Sunday, November 30, 2014
Saturday, November 29, 2014
A Big Change in How the IEA Views Renewables
The future is tough to predict.
The International Energy Agency recently came out with its World Energy Outlook 2014, a comprehensive analysis of global energy demand and the underlying supply mix through 2040. Along with BP's annual forecast, it is one of the most authoritative documents of its kind.
But even the IEA can miss a trend. In the 2014 report, the IEA predicts that the share of renewables will grow from 21% in 2012 to 33% by 33%. Renewables, including hydropower, nearly triple by 2040 and surpass both natural gas and coal as the top source of electricity by 2035. By 2050, solar alone could become the largest source of power by 2050.
In the executive summary of the World Energy Outlook 2004, the words "solar" and "PV" do not appear. The share of "other" renewables, i.e. everything by hydropower, will triple, but only from 2% to 6% by 2030. Hydropower is around 16% of world power today so the base figure fits but the prediction was low.
The same holds for efficiency. "Efficiency" appears only twice in the 2004 summary. The report revolves around supply and the picture is grim for emerging markets.
"Huge amounts of new energy infrastructure will need to be financed. And many of the world's poorest people will still be deprived of modern energy services. These challenges call for urgent and decisive action by governments around the world," the 2004 report states. "Little progress will be made in reducing the total number of people who lack access to electricity."
In the 2014 report, efficiency plays a more prominent role. The slowdown in the growth of demand for energy to 1.1% per year is attributed primarily to efficiency. Efficiency is also identified as a lynchpin in bringing power to emerging markets. It will still be a challenge to extend power to rural areas of Africa and Asia, but hope grows.
"Without the cumulative impact of energy efficiency measures over the projection horizon, oil demand in 2040 would be 23 mb/d (or 22%) higher, gas demand 940 bcm (or 17%) and coal demand 920 Mtce (or 15%) higher. Beyond cutting energy use, energy efficiency lowers energy bills, improves trade balances and cuts CO2 emissions. Improved energy efficiency compared with today reduces oil and gas import bills for the five largest energy-importing regions by almost $1 trillion in 2040," the report states. "Technological progress and improved energy efficiency… allow a higher level of demand for energy services to be satisfied per unit of energy."
Oil? In 2004, oil demand was expected to hit 121 million barrels a day. In the 2014 report, demand will only rise to 104 million barrels a day.
Biofuels? Not in the executive summary of 2004. 2014? "Biofuels use more than triples, rising from 1.3 million barrels of oil equivalent per day (mboe/d) in 2012 to 4.6 mboe/d in 2040, by which time it represents 8% of road-transport fuel demand," the report states. "Advanced biofuels, which help address sustainability concerns about conventional biofuels, gain market share after 2020, making up almost 20% of biofuels supply in 2040."
That prediction is below the sort of predictions from biofuel advocates like Vinod Khosla, but it's certainly higher than in the past.
Again, this isn't to say the IEA needs to rethink its methodologies. It's an authoritative source. The lesson here really is our greatest source of energy is human ingenuity. Over the past decade we've seen a revolution in energy and it has come out because of new materials (i.e. semiconductors) new business models and new ways of thinking about systems.
And some other notes from the 2014 report
- Subsidies for fossil fuels are four times greater those given to renewables. Fossil fuel subsidies come to approximately $550 billion a year. Subsidies to renewables come to around $121 billion. Renewable subsidies will rise to $230 billion by 2030 but then drop to $205 billion by 2040.
- Global investment in power infrastructure will total $21 trillion by 2040. A significant portion will go toward upgrading transmission and distribution networks. It's needed. The average age of transformers in the U.S. is 42 years. The average lifetime expectancy of a transformer is 40 years.
- Nuclear shifts to non-OECD nations. In 2013, there were 434 nuclear reactors worldwide, supplying 11% of the world's power, far down from the 18% market share in 1996. Nuclear's market share will grow to 12% by 2040, but the big change is the locations of the reactors. The bulk of the 380GW coming on line will be in China and other non-OECD nations while the majority of the 148GW retirements will come in North America, Europe and Japan. Still, nuclear remains one of the "limited options" for controlling emissions.
- Watch Sub-Saharan Africa. The region has tremendous potential for solar, geothermal, wind and natural resource extraction. In the last five years, 30% of new oil and discoveries were made there. It will also be a hotbed of grid experimentation. 950 million people will get access for the first time to regular sources of power by 2040 and 70% of those new customers in rural areas will get power through microgrids and off grid systems.
