Clean energy is a world dominated by obscure metrics. You have got capacity factors, returns on investment and levelised costs of energy (LCOEs). But from a project point of view there is perhaps one measure that trumps all others: the internal rate of return, or IRR.
The IRR is essentially an estimate of the profitability of your investment in a renewable asset, or the rate of growth you can expect annually. Investopedia notes that it is not the actual dollar value of the project, but the annual return that makes the project’s net present value equal to zero.
An important distinction between IRR and other metrics, such as LCOE, is that it takes account of the earning potential of a project through available revenues streams, such as power-purchase agreements (PPAs) or merchant sales.
It can also be used to make comparisons between different types of investment. In essence, the higher the IRR, the better the investment. Hence, a key question for renewable energy asset investors and managers is how to keep a project’s IRR as high as possible.
This is particularly the case nowadays, owing to growing competition in the market. In the early days of solar energy, government feed-in tariffs offered high IRRs to offset the risks involved in investing in a relatively novel technology.
Now that solar energy is seen as mature and there are plenty of backers willing to invest in it, projects have to make do with lower returns, reducing the IRR.
Whereas solar projects could command IRRs of anything from 12% to 20% a decade and a half ago, now the range tends to be closer to between 5% and 7%. Against this backdrop, even a half a percent increase in IRR can make a big difference to the profitability of a project.
How do you improve it, though? In a solar project, the first rule is to have an accurate and realistic view of solar resource, since this determines the amount of energy that can be produced.
Solar resource measurements should ideally be carried over a long period on the exact site where the project will be located, or as close as possible to it. And these measurements should be compared to detailed historical data wherever possible, to determine how representative they are.
When it comes to plant design, the key is to aim for a project that will produce as much as possible, as long as possible, with the lowest possible operations and maintenance costs.
It is now generally accepted that achieving this aim may require realistic levels of capital investment at the outset, to make sure the plant uses high-quality components that will not fail easily.
For example, an investment in bifacial panels can increase energy efficiency by 11% compared to standard modules, as well as allowing for an extra five years of operating life.
High quality trackers, inverters and other components can similarly help to improve IRR by ensuring high levels of production and reduced downtime. Finally, a key IRR consideration is the money that the plant can make during its lifetime.
If the project is tied to a PPA or other fixed-rate agreement, then profitability will basically be determined by the amount of energy the plant can produce for the duration of the contract.
If it operates in a merchant environment, then another consideration will be how much it can sell its energy for on the open market. Either way, it can help significantly to add battery storage to the project. Let’s look at the PPA scenario first.
Here, a basic limitation of solar is that the plant only produces energy during daytime. If it can sell all that energy, then great—but the project owner is still missing out on potential revenues at least 50% of the time. Unless some of the energy produced during the day can be stored and sold at night.
This is easy to do with batteries, particularly if the solar plant is oversized to begin with. Overbuilding the solar plant and adding storage obviously has an impact on upfront costs, but in theory it could almost double to plant’s ability to make money.
In reality, just adding enough storage for a few hours of extra energy delivery a day could probably make significant difference to the IRR. In a merchant scenario, meanwhile, the potential gains are even greater.
Here, storage could be used to hold onto energy while electricity prices are low and sell it when they are high. This energy arbitrage can improve the IRR of a project regardless of plant size, and just requires a battery along with some software to execute market trades automatically.
Increasingly, solar developers are looking to use both of these models to maximise their project IRRs. A solar plant will typically make most of its money early on from a corporate or government PPA, then when the agreement is up the project will switch to merchant sales.
Needless to say, in such scenarios storage can act to maximise revenues throughout the lifetie of the project. And the need to use storage to alongside solar is only growing.
As things stand, increasing volumes of solar on the grid are leading to price cannibalisation during peak production periods, to the point where highly saturated markets such as South Australia are introducing incentives for consumers to use more electricity at midday.
Under such circumstances, it hardly makes sense to invest in further solar capacity unless the electricity it produces can be stored until it is needed. That goes for PPAs and merchant sales. Increasingly, therefore, battery storage is becoming a key determinant of solar project IRR.
Nevertheless, making sure a battery system is dimensioned and configured correctly for maximum IRR still takes knowledge and experience.
If you are looking for a partner to help improve the profitability of your solar project, then speak to us: we combine deep solar PV project development expertise with energy storage experience gained from developing a pipeline of 1.1 GW of battery projects in the UK alone. Contact us now for details.