Revisiting Piñatas, Feeding Frenzies and the price of shovels during a Gold Rush

In February 2017, I gave a presentation to the EIANZ Solar Farm Seminar titled “Piñatas, Feeding Frenzies and the price of shovels during a Gold Rush”. In the presentation I made point that solar farm investments will fail if pricing is not sustainable (particularly with respect to servicing the cost of capital).

I made the point that during most gold rushes, many would be miners lost money; however, the people who sold them shovels and other supplies did very well.  I asked the audience to imagine an onrush of developers, contractors, consultants and others seeking their fortunes in the renewable energy industry and made the point that some industry participants would sell shovels and some would buy shovels at any price.

A year and a half on, what has changed?

We’ve seen record low EPC Pricing and PPA pricing for renewables projects. On face value this is great; however, EPC pricing has clearly been unsustainably low (in light of RCR going into administration).

Owner’s Engineering 101 says that extremely low EPC pricing means that the contractor is hurting; and when the contractor hurts, the owner will hurt as well (even if you have the best claims manager in the world, you still won’t see all of your liquidated damages). So, owners are going to have to draw funds from contingency, which (in order to achieve record low PPA prices) is probably not a big pool of funds.

The IRR shoot outs for reverse auctions and tender processes that we are seeing erodes both debt service cover ratios and contingency reserves as optimistic developers struggle to make financial close. Projects with lower IRRs and lower contingency reserves have less ability to recover from setbacks.

When I back calculate IRRs on PPA or reverse auction bids that I have worked on (and thankfully lost) during bid post mortem exercises, I get some very scary IRRs that I would never take to an investment committee (and certainly do not meet the investment criteria for my own funds).

My fear is, that we’ve not seen the last insolvency event in large scale renewables in Australia.

Finally, I have had the pleasure of working with some very good people from RCR over the last twenty years on a variety of projects, I wish them all the best in coming months.