With the number of transactions related to operating PV projects in the UK looking to increase over the next couple of years, a systematic evaluation of PV projects would ease the transaction process. PI Berlin with the BBA have developed the PQ Rating to assist decision-makers verify the performance and quality of PV assets.
Active Secondary Market
According to the market analysts from IHS, the amount of PV projects beings transacted on the secondary market in Europe over the past five years has been between 1.4-2GW. In particular, the most active of these markets is the United Kingdom, where in 2014 close to 1.5GW of PV assets were transacted and as of October this year, another 1GW was acquired or re-financed. This year at the Solar Energy UK conference in Birmingham, a panel of respected financiers and investors unanimously agreed that we have yet to reach the peak of the secondary market in the UK, and it is to be expected that more and more PV projects will be changing hands over the next two to three years.
There are clear reasons for this level of activity on both the supply and demand side of the transaction equation. A wider range of investors has turned to PV projects over the last few years as a safe haven for their investments, where they can achieve stable returns over a long period of time. These investors, such as pension funds and insurance companies, are typically not interested in taking risks associated with the development and construction phases of projects, so they enter the market through acquisitions of operating assets. Meanwhile, many of the parties that developed and built the gigawatts of projects in the UK from 2010 to 2015 to take advantage of the lucrative ROC and FIT schemes, did so by using their own equity in order to speed up the completion rate to beat subsidy deadlines. These project developers and EPC construction companies didn’t have the goal to hold on to the assets long term, and were eager to recoup their capital by selling the projects once in operation so that they could re-invest in new projects – either in the UK or elsewhere.
Stoking the fire of the secondary market were the sudden and significant changes to the solar incentive schemes in the UK by the government. Initially it looked as if only larger scale projects larger than 5MW were to be affected but now development of commercial and residential scale projects will certainly be throttled. With significantly less new projects likely to come onto the market, those projects that are already grid connected with lucrative revenue streams will become more and more valuable. Investors will certainly be placing premiums on these operational projects that will quickly turn most developers into willing sellers.
With a bullish secondary market expected over the next 1 to 2 years, there will be a lot of competition for assets – not only on the seller’s side, but particularly on the buyer’s. Equity investors will be scrambling to find assets to fill their portfolios and funds. Debt financiers will also be competing to re-finance operating projects, as there will be less and less opportunity to project finance new projects. This competition is likely to lead to investors and lenders willing to be more aggressive in their financial models in terms of their return expectations and financing conditions. At the same time, competition will also create the need to act quickly, as any kind of delay may leave the door open for another party to swoop in and make the deal.
Technical Due Diligence
What we end up with is an environment where everyone involved in a transaction is eager to get things done as quickly and as uncomplicated as possible. Add this to the more aggressive financial appetite, there is certainly less room for error and potentially an increase in risk exposure associated with the asset targets. Typically technical due diligence (TDD) is the tool used by investors or lenders to mitigate the technical risks of a project. Based on experience, the TDD is also the last risk assessment conducted and as a result needs to be concluded as quickly and cost-effectively as possible. The deal has usually been mostly negotiated and agreed on both sides and the TDD is left as a tick-the-box exercise. The financial community has become very comfortable with PV technology – almost to the point where technical risks are an after-thought.
PV is certainly a reliable technology and the large majority of projects are built well using quality projects. That said, particularly in markets like the UK that saw very rapid growth in a short period of time with tight deadlines, there are certain to be some projects that may have an increased level of technical risk associated with them. The PV industry is still relatively young and has a minimum of standards that are applied. The modules themselves have IEC standards guaranteed by certificates, of which everyone is aware. There are however limitations to these standards as they do not cover all aspects of quality that can affect the long term reliability of the modules. As for the whole PV system in a power plant, there are no industry-wide accepted standards. The Institute of Engineering and Technology, IET, has recently published its Code of Practice for Solar Photovoltaic Systems. This code is certainly helpful to ensure that safety, functionality and code compliance is fulfilled in PV plants. There is also a working group within the IEC trying to establish a minimum level of quality for PV plants, as opposed to only the individual components – but this is still a work in progress.
