A new report by investment analysts from Citigroup says that in the US “the Age of Renewables” has begun. This is confirmed by the most recent public announcements from First Solar and SunPower, two of the largest solar power producers in the US, which both continue to see solar costs coming down rapdily. Analysts from McKinsey have become convinced that the developments in the solar power sector will have a seriously disruptive effect on the utility sector.
Investment banking giant Citigroup has hailed the start of the “age of renewables” in the United States, the world’s biggest electricity market, saying that solar and wind energy are getting competitive with natural gas peaking and baseload plants – even in the US where gas prices are said to be low.
In a major new analysis released at the end of March, Citi says the big decision makers within the US power industry are focused on securing low cost power, fuel diversity and stable cash flows, and this is drawing them increasingly to the “economics” of solar and wind, and how they compare with other technologies.
Much of the mainstream media – in the US and abroad – has been swallowing the fossil fuel Kool-Aid and hailing the arrival of cheap gas, through the fracking boom, as a new energy “revolution”, as if this would be a permanent state of affairs. But as we wrote last week, solar costs continue to fall even as gas prices double.
Citi’s report echoes that conclusion. Gas prices, it notes, are rising and becoming more volatile. This has made wind and solar and other renewable energy sources more attractive because they are not sensitive to fuel price volatility.
Citi says solar is already becoming more attractive than gas-fired peaking plants, both from a cost and fuel diversity perspective. And in baseload generation, wind, biomass, geothermal, and hydro are becoming more economically attractive than baseload gas.
It notes that nuclear and coal are structurally disadvantaged because both technologies are viewed as uncompetitive on cost. Environmental regulations are making coal even pricier, and the ageing nuclear fleet in the US is facing plant shutdowns due to the challenging economics.
“We predict that solar, wind, and biomass will continue to gain market share from coal and nuclear into the future,” the Citi analysts write.
Setting the bar for alternative energy
Citi says the key metric in comparing power sources will be the levellised cost of energy (LCOE). “As solar, wind, biomass, and other power sources gain market share from coal, nukes, and gas, the LCOE metric increasingly becomes important to the new build power generation decision making,” it says.
Citi defines LCOE as the average cost of producing a unit of electricity over the lifetime of the generating source. It takes into account the amount produced by the source, the costs that went into establishing the source over its lifetime, including the original capital expenditure, ongoing maintenance costs, the cost of fuel and any carbon costs. It also includes financing costs and ensuring that the project generates a reasonable internal rate of return (IRR) for the equity providers.
Here is the key graph on the current state of play, baseload generation and their renewable competitors to the left, and peaking gas and solar to the right.
On baseload, all renewables except marine beat coal and nuclear. Combined cycle gas just hangs on.
As for peaking plant, it depends on the gas prices, but these are rising and in some regions they are now back above their pre-GFC [i.e. before the “global financial crash”, editor] and fracking boom levels. The move to export LNG will likely cause a further increase in prices.
And here (below) is more on those gas prices. As can be seen, natural gas prices have nearly doubled in the past two years, and these have a direct correlation to the price of gas-fired electricity.
At a natural gas price of $US4.00/mmbtu, the LCOE of a gas peaker is $US0.10/kwh and a CCGT (combined cycle or baseload plant) is $US0.06/kwh. If Citi’s commodities team’s long-term gas price forecast of $5.50 is used, the implied LCOE is $0.12/kwh for natural gas peaker or $0.07/kwh for a CCGT plant.
“These numbers,” Citi says, “set the bar for alternative energy. Given the large expected increase in demand for gas, offset by production gains, gas prices are expected to rise over the long term. As a result, the bar for renewables and other fuel sources to cross continues to rise, thus making it easier for alternatives to gain market share.”
(Australia take note: its gas prices are already double the US price, which is why gas generation is being pushed out of the market. Coal, however, is recovering because the Australian government does not set strict emissions standards).
