuring trouble-free operation suited to the environment and design of the PV plant. Warranties and maintenance activities for the inverters need to be carefully assessed to ensure that the risk of inverter failure is minimised.

2.2.3  Technology Failure

Generation of electricity involves mechanical and electronic processes. These may fail under certain conditions, leading to loss of revenue and repair or replacement costs. Selection of modules, tracking systems (if used) and inverters should be based on the track record of manufacturers—and the warranties they offer. These warranties help reduce the risk of technology failure in the initial years of the PV plant’s operational life.

2.2.4  Solar Irradiation Risk

One of the key factors in determining the energy yield of a solar plant is the solar irradiation at the site. Changes in weather patterns such as cloud cover, rainfall and heat waves could reduce the energy output and, consequently, investor returns. However, meteorological assessments and long term averaging show that inter-annual variation over the lifetime of a PV plant is generally quite low, generally in the order of 5%, depending on location.

2.2.5   Solar Module Degradation

The efficiency of solar modules as well as their degradation (loss of performance) has a direct effect on the yield of a solar plant. The degradation is indicated by the supplier (usually less than 1% per year). Any unexpected loss of performance could have an adverse effect on the business.

Module manufacturer’s power warranties generally cover larger losses of power due to degradation. However, the warranties need to be reviewed carefully for exclusions. The financial strength and backing of the module manufacturers should be assessed to verify that the manufacturer can support any claims against their warranties. In some cases, insurance policies may be taken out by the manufacturers to cover warranty claims.

2.3   Pre Completion Risks

2.3.1  Cost Overrun

Exposure to changes in the prices of components can account for a cost overrun. A change in prices for certain key components, in particular modules and inverters, may have an adverse effect on the bottom line.

2.3.2  Delay in Completion

Delay in completion occurs when there is a reliance on third party contractors for installation. In the construction phase of a project, developers and SPVs enter into agreements with third-party professionals, independent contractors and other companies to provide the required construction and installation services. If such contracted parties are not able to fulfil their contractual obligations, the developers may be forced to provide additional resources or engage other companies to complete the work. Any financial difficulty, breach of contract or delay in services by these third-party professionals and independent contractors could have an adverse effect on the business.

2.3.3  Permits, Grid Applications and Feed-in Tariff

Permits and grid applications need to be secured for all project sites. Any project will carry the risk that all approvals will not be finalised and approved by the competent authority or party within the expected timeline. Any delays may have an effect on the income stream from the corresponding project.

2.3.4  Grid Connection

The connection to the third party distribution or transmission network is often non-contestable. Therefore, the final grid connection is reliant on the works of the third party network operator or their contractor. Grid connection contracts and deadlines should be finalised to mitigate this risk.

2.3.5  Delay in Obtaining an Operating Permit

In some jurisdictions, the relevant authorities must determine whether the construction of the plant and connection facilities has been carried out in conformity with the approved design, and whether they comply with the legal requirements. Delays or difficulties in obtaining the operating permit may affect the income and profitability of the solar PV plant.

2.4   Post Completion Risks

2.4.1 Market Risk

Every developer should also keep in mind that government policy towards renewable energy may change unfavourably. Changes with respect to legislation concerning renewable energy policy could reduce the forecast revenues and profits of new projects. As importantly, a global consensus on taking action on climate change may positively influence government policy.

2.4.2  Change of Legislation

Legislation gives qualifying PV power plants the right to receive a levelised tariff which takes into account depreciation benefit. In India, under the JNNSM this tariff is guaranteed for all electricity produced for 25 years. Under Indian law, the government cannot retrospectively change the tariff issued. However, once a project is connected, particularly those under 33kV, there may be a residual risk that individual state governments may ask grid operators to retrospectively adjust the tariff levels.

2.4.3  Operational Considerations

Every operational solar power station engages an O&M Contractor to carry out the day-to-day maintenance of the solar power station. Inefficiencies in the operation and management of the project could reduce the energy output. This can be reduced by adding performance clauses within the O&M contract, based on the availability of the PV plant and targets for energy yield or performance ratio.

