Are the purchase prices of solar energy projects under development consistent with cost of capital forecasts?

Abstract

The reduction in construction and maintenance costs per MW of renewable energy facilities, together with low interest rates, have led to a significant growth in the purchase prices paid for these facilities in the Spanish market. This trend is shared by other European countries, especially for projects that hedge energy price risk incorporating power purchase agreements with third parties. In this framework, questions arise about the economic rationale of the purchase prices paid for these projects. Consequently, we develop a project evaluation model that forecasts expected cash flow and time-varying required rates of return for a standard photovoltaic plant, in order to study the extent to which foreseeable market conditions—interest rates and equity risk premia, among others—translate into economically viable buyouts. Our results suggest that purchase prices paid for these initiatives often lead to buyer returns below those that would be reasonable according to market conditions. Indeed, we find that only facilities that reach a production 23% higher than the number of hours considered in the base case provide returns that compensate long-term financing costs. However, specialised investors can exploit their relatively low cost of financing to pay prices up to 73% higher than those affordable by classic investors.