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Renewables at a Crossroads

Investment opportunities in an evolving environment.

Fortnightly Magazine - June 2011

various stages of development. In solar, for instance, many technology players are forward-integrating into asset development; an example is First Solar’s recent acquisition of project development companies NextLight and OptiSolar. In addition to bringing asset development capabilities in-house, such moves help create a market for the company’s products and enable them to capture margins in the highest-margin vertical of the value chain.

One criterion for success in asset development is the ability to secure offtake agreements such as PPAs to guarantee a future income stream. Relatively few developers currently have projects with PPAs, and there’s evidence that developers have been underbidding for PPAs due to the crowded nature of the pure-play competitive space. Merchants and utilities with ambitious plans for renewables, along with forward-integrating technology companies and OEMs with deep pockets, are increasingly on the prowl for developers with established PPAs and capacity at scale.

As the industry matures, there’s likely to be consolidation among companies dominating the asset development segment, including mega-merchants, utility affiliates, and technology firms. While the best of the pure-play developers will survive, the competitive bidding environment will continue to present challenges, limiting returns to the high single digits for even the most adept developers. The capabilities that will help developers differentiate themselves from the pack likely will come from strong project development experience, including siting and construction management. Developing and maintaining a reputable management team that’s able to secure financing and offtake agreements at the right prices will also prove critical.

Given the various challenges of asset development, many industry players prefer to acquire assets as a way to build a position in renewables without taking on development risk. The current state of oversupply in many renewable energy technologies has supported this strategy, as it has pushed prices below replacement cost for many existing generation assets ( see Figure 7 ). As a result, renewables transaction values have reached as low as $1,200 per kilowatt for certain wind generation assets—a significant discount to the levelized cost to build them. Therefore, there’s a clear advantage for asset acquirers that can find undervalued assets.

However, asset prices do vary, depending on their quality and other considerations. For example, assets with secure PPAs trade at a premium, reflecting the safeguard they offer against price fluctuations. While transaction values for wind, biomass, and solar assets generally have fallen during the recession, hydro and geothermal have continued to trade at a premium, reflecting their higher capacity factors and reduced variability.

The growth of the renewables sector has also attracted an assortment of technology plays in the U.S. and across the globe. The solar PV market, for example, has recently drawn in large diversified companies such as General Electric, Hyundai, and Toshiba. At the same time, new and little-known Chinese companies have established themselves as competitors to established leaders.

Similar to renewable asset companies, technology companies face a host of regulatory and market uncertainties in deciding which technology to invest in and where to invest along the value chain. Though the long-term growth prospects are indeed promising, shifting regulatory conditions and continuously evolving