Texas might be low on solar given how much sun it gets. Many parts get well over 200 sunny days a year, and yet the Lone Star state has only 175 MW of solar generation, a paltry amount compared to over 12 GW of operating wind in 2013, according to ERCOT. However, a confluence of factors, including rising gas prices, demand growth and a drop in solar development costs, are expected to boost development in the state.
Recurrent Energy has signed a power purchase agreement with Austin Energy for a 150 MW project that, if no solar generation came online between now and 2016, would nearly double the capacity in the Lone Star state. Arno Harris, ceo of Recurrent, talked with Managing Editor Holly Fletcher about the shop’s activity in Texas, the budding merchant solar market and why a boom in the state points to solar generation going mainstream. “The reason why Texas is significant is really because from a competitive standpoint, it is an indicator that solar has crossed a new threshold,” he says.
PFR: I’m excited about the Texas announcement for a variety of reasons and I wanted to begin with you comparing and contrasting what’s changed about Texas recently that is pulling in more solar.
Harris: Well, I think there’s really two things going on. Basically, you have wholesale electricity prices and you have solar prices and the changes that we see happening with both of those. Texas is a market that is obviously much more driven by price competition than some of the other big solar markets like California, which has been more compliance driven. In this case, we’re really just talking about the cost-lines crossing. Gas has been trending up and solar continues to go down in terms of cost. We’ve finally reached a point where the price point on solar-generated electricity is really compelling, and I think the fact that Austin Energy decided to make this move is reflective of that.
PFR: That’s interesting. Is this really the first deregulated market where solar has become cost-competitive on this scale?
Harris: Texas is a market unto itself. I think it is the most liberalized, most deregulated market in the country, and obviously you have retail competition, you have wholesale competition. I think from the numbers we’ve looked at this is the largest solar project so far that’s been signed up in Texas, and so, at least in North America, it’s one of the largest deregulated purchases of solar power.
PFR: Okay. The pricing on this is reportedly very attractive and I wanted to see how the pricing in this reflects on the cost convergence you referenced or if it was specific to this project.
Harris: We don’t disclose the exact pricing on our contracts, but I think the price we offered on this project is really reflective of a new phase in large scale solar. We’re seeing this trend continue: one where solar is getting more and more cost effective to build and, therefore, more and more cost effective in terms of the electricity that we’re delivering to our utility customers. In that sense, it’s really exciting.
I think it’s also exciting to see because it is more evidence that solar is becoming part of the mainstream. Solar already last year was the second largest source of new generation after natural gas, and I think when you look at these cost trends—gas is a finite, depletable resource—solar is much more like a technology. I think we’re going to continue to see a price divergence here that’s really going to define a big role for solar in power markets.
PFR: Do you think that’s going to be limited to ERCOT for the time being? And at what point do you think that could reach out into other parts of the U.S.?
Harris: No, I think as solar gets more and more cost effective I think it’s going to find more and more markets in more and more places. The reason why Texas is significant is really because from a competitive standpoint, it is an indicator that solar has crossed a new threshold.
The second reason is the size of the market. Texas and California are the two biggest state electricity markets and the size, the growth potential, and the solar resources makes this really, really significant for the solar industry, but I think we’re going to see growth across the Southwest where you have great resources. We’re even starting to see things happen in parts of the Southeast as well, where historically solar has not been as popular. I think it is hard to resist the price that solar is now able to offer the market, and I think as that price propagates out there, we’re going to see more and more demand.
PFR: With ERCOT looking at its capacity and needs later in the decade, it strikes me that solar could be a really good option given that solar has a shorter development time than most gas-fired projects. Do you think there could be a boom of solar in Texas before 2020?
Harris: Well we’ve certainly had our eye on Texas for a while now. We’ve been developing there for at least a couple of years—filling out our land portfolio. I know there’s a number of other solar developers who are doing the same so the pipeline of projects is definitely there to meet that type of demand if it emerges.
We think that the conditions in Texas are becoming pretty ideal. You’ve got a market that overall is forecast to grow 1 or 2% over the next few years and there is a good overlay of period demand with the kind that solar is generating at its highest level, and so the conditions there are good, and then there’s the fact that gas prices are rising, and that Texas has held fast to a kind of energy-only market structure. I think this is going to be very, very favorable for solar.
