49253 MAY 2009 ABOUT THE AUTHOR The Sun Rises on the Solar Sector REYAZ A. AHMAD is a chief investment officer in the Global Manufacturing and Services Department and Energy from the sun is abundant and free. Solar energy is in essence leads the Energy-Efficient Machinery (EEM) Sector Team, electromagnetic radiation emitted from the sun. Earth's climate, which covers the renewables hydrologic systems, and ecosystems all derive from the sun. Other (including solar) supply chains, the automotive sector, and forms of renewable power such as wind, wave, biomass, and hydro machinery. Reyaz previously worked in the Oil and Gas are an indirect function of solar radiation. Department, Privatization Advisory Services, and the Global Information and Communications Technologies Enough solar energy reaches the Earth's renewable sources (see Exhibit 1), because the Department where he worked with SoftBank surface every minute to satisfy mankind's solar panels themselves are expensive to Emerging Markets, the energy requirements for an entire year.1 It is manufacture and install. However, solar power Venture Capital Fund that IFC estimated that in one year, the amount of offers the potential for much greater cost launched in 1999. solar energy reaching the Earth is equal to reduction than other renewables, based on its twice the amount of energy that will ever be relative technological immaturity (see Exhibit APPROVING MANAGER Stephanie Miller, senior obtained from the Earth's stock of 2). Rising to the challenge of generating solar manager, GMS. nonrenewable energy sources.2 There are power in a cost-effective manner would have opportunities to find and deploy robust, a substantial impact. Over their life, the competitive solutions to convert a small operation of 500 megawatts of solar panels fraction of this plentiful energy source into would avoid approximately 10 million tons of usable electric energy: Solar photovoltaic (PV) CO2 that on average would otherwise be is the main solution used today, involving the emitted to generate an equivalent amount of use of PV panels3 that generate electricity energy. when exposed to the sun. IFC's strategy for solar was approved by the Corporate Operations Committee in October 2008 and focuses on: · investments in the solar supply chain to help reduce the cost of solar modules and installations through shifting production to low-cost countries, scaling-up manufacturing facilities, and supporting new technologies; and · investments in solar farms and installations Death Valley solar farm where there is suitable regulatory support (e.g., incentives, subsidies, etc.) and where solar is already competitive with traditional The problem is that converting solar radiation energy sources (e.g., for isolated systems or into usable electricity is expensive, relative to island systems where expensive diesel- traditional fossil-based energy sources, and based generation is used). somewhat expensive relative to some other 1 Nathan S. Lewis, California Institute of Technology; Daniel G. No- IFC has invested in a number of companies: cera, Massachusetts Institute of Technology. Nitol (manufacturer of silicon) in Russia; MBPV 2 Global Climate and Energy Project, Stanford University. 3 Also known as solar modules. Solar panels are made up of solar (the Moser Baer Group in India - crystalline cells. The main technology is crystalline silicon PV, where thin wa- silicon PV); ENN XinAo (the XinAo group in fers of purified silicon are treated such that an electric current is generated when they are exposed to the sun; in thin film PV, very China - thin film PV); and CEPALCO PV in the thin layers of various materials are deposited on glass or metal Philippines (solar farm). This Smart Lesson substrates to make solar cells. IFC SMARTLESSONS -- MAY 2009 1 draws on IFC's experience investing in the solar industry and few years as silicon prices shot up due to excessive demand, discusses the opportunities and challenges for IFC in this but the recent industry downturn means that the long-term dynamic sector. downward trend has now resumed. The key focus for solar industry players is achieving "grid Exhibit 1: Levelized Costs and Renewables (2007, $/mWh) Exhibit 2: Maturity of Renewables parity," the point at which the cost of electricity from solar PV will be at par with convention- al sources of power without subsidies. At cur- rent average pricing levels, so- lar PV still costs in the range of 20 to 40 cents per kilowatt hour. However, Source: Hydro, Sandia National Laboratory, Idaho National Lab, Source:American Wind Energy Association as the total cost Carbon Trust, Simmons Energy Monthly of a solar instal- lation falls over time, grid parity Lessons Learned will be achieved progressively in various countries (or states in the United States), each characterized by different non- 1) It's all about long maturities and low interest rates. renewable fuel sources, prevailing electricity tariff struc- tures, and the level of solar radiation. The basic characteristic of solar PV installations is that they generate electricity at almost zero cost4 when exposed to the sun: in particular, there is no fuel cost