3. Insurance Liabilities in Investment Risks

At present, the insurance industry has not standardized the insurance products for PV projects or components. A number of insurers are providing PV insurance policies, but underwriters’ risk models have not been standardised. The data required for the development of fair and comprehensive insurance policies are lacking as insurance companies often have little or no experience with solar projects.

However, demand for PV insurance is increasing. In general, large PV systems require liability and property insurance, and many developers may also opt to add policies such as environmental risk insurance. Though PV insurance costs can be quite high, it is likely that rates will drop as insurers become familiar with PV plants and as installed capacity increases.

The insurance companies offers following general liabilities for Investors

3.1  General Liability Insurance

General liability insurance covers policyholders for death or injury to persons or damage to property owned by third parties. General liability coverage is especially important for solar system installers, as the risk to personnel or property is at its greatest during installation.

3.2  Property Risk Insurance

The PV system owner usually purchases property insurance to protect against risks not covered by the warranty or to extend the coverage period. The property risk insurance often includes theft and catastrophic risks. Property insurance typically covers PV system components beyond the terms of the manufacturer’s warranty. For example, if a PV module fails due to factors covered by the warranty, the manufacturer is responsible for replacing it, not the insurer. However, if the module fails for a reason not accounted for in the warranty, or if the failure occurs after the warranty period, the insurer must provide compensation for the replacement of the PV module.

3.3  Environmental Risk Insurance

Environmental damage coverage indemnifies PV system owners against the risk of either environmental damage inflicted by their development or pre-existing damage on the development site.

3.4  Business Interruption Insurance

Insurance against the risk of business interruption is often required to protect the cash flow of the solar project. This insurance policy can often be a requirement of the financing process.

4.  Reducing the Risk during Operations

For an investor to take interest in a solar project, risk must be reduced to an absolute minimum. A solar array must generate electricity at a predictable operational cost structure in order to deliver long-term, reliable returns. The PV industry has made great strides in delivering certainty for the investment community.

As EPC and O&M costs are dominant in the PV lifecycle costs, the technical aspects in the EPC and O&M contracts are decisive for managing the technical risks in PV project investment. Therefore, we have developed seven best-practice checklists relevant for EPC and O&M contracting, targeting different market segments.

4.1  Testing and Due Diligence

Many project developers turn to independent engineers and quality assurance providers to carry out the required due diligence when it comes to key PV power plant components. This is particularly true in regards to solar modules. Testing laboratories and regimes are quite sophisticated, with the ability to expose modules to extreme operating conditions and simulate their likely performance over their operating life. Module failures are well documented and, in some cases, such as potential induced degradation (PID), documented in great detail. Unfortunately, this isn’t the case with the range of components often lumped together under the tag “Balance of Systems.” This includes components such as electrical cabling, connectors, and tracking systems, and it is a crucial oversight.

4.2  Best Practice in EPC and O&M Contracting for Risk Mitigation

From the risk identification technical risks linked to poor assumptions in PV financial models. These risks could be introduced either during project development (procurement, planning and construction, i.e. EPC) or during PV operation (O&M). Since EPC and O&M contracts provide the technical framework of the whole PV project lifecycle, it is important to ensure that all technical aspects of EPC and O&M contracts are based on best-practice quality. In a developed best practices and guidelines the risk can be minimize the practices guidelines to minimize the risks can be categorized as follows for EPC and O&M:

• Best Practice for EPC Technical Aspects.

• Best Practice for O&M Technical Aspects.

• Best Practice for Long-Term Yield Assessment.

• Practices as per guidelines Documents – Type and Details.

• Practices for Record Control.

•Practices for Reporting Indicators

4.3  Minimize Risk with Centralizes Architecture

The report found that the centralized architecture had vastly lower scheduled and unscheduled Operations and Maintenance (O&M) costs when compared to the decentralized architecture studied. The centralized tracking architecture energy loses are less due to component failures compared to the alternative architecture