Financiers, in particular, are conscious about the volatility in US gas prices and the likelihood that they will rise. These are influencing where they are putting their money, and new “yieldco” financing facilities for solar and wind energy are making these technologies both cheaper and more attractive. (For more on this, see here.)
As for solar, costs are coming down. Citi says the base case LCOE for solar is 13c/kWh, the near-term upside in 11c/kWh and the long-term upside (2016) is 10c/kWh. (This is despite the fact that some power purchase contracts are being written as low as 4c/kWh or 5c/kWh, but those are helped by various tax rebates.)
Citi says the outlook for solar LCOE is favourable, but the devil lies in the details. The system costs are comprised of module costs plus balance of systems (BOS) and these vary depend on end user, location, and other factors. As the table above shows, BOS costs are likely to fall sharply in the near term. (In Australia, for instance, balance of system costs are higher because so few large scale plants have been built).
With a lower cost of capital, solar becomes much less expensive to finance and develop. In general the growing financing market for solar has recognised the strong cash flow and low risk profile that is characteristic with solar projects.
“Solar is still early in the growth cycle and in many countries – Germany, Spain, Portugal, Australia, and the South-West US – residential scale solar has already competed with average residential electricity prices,” Citi writes. “In 2013, solar was the second- largest source of new generation capacity behind natural gas – its prospects look bright in 2014 and beyond as costs continue to decline and improve the LCOE picture.”
Wind, geothermal, coal, nuclear
As for wind, it continues to reduce costs, but the most interesting development is the reduction in financing costs, thanks again to the “yieldco” phenomenon. “While LCOE may decline, the outlook for wind is also dependent on the wind levels in the areas where it will be built and the cost of base load alternatives. With gas prices forecasted to rise, the LCOE of wind is becoming more competitive with CCGT alternatives. Despite this, many of the most attractive wind sites are in use and government incentives come into play which reduces the outlook for wind.”
Citi, however, is downbeat on hydro, geothermal, and marine energy sources because of physical limitations. “While hydro and geothermal are competitive from an LCOE basis, they require unique geological conditions and as a result, many of the remaining potential new sites have less attractive LCOEs,” it notes. Marine technologies still appear to be early in their development cycles with an uncertain roadmap.
Coal, Citi says, is basically priced out of the market. Environmental regulations mean that the LCOE for new coal is around 15.6c/kWh, and it notes that coal only accounts for 2 per cent of the generation projects under development.
On nuclear, Citi says cost over-runs at the Vogtle plant under construction in Georgia – now slated to cost $15 billion, way above expectations – mean that nuclear is also pricing itself out of the market. Citi puts its LCOE at 11c/kWh, which it said is relatively expensive versus combined cycle gas plants and solar and wind. And it notes that while financing costs are inexpensive in the current monetary environment, this situation will not last.
“Financing cost are likely to rise which would hurt the LCOE attractiveness of a high construction cost generating source like nuclear,” Citi says. “As a result, we do not expect nuclear to effectively compete on economic merits. Despite this LCOE dynamic, there is merit to increasing fuel diversity and supporting lower carbon generation.”
The disruptive potential of solar power – some additional notes
The Australian website Reneweconomy, from which the above article was reproduced (with permission), has recently published a number of other articles in particular on the rapidly declining costs of solar power.
Thus, it reported recently that US solar company First Solar, one of the largest producers in the world, expects its average manufacturing costs to nearly halve: from an average of $0.63/watt in 2013 to just $ 0.35/watt in 2018. This “will bring the total installed cost of a module (including racking and inverters) from around $1.59/W to below $1/W by 2017 – so meeting the US Department of Energy’s ambitious Sunshot Initiative goals at least three years ahead of time.”
The articles that in the US market for large-scale, utility-size solar power installations, power purchase agreements are being concluded in the range of $50-$70 per MWh, helped by a tax credit. The LCOE of most utility-scale solar is still probably above $100 per MWh. “Gas developers”, says the article, “can simply no longer compete because the forward gas prices are pushing gas generation costs well beyond this”.
