Shining the Light on Solar

Issue 5 and Volume 112.

By Edwin Feo, Milbank, Tweed, Hadley & McCloy LLP

Solar energy capacity will be exploding over the next decade as a result of federal and state incentives, a world class resource in the Southwest and significant technology advances. Utilities signed power purchase contracts for 2,339 MW of new solar capacity in 2006 and 2007, with project completion dates between 2006 and 2014. More contracts are expected to be signed in the first half of this year. There are more than 80 utility-scale solar plants being pursued in the United States. The Western Governors Association projects a potential market in the West of nearly 10,000 MW by 2015 and a long-term potential of nearly 200,000 MW. These statistics are extraordinary given that before last year the most recent utility-scale solar facility in the United States was installed in the late 1980s. Solar has the potential to be a significant market–indeed, one of the fastest growing sectors of energy generation in the history of electric power.

Several drivers for this rapid development exist. Federal and state incentives are fundamental for supporting solar energy. Twenty five states have enacted renewable portfolio standards, including most of the Western states, creating demand for solar implemented through long-term power purchase agreements. The other major regulatory support for solar is the federal energy investment tax credit, which provides a 30 percent tax credit on solar generation equipment’s capital cost. This credit will revert to 10 percent at the end of this year unless extended. The solar industry is lobbying vigorously for a multi-year extension of the investment tax credit. A number of states also provide tax incentives for utility-scale solar facilities.

The U.S. Southwest enjoys one of the best solar resources on the planet. That resource is now convertible to energy at commercially viable rates as technology advances on both photovoltaic (PV) and concentrated thermal solar systems are being advanced by investment. Competing technologies range from PV plate to thin film to solar trough to solar towers, ranging in size from relatively small to significant (500 MW). European developers, fresh from the experience of developing and running projects in Spain (such as Abengoa, Acciona and Solar Millenium), experienced Israeli companies (Sol El) and a number of new technology players (Brightsource, Ausra, SkyFuel, First Solar, Sunpower, E-Solar and others) are pushing the technologies forward and the price down. In addition, competing technologies include energy storage through a molten salt or other medium to convert intermittent generation into a valuable peak-coincident and dispatchable resource.

Despite those bright prospects, however, challenges exist. Current power purchase agreements are being aggressively priced to compete with other renewable energy technologies. Solar developers are betting on technological advances that will drive down generation costs by the time projects are placed in service. If a project cannot be built for the agreed price, the purchasing utility should expect renegotiation or failed development.

A number of the current proposed technologies have a short (or no) history of commercial operation. Parabolic trough technology is best known, having been in operation in the United States since the 1980s and in Spain during the past decade. Power towers have a less developed track record but offer lower cost, lower parasitic loads and efficient thermal storage. A number of tower technology elements, however, are not yet commercially proven. Solar dish systems offer higher conversion rates but this technology has been confined to demonstration projects and requires further cost reduction to be competitive. Linear Fresnel reflectors are a more efficient variation of the parabolic troughs and may offer cost advantages; but, again, commercialization has been limited.

Venture capital funding is backing many of the new technologies. For longer-term financing (as will be necessary to meet the price points for utility power purchase agreements), the developers must demonstrate commercial production at competitive rates–and a balance sheet to back up performance warranties. The European market standard for a performance warranty is a multi-year minimum performance guaranty with a buy-down if the project does not meet the guaranty. The U.S. market is likely to follow that precedent. Such a guaranty requires a creditworthy guarantor. The willingness of utilities to purchase power from solar projects will rapidly disappear if the projects cannot deliver reliably, on time and at the agreed price. It is unlikely that all of the technologies and developers will succeed. The winners are yet unknown.

As noted above, Congress has not renewed the investment tax credit past 2008. For large-scale project success, it must be extended for several years to cover long-term development and construction cycles. A number of the currently proposed projects, not scheduled to be in service until 2012-13, have a significant amount of tax credit value at risk unless the investment tax credit is extended through those dates.

The desert Southwest is the most promising location for future utility-scale solar projects, but even these projects face hurdles. Thermodynamic solar systems require significant cooling, which is usually handled with water, which in turn may be scarce in the region. In addition, transmission lines in remote areas may not be readily available to connect the projects to the customers. At $1.5 million per mile for transmission lines, new lines’ cost may be significant. While state policies, like those in California, seek to align transmission line development with the renewable portfolio goals, coordinating that development with in service dates under power purchase agreements will be challenging. And, of course, the land rush of proposed solar energy projects raises the issue of which projects will get transmission and which will be left behind.

So the prospects are bright, but the challenges are significant. Developers are intent on resolving the potential issues–and if they do, we can expect utility-scale solar projects to be a major component of energy generation in the coming decades.

Author: Edwin F. Feo is a partner with the international law firm, Milbank, Tweed, Hadley & McCloy LLP. He is co-chair of the firm’s project finance and energy practice and is a member of its global executive committee.