During my discussions with lenders and investors over the past twelve months in the UK and elsewhere in Europe, common themes were mentioned time and again when discussing TDDs and the role of their technical advisors. Firstly they want to ensure that the asset is compliant – in terms of permits, H&S, grid, and industry standards. Secondly, they are concerned about the commercially relevant risks associated with the plant – e.g. does the plant produce and will it continue to produce what the seller says it produces. Thirdly, they want the results in a form that they can quickly digest and that their credit committees can easily comprehend. Finally, they don’t want to unnecessarily create concerns that may affect the deals they are considering – again, while everyone is eager to make the deal happen.
PI Berlin and our partner in the UK, British Board of Agrément (BBA), took these comments as a challenge to create a TDD product that addresses the needs and concerns of the players in the secondary market. The PQ Rating is a summarized report evaluating the performance (P) and quality (Q) of a PV plant, beyond the standard compliance evaluation of a TDD. The two-page report gives decision-makers a quick overview of the plant’s performance and quality based on an overall score out of 10 points. Partial scores for each key aspect of the plant and their subset of topics are presented in bar charts with a summary explanation of the scoring results (see example in graphic). The reader has the ability to get an understanding of the key strong and weak points of the plant,
before reviewing the complete TDD document, and can then focus only on the aspects that are of particular interest and concern.
The PQ Rating methodology is based on dividing the operating project into seven key aspects: contracts and permits; technical design; module quality; system performance; commissioning; electro-mechanical installation; and operations and maintenance. For each aspect there are detailed checklists with pass/fail criteria (in total over 1400) that result in partial scores. Each of the aspects are weighted in a manner that gives particular emphasis on performance and quality issues that are of most interest to investors and lenders of operating assets. Contracts, permits, commissioning protocols and design issues would have more weight in the development and construction phase, but have less significance once a plant is in operation. That said, there may be a point that could be a red-flag deal-killer, such as missing land agreements or an invalid generating licence. System performance, installation and module quality are aspects that have greater weight as they directly impact the long term revenue line and reliability of the investment. If a serial defect is found in the modules that leads to excessive annual degradation, this can completely change the business case for the buyer.
If deficiencies in the plant are determined, the investor or lender is provided with quantitative impacts and concrete measures to address the aspect which can be used in the negotiation with the current owner. For the module serial defect mentioned above, the annual production can be re- simulated and estimated which can directly affect the purchase price. In addition perhaps there will be the need to develop a maintenance reserve account to address potential large scale substitution of modules in the future. More and more asset managers are noticing the need for a more robust budget for the operations phase of the project to address ongoing issues in the plant – the PQ Rating results can assist to determine this budget.
The systematic approach and evaluation of PV projects with the PQ Rating allows for a relative comparison of a number of assets that an investor may be targeting for a fund. While the projects may be in the same market, they may have had different developers, different installers and different main components. By taking the final PQ Rating for each of the assets, the investor can quickly compare the projects and determine a value for the assets based on the results for negotiation with the seller.
Rating provides Comfort
Rating systems are common place in the financial world to evaluate stocks, companies and assets. In the PV industry, investors and lenders have typically used TDDs to verify the technical risks associated with an operating asset. These TDDs have primarily focused on red-flags and compliance rather than performance and quality that have a significant effect on investment and financing decisions. The amount of activity on the secondary market for PV assets is highest in the UK and will likely continue for the next couple of years. With the backdrop of the regulatory uncertainty for new development, competition for attractive operating assets is strong. A rating system such as the PQ Rating can help decision-makers evaluate technical risk quickly, with a focus on commercially impactful aspects. With return expectations diminishing and lending conditions being more aggressive, an efficient rating tool can provide the comfort that investors and lenders need when evaluating and valuing assets.
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