The Success of the Solar PPA Business Model: Lessons for Other Industries
8th July 2020
To have a successful business model, three ingredients are very important: proven technology, market demand and financial viability. If one of them is missing, the business idea will probably fail. The solar PPA business model provides a great example of how to balance these three elements, by connecting key players in the energy industry.
First of all, the product or service being considered for business must be technologically viable. Think about teleportation as seen in science fiction movies: it would have a huge market in the real world, but current scientific knowledge has not proven if the concept is even possible. Generating electricity from the sun was also impossible a few centuries ago, but solar power is now a thriving industry around the world.
Once a concept becomes technologically viable, you need a market segment and you must develop a lucrative way to serve your customers. The first solar panels date back to the 1800s, but they were inefficient and commercial electricity did not exist – there was no market for these solar cells. Electricity had to become commercial first, and then solar panels had to become efficient and affordable to be considered a viable power source.
For a long time, a key barrier for solar power was the high upfront cost. This resulted in long payback periods and a low return on investment, which few customers were willing to assume. However, manufacturing innovation and economies of scale reduced the cost of solar power systems, and California developed the solar power purchase agreement (PPA) business model.
Why the Solar PPA Business Model Was a Brilliant Idea
The solar PPA business model has been successful because it connects two key groups with solar developers:
- Electricity consumers who want to reduce their power bills, but are unwilling or unable to pay the upfront cost of a solar PV system.
- Investors looking for innovative businesses with attractive returns.
Under a solar PPA, investment capital is used to supply a solar array for the client. In exchange for not paying the upfront cost, clients sign contracts where they agree to purchase electricity from the installation over a specified period. These electricity sales provide the constant income that investors are looking for.
However, this concept only works if the deal is beneficial for both the end user and the investor. Solar PPAs accomplish this in two main ways:
- Electricity from the solar array is sold directly to the user, without an electricity network and power retailers acting as middlemen. Therefore, a solar PPA offers a lower electricity price than conventional power retailers.
- The solar PV system is still owned by the provider, who assumes responsibility for operation maintenance. Since the photovoltaic system is serviced by qualified personnel for the entire term of the PPA, it can be considered a safe investment.
A lower kilowatt-hour price makes solar PPAs attractive for electricity consumers. On the other hand, investors feel confident because the client signs a legal document, while the solar system provider is responsible for operation and maintenance.
When solar components come from reliable manufacturers, warranties make the PPA business model even safer for everyone involved. Solar panels typically come with a 10-year warranty against manufacturing defects, and a 25-year energy production warranty. Also, inverters are normally rated for 10 years. If any solar system component fails within the warranty period, the manufacturer will provide a replacement.
Client Benefits When Signing a Solar PPA
Large consumers often deploy commercial solar systems with PPAs, even when they can afford an upfront purchase. In many cases, they are simply choosing a solar PPA for the benefits it offers:
- The solar power system remains under the ownership of experts. For a company in a nontechnical business sector, outsourcing maintenance is much easier than building their own team.
- The capital that would have been spent on a solar PV system stays available for other investments.
In other words, a solar PPA provides a low-risk option to deploy solar panels at large scale. No capital is spent upfront, and the provider is responsible for keeping the solar array under optimal conditions.
Solar PPAs can also be used as protection against future increases in electricity tariffs. Consider that the kilowatt-hour price in a PPA is established in a contract, while the electricity supply from conventional power retailers is subject to unpredictable price increases.
In addition to charging high kWh prices, Australian power retailers are notorious for their confusing electricity plans. These include many complex pricing schemes and conditions, and the kilowatt-hour price is not always clear. There are also misleading tariffs that seem like a good deal, while you are actually paying more than necessary. For example, a 15% discount on an electricity plan that is overpriced by 30% not a deal – it is actually a legal scam!
When the solar PPA business model is deployed properly, it benefits clients, developers and investors. The client’s electricity savings provide revenue, the solar company provides technical expertise, and the investor provides capital.
Without solar PPAs, the market for photovoltaic systems would be greatly reduced:
- Solar arrays can only be sold to clients who are able and willing to pay upfront.
- Investors have a reduced business opportunity, simply because the market is smaller.
- Lending capital for solar PV system purchases is less lucrative than financing solar PPAs.
If you have doubts about the financial viability of photovoltaic systems, consider that Warren Buffet has invested aggressively in the solar industry. He is considered the world’s greatest investor, and he is characterised by focusing on businesses he knows well, staying away from most technology sectors. However, he made an exception for solar power, and has developed some large solar farms in the USA.