Auction prices are some of the lowest ever recorded for solar energy; Investors' returns probably squeezed to single-digits

São Paulo, 4 November 2014 – Extremely aggressive bidding at Brazil's first-ever specific auction for solar power, held on Friday, 31 October, resulted in the awarding of 890MW dispatchable capacity (1,048MW – total capacity) of contracts at a clearing price of BRL 215/MWh (USD 87/MWh). This marks one of the lowest prices for solar energy ever recorded, according to research firm Bloomberg New Energy Finance (BNEF).

To date, the cheapest contracts for solar have occurred in the US for an estimated USD 50/MWh, but the projects behind those contracts benefit from significant subsidies. Globally, the cheapest unsubsidised solar power contracts have occurred in Uruguay, for USD 91.5/MWh. According to BNEF, the estimated 'levelised cost of energy' (or LCOE, a measure that amortises the project costs over a 20-year project lifetime, assuming respectable returns for the project investor) of solar in Brazil today is around BRL 235.4/MWh (USD 95/MWh).

That the clearing price in this auction fell below the LCOE probably means two things:

· First, the project owners (ie, the bidders) feel they can drive down the costs of their projects well below today's levels (the projects must be commissioned by October 2017).

· Second, these owners probably compromised significantly on their returns.

The auction resulted in the awarding of 20-year contracts at the BRL 215/MWh clearing price. The winners of these contracts consisted of 31 projects totalling 890MW of dispatchable capacity. Winning companies include well-known domestic renewable energy developers such as Renova Energia and Rio Energy; international developers such as Enel Green Power; solar developer Solatio (with 360MW); and four other companies (whose projects sum to 130MW).

Using its Brazil Reverse Auction Valuation Model, BNEF estimated that the 'rational' clearing price in the auction would have been BRL 260/MWh, very close to the auction's ceiling price of BRL 262/MWh. But that analysis assumed that most project owners would be seeking 13% returns (after-tax equity IRR) for the risk of building the first-ever large-scale solar projects in the country. However, as BNEF explained in a note to its clients before the auction, previous auctions for renewable energy in Brazil have shown that 'irrational' bidding behaviour is common, and that the clearing price could fall significantly under these circumstances.

There were separate auctions for other technologies, running in parallel with the solar auction. The auction for wind energy resulted in the contracting of 769MW across 31 projects at a clearing price of BRL 142.3/MWh (USD 57.4/MWh). This is below the estimated best-in-class LCOE for wind in Brazil, which is around BRL 147.5/MWh (USD 59.5/MWh), according to BNEF, and above the clearing price of the previous wind energy auction held in Brazil, which occurred on 6 June 2014. Winners of the wind contracts included Renova Energia, Enel Green Power (which also secured contracts in the solar auction), CER Energia, Copel, Gestamp and PEC Energia. There were no bids for an auction seeking biomass/biogas projects.

"In the first auctions in which wind projects were the major winners, we also saw strong competition between projects, resulting in low bidding prices with low return rates. Something similar happened in this auction with solar projects. The lowest bidding price from a solar projects was BRL 200.8/MWh (USD 81.1/MWh); we estimate the return rate for this particular project will be around 8%" said Helena Chung, São Paulo-based analyst covering Latin American renewables for BNEF.

The economics of solar in Brazil have some unique characteristics. On one hand, the upfront costs are higher than in other parts of the world, owing to import taxes and to regulations that effectively require that a portion of a project's equipment be domestically manufactured. On the other hand, Brazilian solar resources are very good – the average capacity factor for winning projects is around 19% (compared to 11% in Germany) – and can be as high as 23.7% for a project in the state of Bahia using tracking technology. Furthermore, Brazilian renewable energy projects can benefit from low-cost loans from the Banco Nacional de Desenvolvimento Econômico e Social (BNDES, the country's development bank). There is one more aspect that complicates the economics of solar in Brazil. The compensation scheme includes provisions to reward over-performance and penalise underperformance.

The auction occurs at a momentous time for the country, which is fresh off a highly-contested presidential election and has seen its power sector struggle amidst supply shortages and high electricity prices.

"The Brazilian solar opportunity is only just getting started, but has the potential to be gigantic, on the order of tens of gigawatts by the middle of the next decade," said Michel Di Capua, Head of Analysis in the Americas, for BNEF. "Investors would ordinarily want to keep their return targets high when entering a new market with a relatively new technology. But in this case, the temptation of being a first mover into this market, even though it meant conceding on returns, proved to be just too irresistible."

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