Creating value with solar energy

The market for solar power is growing faster than ever but continues to lack profitability. Besides operational efficiency, an improved capital allocation is a key to success.

The world could install as much as 66 gigawatts of solar energy this year, says McKinsey in a recent report. Last year, investors have invested $161 billion into the source of renewable power and with that, the second largest amount in any single energy source.

The higher demand for solar energy is thereby mostly driven by lower prices. Since 2009, installed costs of solar have fallen by as much as 70 percent and is now frequently below $100 per megawatt-hour with some reaching as far low as $30. Low prices make solar power competitive or even cheaper than new natural-gas plants. With beneficial regulation such as tax incentives solar is often less costly that the next most economical alternative. In their report “How solar energy can (finally) create value” McKinsey states that almost half of the today’s worldwide electric power demand could be met economically using solar energy in 2025.

Despite the rise of solar energy, many solar companies are struggling. Developers and builders gain market shares but are hardly profitable. One reason are macro factors such as lower oil prices that thread the competitiveness of solar energy and the potential of rising interest rate increasing the cost of capital for new projects. Despite, McKinsey sees opportunities for growth and profit throughout the solar value chain if two major challenges are overcome:

First, margins are challenges. As more companies are entering the rising solar power market, profits narrow. To maintain attractive margins, firms need to reduce the cost of building plants faster than the industry average to grow and acquire a larger market share.
Doing so, they must change their system design. Power plans are designed to fit into their environment (such as a roof) perfectly, which is driving up installation costs. Companies must develop components that fit well enough but not necessary perfectly for a wide range of sites.
Many firms also struggle to complete projects on time and within the budget. Companies need to improve their construction to increase productivity and decrease labour costs. Moreover, they can mitigate reputational effects and improve their capital management.

Solar energy must also find new ways to attract capital from institutional investors - either through the capital market or private placements. Completed solar projects offer attractive long-term cash flows for investors while developers require a dependable way to liquidate their equity stuck in construction. As project sales are less predictable, they tend to need more equity and have a higher cost of capital that the operating plant. The market needs to find a transparent vehicle with a simple governance structure that provides a home to long-term capital from institutional investors while maintaining flexibility to project developers, says McKinsey.