Australia's ambitious renewable energy target of 82% by 2030 hinges significantly on the success of building new wind and solar farms. However, the solar farm industry faces a looming financial crisis that could stall future development and potentially trigger write-downs of existing solar farms.
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Executive Summary:
Existing solar farms, particularly those nearing the end of their Power Purchase Agreements (PPAs) as well as the pipeline of new solar farms are vulnerable to declining revenues due to several converging factors:
- a projected drop in solar-weighted average power prices,
- an oversupply of solar energy driven by both large-scale projects and the proliferation of rooftop solar,
- increasing solar farm energy curtailment,
- a falling environmental certificate price.
The analysis presented tracks the performance of solar farms across different States, highlighting the impact of these factors on their profitability. Forward-looking scenarios further illustrate the potential for suppressed power prices that when combined with lower certificate prices, will lead to reduced returns. However, for some, the Capacity Investment Scheme (CIS) could be a parachute kept aloft by taxpayers.
The article draws a parallel between the solar farm industry and the challenges faced by the brown coal sector in Victoria in the early years of the market. Unlike the coal generation sector, the solar industry is more fragmented and has contractual obligations that will make it more difficult to manage power spot prices. While potential solutions like shifting or growing daytime demand, energy storage and hydrogen are discussed, their near-term viability and required scale is questioned.
The article concludes with a cautionary outlook, suggesting that a "solar eclipse" is on the horizon, potentially leading to asset write-downs and a slowdown in solar farm development, jeopardising Australia's renewable energy goals.
Introduction:
Under the current Federal Government, Australia is committed to a renewable energy target of 82% by 2030. Solar farms along with wind farms are a crucial component of this transition, providing a significant source of clean energy. However, the long-term financial viability of these solar farm assets is increasingly problematic.
The Problem: Financial Insecurity of Solar Farms
Most existing solar farms operate under a Power Purchase Agreement (PPA), as few entities are willing to assume the merchant risk associated with spot market volatility. Solar farms that have pre-sold their generation and certificates using a PPA are insulated from the fluctuations of prevailing spot prices for power and Large Generation Certificates (LGCs). However, for many solar farms, the PPA protection will eventually expire before the end of the asset life, thereby owners will seek a renewed PPA. At that point, the inherent value of their generation will likely have declined, driven by several key factors:
- Price Decline: Forecasts indicate a significant drop in solar-weighted average power prices in the coming years; combined with a falling certificate price.
- Oversupply: The market is increasingly saturated with solar energy, driven by both large-scale solar farm projects and the continual adoption of rooftop solar systems.
- Competition: Existing solar farms face competition from lower-cost new entrant solar farms and the growing prevalence of rooftop solar.
- Curtailment: As solar generation expands and faces congestion during the sunny daylight hours an increasing amount of solar energy is being curtailed, further reducing revenue for solar farms.
-> Analysis of Current Market:
To assess the current performance of solar farms, we have calculated the rolling annual average solar dispatch prices and combined this spot revenue with the rolling annual LGC spot price to determine the combined rolling average price for each State. Our analysis indicates that while the current combined rolling annual average price may be sufficient to support these projects, the cost to maintain this combined price is increasing due to greater energy curtailment.
The chart below shows the detail since January 2020 and the drop-down list allows you to toggle through each State. The legend can be used to turn on or off the series you wish to have displayed. In the chart, the global energy crisis of 2022 caused the large upward bump in the rolling average prices.
Key observations from the chart include:
- Queensland (QLD): The rolling annual average solar weighted power price has been languishing around $30/MWh since October 2023. LGC revenue, which has been representing more than half the total revenue, is also declining. Rolling annual curtailment has increased to around 15%
- New South Wales (NSW): The solar weighted average power price has been buoyed by a productive Nov-24 and Dec-24; and winter of 2024. It is currently $58/MWh, but the level of curtailment has increased to about 15%. Rolling annual power prices are expected to soften, along with a falling LGC price, especially post winter this year.
- Victoria (VIC): The solar weighted average power price has been just under $30/MWh since July-24 and LGC revenues are dominant. The 2024 winter was exceptionally good for solar with strong sustained daytime prices caused by the tight water storage issues in Tasmania. The rolling annual price will likely soften post winter this year compounded by a falling LGC price. Rolling annual curtailment peaked at 27% and is currently just under 20%.