because the sun's PV Module Learning Curve energy is free. Solar installations thus represent an excellent hedge against highly variable fossil fuel prices, and this is one of the reasons that large utilities are now taking it much more seriously than in the past. However, the flip side of this characteristic is that virtually 100 percent of the cost of solar PV is capital cost, all paid up front at installation. Solar installations are very durable, with the solar panels themselves continuing to function for 25 years or more, so the up-front cost is recovered over more than two decades of essentially free electricity. This cash-flow profile makes solar especially sensitive to the availability of large amounts of long-term funding, so it is a natural fit for IFC. 2) Solar offers more cost-reduction potential than other Source: P. Minst, Navigant, 2008 renewables. From Applied Materals presentation to IFC June 2008 Thesolarindustry,applyingtechnologiesandmanufacturing processes derived from the semiconductor industry, is the Industry observers project that grid parity for a large only renewable energy solution with a well-established and number of countries will be reached when solar PV modules reasonably predictable cost-reduction curve. For example, are priced at about $1.50 per watt peak (Wp)5. The price of wind is cheaper than solar today but is fundamentally based solar PV modules has fallen dramatically since the 1980s, on more mature technologies and manufacturing processes and is expected to continue to drop. The price of modules and so has a lower cost-reduction potential, compared to was about $19 per Wp in 1982 (in 2007 dollars) and has solar (see Exhibit 2 above). fallen to around $3 per Wp on average. Solar PV module prices have been dropping by about 4 percent per annum The solar PV industry has a strong track record of steady over the last 15 years, with some companies already cost reduction, as illustrated in the chart above, which beginning to offer volume discounts at about $2 per Wp for shows that the price per unit of output of PV modules has advanced thin-film modules, and prices are projected to decreased over a long period, as capacity has expanded. drop to as low as $1 per Wp in the next four to seven The steady downward trend was reversed just in the last years. 4 Minimal maintenance is required during the life of the installation, and periodic re- 5 Watt peak, or Wp, is the direct current watts output of a solar module as measured placement of the electric inverter is required, but this averages out to close to zero. under a standardized light test. 2 IFC SMARTLESSONS -- MAY 2009 3) The future is in storage and hybrid solutions. solar PV an integral component of power system supply planning for both utilities and their customers even if Solar panels only generate electricity when the sun shines subsidy supports are reduced or eliminated. Furthermore, on them. (In fact, peak solar generation corresponds closely solar PV is already very economical in many developing- with peak electricity demand from airconditioning in warm country rural off-grid markets where the alternative countries.) Without adequate storage--for example, in electricity source may be a diesel generator, and the falling batteries--electricity from solar panels has to be consumed costtrendoutlinedpreviouslyisexpectedtofurtherimprove when it is being generated, and various innovative storage the attractiveness of solar PV in the off-grid segment. A solutions are being developed to address this issue. In vibrant supply chain is expected to emerge in developing addition, hybrid approaches, such as combining solar and countries, along with growth in demand and the creation wind or combining solar with hydro or even with of many green jobs. conventional electricity generation, are being explored to develop solutions that address the need for continuous 5) IFC has become comfortable with investing in an power while taking advantage of the benefits of solar. industry benefiting from subsidies. 4) IFC has significant opportunities in solar as a result of IFC has a long-standing and well-founded aversion to the economic crisis. investing in subsidized businesses. Our experience clearly shows that investing in a company in a protected market The financial crisis has taken a heavy toll on the solar that benefits from tariff barriers is uneconomic (that is, a industry with stock prices of many solar companies falling poor allocation of scarce resources) and represents a by 80 percent or more due to uncertainty in the market as significant credit risk because the investment is invariably banks have reduced lending and households have cut back. vulnerable once protections are reduced or removed (a IFC has been approached by the industry's top players consistent trend in a globalizing world). This aversion to (including Suntech, SunPower, First Solar, and Q Cells) as subsidies was a major challenge in IFC's initial solar they seek to align themselves with a long-term partner with investments. similar broad corporate goals and the financial capacity and long-term perspective to work with them in the emerging IFC has become