A New Way To Finance Solar and Storage: The LOPPA
But to be honest, they are an odd couple with very different personalities.
Solar is passive: solar modules are typically planted in a fixed position to generate power for 20 or 30 years. You have to hose them off occasionally, but active maintenance and management reimains fairly minimal. Except for the occasional inverter glitch, lifetime energy output is also somewhat predictable.
Storage systems, by contrast, are active, continually discharging and/or charging to arbitrage pricing or balance loads. Maintenance and upgrades are part of the territory: batteries need to be swapped in and out of the system over its lifetime. The software installed with solar systems functions mostly to document power production. The software inside of storage systems functions more like a true operating system, controlling battery activity and monitoring cells for potential failure or degradation.
Most important of all, the function and "value" of a solar system is straightforward: they generate electrons. Unless the sun implodes in the near future, you understand the value of your investment with sterling precision from day one.
Storage is deployed for demand response, smoothing intermittent renewables, reducing peak charges and frequency regulation. The same system will perform these and more functions, often in the same day. The "value" thus will vary wildly: a system used for frequency regulation will potentially earn far more revenue than one used simply to store electrons from a solar system for nighttime enjoyment. Using storage to capture solar energy for nighttime enjoyment, in fact, seems almost a futile way to use a storage system: you're deploying a somewhat elegant, intelligent piece of equipment to replace off-peak grid power, the cheapest power you can buy. It's like buying a BMW to only go back and forth to the convenience store.
As a result, they probably shouldn't be sold within the same contract. Right now in solar, a growing number of customers are choosing to buy their systems through loan contracts instead of PPAs. The declining cost of solar, along with the established reliability, simply make loans a better option in most cases.
But storage? Consumers simply aren't in a position to manage and monetize storage in an optimal fashion. Solar you can set and forget: storage you want to constantly massage.
Hence, the LOPPA, which stands for Loan PPA. Under a LOPPA, a solar system is purchased by a loan while the storage system gets installed under a PPA. The beauty is that the two payment vehicles can be combined in the same document, covering up the legal messiness with one monthly payment. The consumer gets the benefit of greater energy independence at a lower price while the solar dealer gets to earn revenue from a sale (the solar loan) a PPA and additional, incremental revenue streams.
One could imagine a wide spectrum of variants. Solar dealers, for instance, could sell a consumer a residential system under a loan and a portion or condominium interest in a community storage system. Larger storage systems can have a better ROI. It is also easier for developers to sell utilities more services through fewer systems.
There's a good variety of acronyms too: Solo Stoppa, StoSo, etc.
Who offers LOPPA? Right now, I'm not sure. I made up the term. But creative financing has been the hallmark of the U.S. solar industry and storage is on the way. You will see contracts like this. It's just a matter of time.
What Game Theory Can Tell Us about Middle Market, Commercial and Industrial Solar
The decisions made along the path of solar project finance and development have major implications for the growth — or stagnation — of the commercial and industrial solar market. How does a developer choose the right financier for their project, or an investor decide to interact during contract negotiations? Together, what impacts do these decisions have on the value chain?
To answer these questions, we look to game theory, specifically the Prisoner's Dilemma, to analyze and predict how decisions made in these transactions affect the interactions in the solar industry, specifically in the 200-kW to 5-MW space.
Game Theory and The Prisoner's Dilemma
In case it has been a while since your last Econ 101 class, here is a basic example of game theory.
The police catch two partners in crime, Matt and Colin, after they have been selling counterfeit solar modules. Upon return to the police headquarters, the police separate the two and question them independently. The police don't have enough evidence to charge the criminals, but a confession would be sufficient to put them away. Per the example the criminals can either confess (thereby incriminating their partner), or they can remain silent. The full breakdown of possible decisions and outcomes is below:
Colin Does Not Confess
Both serve a 5 year sentence
Matt is released
Colin serves a 10 year sentence
Matt Does Not Confess
Colin is released
Matt serves a 10 year sentence
Both are released
The decision structure incentivizes both Matt and Colin to confess as this improves their position in two of the four possible outcomes: 1) if they both end up confessing or 2) in the event that the other remains silent. However, the optimal group outcome only occurs if both remain silent. As the two partners individually ponder how to proceed, the dilemma becomes clear — how can one trust the other to not confess? If one can't trust the other, isn't it just better to confess?
Now, think about that in the context of solar project finance and development.