- South Australia (SA): The solar weighted average price is rising to just under $50/MWh buoyed by a strong February and winter of 2024, but the curtailed energy has rapidly increased and is currently 34% on an annual basis. Noting that $50/MWh average price at 34% curtailment is equivalent to $33/MWh at 100% generation. Rolling annual prices are also expected to soften appreciably post winter this year given the softening power and LGC prices.
-> Price Forecast Scenarios:
To understand the potential future impact of solar farms, we modelled three scenarios using our probabilistic forecasting model (fourcast) based on three different solar farm build scenarios.
Our so-called 'Disciplined' case has the solar capacity accelerating earlier than the AEMO ISP 2024 Step Change Scenario, but then draws about equal by 2030. However, after 2030 our forecast tapers while the ISP Step Change Scenario continues to climb.
The other scenarios modelled were a build-out more closely resembling the ISP 2024 Step Change Scenario ('Like ISP') and then the 'Pipeline' scenario that assumes most of the projects publicly listed are built. A comparison of the cumulative capacity build-out is shown in the following chart.
-> Green Certificates:
Each solar farm can earn revenue from Large Generation Certificates (LGC) or post 2030 from the Renewable Electricity Guarantee of Origin (REGO) certificates, assuming the scheme becomes operational. The current forward LGC prices have been softening and are trading around $15.00/certificate for Cal−27, then falling to $13.50 for Cal-28 and $12.50 for Cal−29.
With an LGC price below $12.50/certificate in Cal−29, the combined solar weighted average prices are set to decline. Revenue will also be adversely impacted by curtailed energy, leading to a reduced spot power revenue and lower certificate revenue.
-> Financial Viability:
It was possible to derive an indicative solar farm breakeven power cost using the BloombergNEF forecast construction cost (see next section) and then by deduct a green certificate price (say $15/MWh in the 2030's). We then compared this new entrant breakeven power cost with the expected solar farm spot revenue from our spot forecast.
The chart below shows our probabilistic solar farm spot forecast (25th to 75th percentile) for the dominant solar States of NSW and Queensland. The 3 scenarios of Disciplined, Pipeline and Like ISP were considered. You can use the drop-down list to toggle between NSW and Queensland.
In this forecast we have assumed that Yallourn (VIC), Eraring (NSW) and the Queensland coal plant will be extended from their current retirement plans. We note that the Queensland Government has announced a 3-year extension to Callide B, and announcements for other power stations are to follow.
The results show the so-called Disciplined scenario is expected to deliver a much higher average solar farm price than the other two-scenarios; however all 3 are below the predicted new entrant breakeven power cost.
These price forecasts are a distribution and we have presented the 25th to 75th percentile range; and so there is a 25% chance the average price will be above the floating bar, and then a further 25% chance the average price will be below the floating bar. In this instance, the top quartile has a very long-tail which can be caused by a fortuitous event (or structural market movement) for a solar farm, while the bottom quartile is very compressed; and close to the bottom of the floating bar.
These forecasts are most likely well below existing PPA prices which means those solar farms seeking a renewal PPA, will do so under a very different valuation. For PPA off-takers, the tables are about to turn where payments will be made to the owners, rather than receiving a favourable settlement payment.
We are expecting the rolling annual price to dramatically fall late next year as the industry absorbs the current build-out of solar farms and roof-top solar. By the end of 2026, it is expected about an additional 3,200MW of solar farm capacity is to be connected compared to 2024 levels.
The solar weighted power price is expected to bottom-out around 2027 or 2028. By the end of 2027, about 5,900MW of solar farm capacity is expected, and by the end of 2028 some 7,600MW added across the NEM since 2024. This additional generation capacity is set to crush the sunny daytime prices, particularly in the sunny States of NSW and Queensland where most of the build is expected.
In the Disciplined scenario, the growth in solar farms slows significantly in anticipation that the financial returns will be inadequate for any further investment. However, there will be some PPA’s executed because of the off-taker‘s clean energy objective, and the solar farms will most likely be accompanied by an energy storage system. As a consequence of this slowdown in the build rate, there is an anticipated gradual climb in average solar farm prices. The other scenarios of Like ISP and Pipeline continue to add more solar farm capacity, which causes the solar weighted average price to remain suppressed.
