The Economics of an Investment in Solar Power - part 1

by Energy Action | Aug 04, 2016
It is now a reality that the cost of generating electricity from the sun can compete with traditional sources of power. Add to this equation the breakthrough advances in battery technology, and sustainable, clean and dependable solar power can increasingly become a practical, cost-effective way to meet the businesses demand for energy. A win-win for Australian businesses, right?

We have recently written about solar power for commercial and industrial companies which digs deep into the benefits and considerations. However, before you start telling your boss that your organisation needs to lead the charge to electricity sustainability, you should consider a few realities of an investment in solar power.

Solar power is an investment and it has a great payback relative to its expected life, though not such a good payback relative to the investment hurdle rates of many Australian businesses. That said, there are options to dodge the hurdle rates: packaging arrangements such as Power Purchase Agreements (PPA) transform a capital investment into an operational cash flow.

However, while packaging may make the realities of energy efficiency seem more within reach, the fundamentals of the investment are just as important: payback, sizing, and coverage of the solution will still drive the benefit that your organisation receives, or the opportunity your organisation misses out on.

In this three part series, we look into the above three key factors in the economics of an investment in solar power. In this first article, we look at ‘payback’.

Payback

The payback on a solar installation is the time it takes to recoup your investment costs. It is calculated by dividing the capital cost of your solar investment by the avoided cost of energy supplied to your site from the electricity grid consumption less any new costs. It is expressed in years. This payback (before batteries) for most commercial and industrial sites – on an un-bundled bill – will be in excess of six years. Perhaps even as long as nine years. A battery installation in parallel with this may double the payback and extend the period required for a positive return on an investment, beyond the warranty period of the batteries themselves.

This payback range for solar power occurs in spite of the components of a solar installation. Component pricing is now at historic lows as China takes a dominant position in the solar production market. If a solar quote is presenting an investment payback shorter than this range, then there are three possibilities as to what is going on:

1. the design, hardware and installation services you are being quoted are not fit for purpose and will not last the expected lifetime of a well-engineered project;
2. the energy costs reported for grid supply are being over simplified and over stated. It is likely that the fixed costs of your grid costs have not been removed from the equation, presenting a false economy that understates the costs you are actually going to avoid
3. you are being eaten alive in the energy market and there are cheaper means for you to reduce your energy costs that you should investigate – if you want to get full benefit from a solar investment.

So, what does payback mean for your decision to invest in a packaged solar investment, such as a Power Purchase Agreements (PPA)? The same fundamentals that drive the payback on a ‘pay to own’ investment in solar, also apply to a PPA. Given the 6+ year payback on a capital investment, the PPA you will sign will be a long term agreement, or it will have a significant buyout figure at the end of the term.

 Payback part 1_image

To make a commitment then, the questions you need to consider are: How does the business make long term commitments such as this, now? Is there a business case and sign off process that requires more due diligence than a short term business as usual proposition? Also, is there a property lease on the premise in place which may see us seeking to break the PPA before the term ends?

There are typically payout conditions in place in the PPA's we have seen in the market, however there is some fluidity in these as the market matures. Most PPA sales consultants will recognise the challenge of transferring your obligations to your landlord or an incoming tenant. Unfortunately, in relation to this, a lot of the dynamics here are well beyond the control of the PPA provider.

It is worth considering what arrangements you should write into your next premise lease negotiation with your landlord to protect your organisation from the need to buy out the PPA.

In terms of pricing, the price you pay for energy will escalate at Consumer Price Index (CPI) or another index, which may or may not provide a reduction in costs to your site in each year of the contract.

Complicating your decision is the fact that you may have visibility of your retail energy contract prices for the next three years. There is some certainty about your network prices for the next five years (in NSW), but beyond that it is difficult to say.

Check in with us next month for Part 2 of our series where we will look at solar installation sizing and what that means for your decision in investing in a PPA.

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