The Number of Games Played Matters
Solar industry stakeholders do not make strategic decisions in a vacuum. However, industry players do vary in the way they view time horizons — and how their decisions impact future transactions.
If a developer or investor views a deal as a one-time transaction, they are more likely to defect in search of economic gain. Players that anticipate future transactions with the same parties are more likely to opt for cooperation to protect future possible gains. In short, the number of games played matters, and directly correlates to the amount of trust between two parties. If Matt and Colin have worked together many times, they can trust the other to remain silent and will be back on the streets selling counterfeit modules in no time. However, if this is their first collective trip to the rodeo, the trust is not there and jail time is likely in store.
To put it simply, in the world of solar project finance, relationships matter. If two players treat the deal at hand as the beginning of a long-term partnership rather than a one-off transaction, they greatly increase their likelihood of achieving both short-term and long-term success. Defecting to increase returns in a one-off transaction may have a higher short-term payoff, but does not carry the same return in the long run. The more interactions that a developer and investor have with each other, the greater their chances are for cooperation — and success.
Defection Has Its [Temporary] Gains, But Hurts C&I Solar
Cooperation provides the best group-level outcome, but defection enables the greatest outcome for an individual player. Defection manifests itself in the solar industry in a number of ways. During financial negotiations, both investors and developers have the ability to protract discussions or be punitive in the name of an additional penny or two per Watt. In the greater project marketplace, industry players have the incentive to misrepresent projects or their financing capabilities in order to increase financial gain — the notorious "free look."
Defection is risky because it quickly erodes trust and the potential for any long-term gains. The opposing counterparty may also defect in retaliation and wipe out any advantage the decision maker gained by defecting in the first place. Further, and possibly more importantly, it can corrode one's reputation in a relatively small industry. If a player considers defection, there must be a very good economic case supporting this decision because the long-term results may not contain an attractive payout.
Unfortunately, defection is all too common with middle market solar projects, and thus, many projects never make it to the finish line. The most typical explanation for defection persisting in an environment of repeated games is that one party is "hyperinflationary." That is, that their personal cost of money or return expectation is so high — or their value of future business so low — that rationally they assign no value to future years. If Colin has no realistic prospect of living more than five years, he will defect every time. Similarly, if a solar industry player can't make payroll without that extra cent on a project, or has no future projects in the pipeline, they'll grind all counterparties to maximize the money they can get this time, with no thought to speedily getting to the next transaction.
In the more mature residential and utility scale solar markets, cooperation takes on a greater role as companies have engaged in multiple transactions due to the limited number of market players. In the more fragmented middle market, companies rarely conduct repeat business. Instead, many developers opt for the term sheet with the highest pricing without fully conducting due diligence on their financing partner. Then, down the line, they may realize that the financing partner misrepresented their ability to bring tax equity to the table, or later reduced pricing due to mysterious "concerns uncovered during due diligence."
Given the rapid rise of the middle market over the last five years, most transactions take place between new market entrants and/or players who are interacting for the first time. This increases the likelihood of defection as new players remain focused on short-term gains and growth, often at the expense of potential future interactions with repeat partners.
Building Trust, One Iteration at a Time
In solar project finance, as in game theory, repeat transactions build trust and enable parties to optimize returns on both sides without fear of defection. Further, a tendency to defect is a grim signal of lack of capability itself — it means a player is showing, in a way hard to fake, that they don't plan on a long future. However, game theory nirvana (aka "Nash equilibrium") is not always easy to achieve. In a nascent industry with many new entrants, the temptation is certainly always there to defect in pursuit of economic gains. However, firms with a long-term focus recognize that the industry is small, reputation matters, and that success requires repeat interactions with a similar cast of partners.
The cornerstone of building a sustainable relationship first comes through trust. Once two players cooperate, they open the door for future cooperation. It is important to note that players do not cooperate for the sake of cooperation. They cooperate to unlock all of the benefits that come with cooperation: growth, sustainable revenue streams, access to additional resources, and (most importantly) the ability to achieve things that a single industry player could not achieve on his or her own.
What Game Theory Can Teach Us about Middle Market Solar
Developing and financing middle market projects is not easy. The sales cycle is long, and fraught with risk. Most projects don't even make it to the finish line. In addition to this, looming industry challenges lie in wait, including a reduction in the investment tax credit (ITC) at the end of 2016. We view partnerships as the most efficient and effective way to overcome these challenges. To do this we must work together, building trust one iteration at a time.