The below article is the second installment in a two-part series. The first installment was published on February 24, 2020.
How Did We Breach the Two-Cent Barrier?
Unit-cost solar electricity for less than two US cents per kilowatt hour (kWh) is the cheapest electricity in the world, but most of the recent ultra-low bids in the global solar market likely required the stars to align to breach this barrier. Using very high efficiency or bifacial modules in some of the sunniest parts of the world, combined with aggressive forward module pricing and system cost assumptions, a transparent and supportive national policy environment, and access to concessional terms for finance, taxes, land, or labor, has driven capital expenditures down significantly. It is important to note that it is not uncommon for public utilities to offer concessions of various kinds in order to reduce contracted prices from independent power producers, or IPPs, but it does make comparing bids in different markets difficult. These concessions can include low-cost financing, loan guarantees, tax breaks, land, delivered diligence, and labor restriction exemptions, among other benefits. Further benefits not immediately apparent may include tariff policies detailed in the tender documents like high escalators or peak pricing premiums that raise the effective net tariff.
As price competitiveness continues to intensify and the leading price continues to fall, competitive tendering has become the principal method for procurement of renewable energy globally and will continue to apply downward price pressure on awarded tariffs, establishing a virtual price ceiling for unsubsidized solar power.
A Race to the Bottom?
This trend of ultra-low bids can be sustainable, but only under the right conditions. On a fundamental level, auctions are one of the purest, most transparent forms of price discovery in a market. Direct incentives set by policymakers may over- or under-estimate the current market price because they have an asymmetric understanding of market forces. However, that information asymmetry curse also affects market participants. Banking on overly aggressive assumptions of forward component pricing, preferential non-recourse financing, or concessions could mean many of these ultra-low-priced projects are not realized, especially if unforeseen external market forces—such as political winds, trade protectionism, or interest rate spikes—come into play in future years.
Some ultra-low bid projects may face serious execution risks if the true margins developers are earning remain razor-thin, or if forward pricing assumptions turn out to be overly aggressive. This is known as the “winner’s curse.” But that does not mean these projects are not bankable. Many of the recent record-holding tenders have interconnection deadlines two to four years after award, with commence construction deadlines of twelve to eighteen months before interconnection. This is a distant future in the solar market.
One market observer wisely contends that these successful bidders effectively “bought an option to ‘wait and see’ how technology costs and electricity prices have developed when they come to make their investment decision.” If the cost of non-compliance penalties is lower than the value of the option, it is a rational choice for a developer to renege on the contract, despite the potential implications for the country’s long-term energy planning. So long as the right mix of market conditions leading up to the engineering, procurement, and construction phases exists, the global market will likely see most of these “options” bets pay off. In markets that show significant long-term promise, tender participants may also be willing to accept low returns in order to gain a “market-entry discount,” which may help explain why bid prices sometimes differ from market expectations. For riskier electricity markets with traditional energy opportunities, offering large, competitively priced, balance-sheet financed renewables projects could incentivize traditional oil and gas firms to bid attractive combination gas-plus-renewables packages with energy ministries.
Auction designers and regulators should seek to avoid the pitfalls listed above through a combination of intelligent market design, learning from previous auctions’ outcomes, and clear penalties for non-delivery. These programs are more likely to attract private capital when auction rounds are carried out with regular, predictable, transparent cadence because they offer stability, allow developers to plan up the supply chain, and influence the learning curve of the competitive market, increasing the volume of bids and bid qualification rates and decreasing contracted prices to their current record lows.
The Next Decade of Competitive Procurement and Solar PV Bid Pricing
Even after the aggressive cost declines in the 2010s, global average bid prices will still likely continue to fall in the 2020s, even if the rate of descent slows and cost declines are able to catch up. Competition in large auctions will continue to intensify, and participants will increasingly require new ways to stay competitive, including banking on the non-contracted value of an asset, consolidation through joint ventures, mergers and acquisitions, and larger consortia. New auctions will increasingly capitalize on volume and require a share of local content (intermediate goods or services sourced from domestic manufacturers or the local labor force) or even the establishment of new domestic manufacturing. As solar PV’s share of generation in electricity markets—particularly in deregulated wholesale markets—increases, auction structures should increasingly accommodate “solar plus” bids, paired with storage or gas, enabling solar to participate in electricity markets as an ultra-low cost-dispatchable resource. As future electricity markets shift from forecasting load and dispatching generation to the inverse, increased dispatchability of low-cost PV will be essential, particularly in high-penetration PV markets, where wholesale power prices see mid-day lows from peak solar generation. Advanced analytics and real-time performance monitoring will play a role in converting PV projects into semi-dispatchable resources. The future grid will increasingly value contracts that offer grid services such as frequency regulation, demand response, and resilience—and that hedge fuel risks for legacy power plants. Under the right market conditions, ultra-low cost solar looks poised to lead a fundamental disruption in the economics of global electricity markets for decades to come.
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Benjamin Attia is a Research Analyst in the Energy Transition Practice at Wood Mackenzie covering solar PV markets and a Non Resident Fellow at the Payne Institute at the Colorado School of Mines.
Shayle Kann is Managing Director at Energy Impact Partners and a Non Resident Fellow at the Center on Global Energy Policy at Columbia University.
Morgan D. Bazilian is a Professor and Director of the Payne Institute of Public Policy at the Colorado School of Mines.