Another major US solar power producer, SunPower (majority-owned by French oil company Total), has also recently announced spectacular futher cost reductions. It announced in March that it had succeeded “in reducing manufacturing costs by 20 per cent over 2013, following a similar fall a year earlier (and the year before that). And it managed to obtain an even bigger (25 per cent fall) in the balance of systems costs, the amount it costs to make and install solar modules in utility-scale solar farms.”
And SunPower president and CEO Tom Werner said the cost falls are not over yet. “He told analysts that its next line of manufacturing plant will likely reduce the cost per watt by a further 35 per cent over its current manufacturing lines.”
The rapid development in the solar power sector has led the analysts of McKinsey to conclude that solar power now has a seriously “disruptive potential” for the business model of traditional utilities. In a new paper for the McKinsey Quarterly, they write that solar power is “a far more cost-competitive power source today than it was in the mid-2000s, when installations and manufacturing were taking off”.
The bottom-line, they say: “the financial crisis, cheap natural gas, subsidy cuts by cash-strapped governments, and a flood of imports from Chinese solar-panel manufacturers have profoundly challenged the industry’s short-term performance. But they haven’t undermined its potential; indeed, global installations have continued to rise—by over 50 percent a year, on average, since 2006. The industry is poised to assume a bigger role in global energy markets; as it evolves, its impact on businesses and consumers will be significant and widespread. Utilities will probably be the first, but far from the only, major sector to feel solar’s disruptive potential.”
According to McKinsey, “sharply declining costs are the key to this potential. The price US residential consumers pay to install rooftop solar PV (photovoltaic) systems has plummeted from nearly $7 per watt peak of best-in-class system capacity in 2008 to $4 or less in 2013. Most of this decline has been the result of steep reductions in upstream (or “hard”) costs, chiefly equipment. Module costs, for example, fell by nearly 30 percent a year between 2008 and 2013, while cumulative installations soared from 1.7 gigawatts in 2009 to an estimated 11 gigawatts by the end of 2013, according to GTM Research.”
While module costs should continue to fall, even bigger opportunities lurk in the downstream (or “soft”) costs associated with installation and service, note the authors. “Financing, customer acquisition, regulatory incentives, and approvals collectively represent about half the expense of installing residential systems in the United States. Our research suggests that as they become cheaper, the overall costs to consumers are poised to fall to $2.30 by 2015 and to $1.60 by 2020. These cost reductions will put solar within striking distance, in economic terms, of new construction for traditional power-generation technologies, such as coal, natural gas, and nuclear energy. That’s true not just for residential and commercial segments, where it is already cost competitive in many (though not all) geographies, but also, eventually, for industrial and wholesale markets.”
The authors from McKinsey explain what the broader impacts are of this solar revolution:
“As solar becomes more economic, it will create new battlegrounds for business and new opportunities for consumers. When a solar panel goes up on a homeowner’s roof, the installer instantly develops a potentially sticky relationship with that customer. Since the solar installation often puts money in the homeowner’s pocket from day one, it is a relationship that can generate goodwill. But, most important, since solar panels are long-lived assets, often with power-purchase agreements lasting 15 or 20 years, the relationship also should be enduring. That combination may make solar installers natural focal points for the provision of many products and services, from security systems to mortgages to data storage, thermostats, smoke detectors, energy-information services, and other in-home products. As a result, companies in a wide range of industries may benefit from innovative partnerships built on the deep customer relationships that solar players are likely to own. Tesla Motors already has a relationship with SolarCity, for example, to develop battery storage coupled with solar. It is easy to imagine future relationships between many other complementary players. These possibilities suggest a broader point: the solar story is no longer just about technology and regulation. Rather, business-model innovation and strong management practices will play an increasingly important role in the sector’s evolution and in the way it engages with a range of players from other industries. Segmenting customers, refining pricing strategies, driving down costs, and optimizing channel relationships all will figure prominently in the solar-energy ecosystem, as they do elsewhere.”