COVID-19 has had a dramatic impact on every person and every industry on the planet, and at LevelTen, we are truly heartened to see our global community collaborate, improvise, and sacrifice during this unprecedented global crisis. To understand the effects the crisis could have on the renewable energy market, we conducted a survey of project developers, analyzed data from the LevelTen Marketplace, and talked to our customers. Here are five key takeaways.
1. PPA Prices Could Increase, But Values are Holding
According to LevelTen's Q1 2020 PPA Price Index, the blended P25 index of wind and solar PPA offer prices in North America rose 4.3% quarter-over-quarter (full report coming soon!). We might see an even greater increase in Q2. We surveyed 27 North American developers with active projects on the LevelTen Marketplace to ask if they expect COVID-19 to impact their PPA prices in Q2 2020, and if so, why that might occur. According to the results, 56% of developers surveyed expect PPA prices to be impacted; 7% do NOT expect them to be impacted, and 37% aren't sure yet.
When it comes to WHY the novel Coronavirus could impact PPA prices, "Module/turbine costs and/or availability," and "construction timelines" emerged as the top two factors.
Long-term PPA Values are Holding
Although COVID-19 is causing lower settlement values in the short-term, we believe it's important that corporations maintain a long-term perspective on what drives project valuation. This means keeping their eyes focused on the intersection of demand growth and the cost of supply, and not on short-term disasters or their economic effects. On the LevelTen Marketplace, we run 20,000 independent Monte Carlo simulation trials on more than 750 PPA offers every day, so our clients have a complete picture of how a PPA could perform over the life of the contract. The price drops we've seen in the last month are within the range of values our risk analysis approach would produce.
Furthermore, the net present value of long-term PPA offers hasn't dropped during the recent period of energy price declines. LevelTen calculated estimated PPA values for two batches of offers in the LevelTen Marketplace. In aggregate, the PPA values calculated on April 8, 2020 were actually slightly better than the values calculated on March 1, 2020 - illustrating that recent market price declines (i.e., between March 1 and April 8) did not affect the estimated value of long-term PPA offers on the LevelTen Marketplace. Renewable energy PPAs are long-term contracts that are relatively insulated from short-term price fluctuations.
2. Supply chain impacts & financing friction could delay projects, risking tax credits
In addition to COVID-19's potential impact on PPA prices, equipment delivery days and labor constraints could push projects' expected commercial operation date. As a result, developers could miss key delivery milestones in their offtake agreements. In the U.S., this could also cause developers to miss critical federal tax credit deadlines. This is precisely why U.S. industry trade groups are pushing so hard for tax credit extensions and clarity from the IRS on how COVID-related delays will be treated.
3. Project finance: challenges in the short-term, but long-term fundamentals remain strong
Tax Equity Financing: Speaking of tax credits: In the U.S., qualifying wind and solar projects receive federal renewable energy tax credits. A relatively small pool of institutional tax equity investors place cash into these projects and receive tax credits in return, which are typically received over a five-year period for solar projects and a 10-year period for wind projects. If the COVID crisis reduces tax equity investors' earnings, they will have less of a need to reduce their taxes, which could reduce the availability of tax equity. The investors that remain in the market could also seek higher returns, making financing more expensive for developers. The outlook for tax equity remains positive, with participants from a project finance panel noting that appetite for strong projects remains in place.
Debt Financing: In addition, it may also become more difficult for developers to obtain debt financing. Many lenders are asking for more granular detail on new projects while they wait to see how COVID-related uncertainty plays out. With a reduced lending pool, projects could become more expensive to finance and fewer projects could reach financial close. For corporate buyers, that means PPA prices could rise, and there could be fewer projects to choose from.
Creditworthiness: Whenever investors or lenders experience uncertainty they tend to seek security by dealing with creditworthy financial partners. In the renewable energy space, we expect this could manifest in the near-term both on the seller side (e.g., a preference to finance projects brought by developers with demonstrated track records) and on the buyer side (e.g., a preference to finance PPAs with investment grade off-takers). As a result, lenders may insist on higher debt service coverage ratios or other risk-mitigating contract terms. In the longer-term, we would expect restrictions to ease as stability returns to the broader economy.
Asset-Ownership: Finally, institutional investor interest in operating renewable energy assets with contracted cash flows has held strong in the face of recent economic uncertainty. Renewable energy investments are holding value because their revenue streams are less correlated with other asset classes, making them an intriguing alternative for infrastructure investors going forward. This creates an encouraging feedback loop to project developers and financiers to continue advancing their supply pipeline, by instilling confidence that long-term exit opportunities will remain once projects reach critical development milestones (e.g., financial close; commercial operation).
4. Electricity prices are lower, affecting the generation stack and PPA settlements
With no one commuting to the office, and stores and plants closed, we've seen a dramatic effect on when energy is being used. Typically, demand (and prices) peak around 6pm, when everyone gets home and starts using their stoves and dishwashers. Now, we're not seeing those dramatic peaks; energy use is spread out more evenly over the day. In PJM, for example, the reduced demand has caused wholesale electricity prices to drop more than usual for springtime: 25% in the last three weeks, from $21 to $16. More information on this is available in our recent report: Flattening the (Demand) Curve: Renewable Energy and COVID-19
Fossil Fuel Generators Impacted the Most
The electricity generators who rely on peak prices for their revenue could be impacted the most, particularly coal and natural gas. The lower demand peaks may result in less use of fossil fuels, and relatively more use of renewables in the generation stack. Most renewable energy projects have long-term PPAs, so their revenues will be less affected; although merchant projects - those without PPAs - will be impacted by lower market prices.
Corporations with existing virtual PPAs will face less favorable settlement economics as wholesale energy prices decline against fixed PPA prices. But at the same time, lower wholesale prices means these same corporations may benefit from lower energy bills, illustrating the potential hedge value of a PPA.
5. Corporations remain committed to fighting climate change
From LevelTen's vantage point, the demand for renewable energy from corporate buyers has remained strong, thanks to their public commitments, stakeholder demand and understanding of the long-term consequences of climate change. So far, corporations have signaled that they are still interested in procuring renewable energy through new PPAs to meet their targets. Only a few planned transactions on the LevelTen platform are on pause during the COVID-19 crisis, and no buyer has asked to cancel. This is certainly understandable, as many corporations are having to shutter stores, reduce staff, and move their entire business online; they are focused on other priorities at the moment. That said, RFP activity has by no means come to a standstill; in fact, LevelTen just launched its first European RFP for a large energy buyer. We're heartened to see the business community maintain renewable procurement momentum.
When we emerge from this pandemic, we know that the threat posed by climate change will be no less real. Fortunately our collective dedication to fighting it can also be stronger than ever. We've seen global carbon emissions plummet in recent weeks, and it will be incumbent upon us, as we again ramp up the global economy, to accelerate the renewable energy transition. That means renewable energy projects are more important than ever, and it's why LevelTen is so grateful for the privilege of working, remotely, through this crisis.