comfortable with investing in the solar solar markets in developing countries. By coinvesting with industry, notwithstanding the fact that it benefits from such companies at this time, IFC can simultaneously help substantial subsidies in various forms.6 Furthermore, build scale, drive costs down, bring grid parity closer, and countries with an active solar industry also impose various share in the upside created as the stock prices of these regulations favoring or encouraging investments in solar companies start to rise when the solar market recovers. (and more broadly, renewables). IFC's comfort with these arrangements is based on a number of key considerations: · It is widely recognized that fossil-based electricity generation is a major contributor to global climate change through the emission of CO2 into the atmosphere; however, agreement is yet to be reached on how to take this economic externality into account when assessing fossil fuel-based electricity projects. In effect, the playing field is tilted toward coal and gas- fired power plants, compared to solar and other renewables-based solutions. IFC's support for solar projects goes some way toward redressing this situation. But this is not a scientific approach, and a more systematic way to regulate carbon emissions remains a priority. Commercial solar panel rooftop · As noted earlier, grid parity for solar in a number of locations is quite close: IFC's financing for solar projects can be seen as a necessary transitional support to help The industry downturn means that solar panel prices have the industry achieve grid parity. fallensharply(about25percentsofar,withperhapsanother 20 percent expected in 2009), and solar companies are · In a narrower sense, the vast majority of solar panels are eager to find new markets, including developing countries, installed in industrialized countries (Germany, the United for their products. Growth in the solar industry, which had States, Spain, Japan, Italy, etc.) because this is where the been running at 30- to 40 percent per year, has slowed industry benefits from substantial, credible subsidy significantly this year, but growth is expected to resume in 6 These include (i) feed-in tariffs: higher electricity tariffs paid to households and oth- 2010. As grid parity is achieved more widely, solar PV ers who install solar panels and sell surplus electricity to the grid; (ii) tax credits: credit demand is expected to increase sharply, permitting greater for the amount spent on solar installations, deductible from taxes due; (iii) capital subsidies: grant funds or subsidized loans available to complement private capital for scale and lower costs in the supply chain, thereby making solar installations. Germany is the largest solar market, based on feed-in tariff sup- port; the United States has deployed tax credits and other supports. IFC SMARTLESSONS -- MAY 2009 3 arrangements. Thus, in calculating the economic rate of return (ERR) for an investment in a solar company in China, for instance, the subsidies arising in Germany are not taken into account, as the ERR is calculated for the host country of IFC's investment. · From a credit standpoint, there is now a clear understanding that: · the subsidy programs in major solar markets (including Germany and the United States) are based on a stable domestic political consensus so that no radical change is expected ·IFC'sinvestments,bybuildingscaleand supporting the shift of the supply chain to lower labor cost countries, are helping the industry achieve grid parity earlier, and that once grid parity in key markets is achieved, theriskassociatedwithsubsidiesdisappears; and ·IFCisworkingwiththelargestandmost successful companies in the solar industry, which are expected to survive the present downturn and emerge strengthened Conclusion IFC is leading the way in treating the nascent solar industry and the vast potential of the Earth's largest energy resource as a serious long-term opportunity for good business with substantial global development impact. Supporting industry players as they expand in developing countries accelerates solar's potential for cost reduction and brings closer the achievement of grid parity, while enabling IFC to benefit from the expected upturn in this dynamic industry. Investment in the solar industry coincides with IFC's goal of focusing on climate change-related projects and capitalizes on our role as an investor willing to DISCLAIMER take a long-term perspective and to help IFC SmartLessons is an awards support our clients over the long haul. program to share lessons learned in development-oriented advisory services and investment operations. The findings, interpretations, and conclusions expressed in this paper are those of the author(s) and do not necessarily reflect the views of IFC or its partner organizations, the Executive Directors of The World Bank or the governments they represent. IFC does not assume any responsibility for the completeness or accuracy of the information contained in this document. Please see the terms and conditions at www.ifc.org/ smartlessons or contact the program at smartlessons@ifc.org. IFC SMARTLESSONS -- MAY 2009 4