Curtailment of solar production is also predicted to increase, which has the by-product of slightly higher power prices, but less LGC or REGO revenue. The net impact is detrimental for the solar farm.
-> Competition in Detail:
Each existing solar farm has two key competitors:
- Lower-Cost New Entrant Solar Farms: BloombergNEF predicts that the levelised cost of solar farms will decrease from $55/MWh(USD35) to $39/MWh (USD 25) by 2035 in real terms. Scale will undoubtedly play a role in driving down solar farm costs, and the industry pipeline commonly includes proposed 1,000 MW solar farms. However, while large solar farms may achieve lower construction costs, they will also accelerate the cannibalisation of their own future revenue.
- Rooftop Solar Systems: Rooftop solar is the primary competitor to large-scale solar farms. While solar farms can leverage economies of scale, behind-the-meter rooftop solar installations continue to offer investors the added value of avoided costs. Network costs are undeniably increasing as the transmission network is "re-wired". Rooftop solar can mitigate some of these rising network charges, as well as retail charges, market fees, and commodity charges. The continued adoption of rooftop solar is expected to remain strong, as illustrated by the chart below showing cumulative capacity by year. We anticipate that other solar applications, such as solar glass and solar roof tiles, will also become more economical in the 2030s.
Unfortunately for large-scale solar farms, rooftop solar generation is highly correlated, making it a strong competitor that contributes to oversupply and downward pressure on sunny daytime prices.
Uncanny Parallel to the Brown Coal Sector:
When assessing the solar farm industry, there's an uncanny similarity to, dare I say it, the brown coal sector of Victoria. For some, the notion of solar farms having parallels with brown coal generation may be unsettling, as they represent opposite ends of the carbon emission spectrum.
Solar farms have the lowest marginal cost in the market (shared with wind farms), but relatively high fixed costs. Before renewables claimed the crown of the lowest marginal cost generator, the brown coal sector held that position for approximately the first 5 to 10 years of the market's operation.
Once privatised, the brown coal sector was debt-laden although had the lowest marginal cost, but faced the challenge of falling spot prices. If not for legacy hedging agreements (similar to solar farm foundation PPAs, except shorter term), the brown coal sector would have struggled to meet its debt payments. How did the brown coal generation sector address this situation?
Their first lesson was recognising the importance of the spot price level. Even though early in the deregulated market they weren't highly exposed to the prevailing spot price, it was not in their commercial interest to allow it to collapse. They needed to re-contract in the future, and a significantly devalued product would jeopardise their financial future.
Consequently they began a relay race, sacrificing short-term cash by placing capacity at risk in higher price bands to try to raise spot prices, risking non-dispatch. Black coal generation reached the same conclusion and Loy Yang Power with Macquarie Generation became key proponents of this strategy, learning the trade-off between price and quantity. They realised it was possible to burn less coal and earn more revenue.
However, this strategy was a relay race. Those sacrificing short-term cash sometimes grew weary and relinquished the baton, only for another party to pick up the baton and continue the race until they grew weary. By which time an earlier proponent would re-engage and pick-up the baton again.
Over time, these assets became part of vertically integrated businesses, providing them with another channel to market. The more lucrative residential market opened up to the coal generation sector.
As history unfolded, the market tightened after many years, initially aided by Macquarie Generation reducing availability from 8 to 6 coal units for several years, followed years later by the closures of Munmorah (NSW), Swanbank (QLD), Wallerawang (NSW), Playford (SA), Northern (SA), Hazelwood (VIC), and Liddell (NSW). The east coast of Australia also became connected to the global LNG market, and all these factors combined to cause spot prices to rise and volatility to increase, with a higher maximum price cap in operation. To top it all off, the global energy crisis of 2022 occurred, triggering another chapter of the market story.
Compared to the coal generation sector, the solar industry has many more market participants, and the expiration dates of the solar farm foundation PPAs vary considerably. While some have whole-of-life PPAs, this is not universally the case. Consequently, the alignment of incentives is not as strong as it was in the brown coal (or black coal) generation sector.