You need a diverse portfolio of resources on the grid—I don’t think it’s ever realistic to talk about one technology dominating to an extreme. At the end of the day you need that resource mix to be able to diversify risk and maintain reliability. That said, I think the conditions are very, very favorable for solar.
PFR: Do you think that you would ever do a merchant project in Texas—have the economics proved to that extent?
Harris: There’s a lot of discussion about merchant, and it’s something that we’ve talked about in theory for a while. That the talk is happening it really reflects the other major trend that is shaping opportunity for solar, which is what is happening in capital markets. What we’ve seen over the past five years is the increasing acceptance by investors and lenders of solar as an asset class, which means there is an increasingly large pool of low-cost capital available to fund projects.
We’re now in a transition from a project finance market to a more public investor-driven market and that is an exciting evolution because that means that pool of capital is expanding very, very rapidly and the cost of capital is coming down. There have been successful yieldco offerings, there has been interest in other types of securitized offerings to support solar projects.
The key question is going to be: how far does that enthusiasm go? And to what extent do investors become increasingly bullish about the position solar can be in in power markets? For a merchant plant to operate, you’ve got to have a really high degree of confidence that it is going to offer a very competitive source of electricity in the future. I think we’re coming to the threshold where merchant-type plants become feasible, and I think that is likely to be something that public markets will support a few years from now as they become increasingly comfortable with just how cheap solar can be. I think sometimes when people talk about merchant projects, they imagine a project just selling into the day-to-day market, and the reality is most players are going to hedge most of their volumes. You might have a project that does not have a 20-year power purchase agreement but it’s got a stack of five-year hedges so as you work through your hedges you are gradually rolling more hedges onto that.
The fact that we’re talking about it signals a shift in the role solar is going to play in the power market, and the potential and the scale that is possible. I do think that is something that is on the horizon, particularly as the cost of solar continues to go down.
PFR: You know, I think it would have been fantastical on my part to have asked you two years ago about a merchant solar project. There just wasn’t the reception in the market at that point.
Harris: It would have been fantasy for sure. You see this trend of ebb-and-flow in wind and gas as well. It really is reflective of what people think long-term power prices are going to be. If you have a developer that can build at a cost that makes the project profitable below whatever the marginal cost of that market is, is in a very, very interesting position to take advantage through merchant-type structures. I think that’s something the industry is going to have to evolve into.
PFR: A couple of other things. I’m glad you brought up capital markets versus project finance. What is currently most attractive for a contracted project? Would you want a bank loan, a bond?
Harris: I think what everyone is focused on, and we’re sort of focused on along with them, is the ability to tap public capital markets where across the capital structure you might see a weighted average cost of capital in the 6-7% range. And there are some that suggest it could go even lower than that. That range compares very favorably to what you see with conventional project finance.
It’s an evolution, I’d like to think of it in terms of steps. The industry started out with, five or six years ago when the projects were new, having to do a lot of credit support to get lenders and investors into the projects. As they got more comfort, that credit support wasn’t needed any more and the cost of capital, at least for project finance capital, for solar came down, and now the industry has proven itself and is delivering enough scale to make the leap from the project finance markets into public capital markets. I think in the current environment, that is the lowest cost capital and therefore it’s the most attractive option.
PFR: You mentioned that you have been securing land in Texas for a while. Does that mean you’re looking mostly for utility-scale projects there?
Harris: Yes. We are exclusively focused on utility scale projects, and I think we’re increasingly seeing our strategy driven by the opportunity emerging from the convergence of solar and gas pricing, so for us, larger scale is becoming more and more the norm. We, historically, have had a mix of medium scale projects—20 MW projects, 40 MW projects—along with some of our megaprojects—100, 200-plus MW type projects—but when you’re trying to drive the cost out, those big projects benefit from enormous economies of scale. So, I think this 100-200 MW range is what we’re going to be focused on for a while.
PFR: Have you estimated what your pipeline ERCOT is yet? Rather, is it public yet?
Harris: We haven’t publicly stated it yet, but it’s been a market of focus for us for a couple years now and we’ve been accumulating land portfolio because we think it’s going to be big. Everything’s big in Texas!