It will be more challenging for the solar industry to initiate the relay race of forgoing short-term cash to drive long-term value. Their PPAs likely obligate them to maximise generation above the contracted floor price (e.g., zero or a negative LGC price). These contractual constraints, varying PPA tenures and fragmented ownership will make it difficult to raise spot power prices during sunny daytime hours.
The prospect of a solar farm becoming part of a vertically integrated business is also unlikely because many customers already have rooftop solar, and many retailers are already swamped by surplus solar generation.
Potential Solutions (and their limitations):
So, what can the solar industry do to address these challenges?
One might hear the simplistic solution: store the solar farm energy and dispatch it at more valuable times. While this is true, the counterargument is that storage devices can be charged from the spot market, often at a price lower than the cost of a solar farm. In other words, a solar farm isn't necessary to implement an energy storage arbitrage business strategy.
Building storage to accompany an existing solar farm may be viable, but building a new solar farm to charge an energy storage system would not likely be financially optimal. Nevertheless, for existing solar farms exposed to the soft sunny daytime spot prices, they could rush to create a hybrid storage and solar farm. For some owners, they may be up to the challenge of seeking approvals and securing finance; while for others it may be an opportune time to exit. If so, valuation pressures will no doubt prevail upon exit, leading to potential write-downs. Remembering an energy storage arbitrage business model does not need a solar farm; but a solar farm needs energy storage to value-add.
Is hydrogen the solar farm's savior? Perhaps, but it's a long way off.
It's fair to say that Australia needs to increase daytime electricity demand. The more electricity consumption we can shift from nighttime hours, the better for everyone. Electric vehicles, energy storage, and restructuring retail tariffs to send price signals to consumers are clear potential solutions for the solar farm industry.
Relying upon the scheduled retirement of further coal plants to elevate spot prices during the day is problematic, as these planned dates are not guaranteed and are already operating at minimum generation levels.
The prospect of daytime demand surging to absorb all the surplus solar generation is hard to conceive to the scale required. It would be fantastic if Australia could find a way to capitalise on this opportunity. Energy storage including electric vehicles and other demand growth (or shifting) initiatives are big contributing factors; but from our analysis, they won't be enough for a decade or so.
We note that the Federal Labour Party has announced their home battery policy that will subsidise 30% of the cost of installing home batteries for 1 million homes by 2030. Our modelling was undertaken prior to this policy announcement, however we expect this policy if implemented will assist solar farms, but not avoid the solar eclipse.
Role of Capacity Investment Scheme (CIS):
The Capacity Investment Scheme (CIS) is in place to underwrite the risk with renewable projects. It is understood this is achieved by setting in place an annual revenue collar. If annual revenue falls below the floor, then the Government will make-up the difference with the owner; and conversely if the annual revenue exceeds the cap, then the owner will pay the difference to the Government.
Based on our forecasts, the Government is likely to be paying-out for awarded solar projects shortly after they come online due to the annual revenue floor being triggered and it is likely to remain so for about 10-years. Unless of course, the floor was set at an exceedingly low level.
Conclusion:
The solar farm industry faces a significant challenge. Existing solar farms coming to an end of their foundation PPA, are likely to face a substantial lower revenue flow for their next PPA tranche; triggering potential write-downs. Existing PPA off-takers who have enjoyed a favourable start to the agreement, are about to face the table turning.
For new solar farms aiming to start about 2028 and beyond without being under-written by the CIS, will most likely be stalled for about a decade unless they can find a willing PPA off-taker. For those new solar farms unwritten by the CIS, are likely to enjoy top-up revenues from the collar floor being triggered over the next decade. Taxpayers will likely be making a valuable contribution to these projects.
The market is also pursuing expanding transmission infrastructure to accommodate additional solar and wind farms, but from our analysis it is hard to see these medium term solar farm projects proceeding at the assumed build rate. We are probably facing an under-utilised transmission asset for many years, unless wind fills the void.
I conclude with some hesitation, that a solar eclipse is coming and is likely to lead to asset write-downs, which will be detrimental to some investors in the industry. Join me in watching the laws of economics, trigger a phenomena determined by the laws of physics.
Disclaimer and Notes
Energybyte is published by Empower Analytics Pty Ltd (ABN 38630239002), Authorised Representative no 1274453 of Capital Treasury Solutions (AFSL 429066). Any questions or feedback must be directed to Empower Analytics Pty Ltd as the sole publisher.
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