The reductions in the FITs mean that the success of the German PV market in 2012 will hinge on its capability to generate an attractive ROI based on free-market dynamics, rather than on government incentives

El Segundo, Calif., March 1, 2012—Despite the German government's plan to reduce incentives for new solar installations, some market segments in the country will remain attractive for photovoltaics (PV) in 2012, with the return on investment (ROI) remaining sufficient to attract financial support for residential systems—and even some large-scale systems—according to the IHS iSuppli Photovoltaics Service at information and analytics provider IHS (NYSE: IHS).

The two German ministries for the environment and the economy last week jointly published a proposal to cut feed-in tariffs (FITs) and to simplify the tariff system. The proposal still must pass the German parliament and the upper house, but is likely to be accepted.

"The reductions in the FITs mean that the success of the German PV market in 2012 will hinge on its capability to generate an attractive ROI based on free-market dynamics, rather than on government incentives," said Dr. Henning Wicht, director and principal analyst for photovoltaics at IHS. "To justify investments, those who install solar systems must pay their own way to a much larger degree than before, either through their own consumption of electricity, or from power sales to others. Although this is likely to lower the ROI on solar installations in Germany, returns are likely to remain attractive enough to attract financial support."

Throwing the FIT

As presented in Table 1 below, the new proposals call for tariffs to be reduced and application categories to be simplified. Starting on March 9, installations will be classified into only three types of applications. The new tariffs exclude any bonus for self-consumption of electricity generated by solar installations. Tariffs by system size are:

· Systems up to 10 kilowatts (KW) will have a FIT of 19.5 euro cents/kilowatt hour (kWh), a segment that consists of residential roofs, but not farm houses

· Systems up to 1,000KW: 16.5 euro cents/ kWh, an area consisting of larger roofs

· Systems up to 10 Megawatts (MW): 13.5 euro cents/kWh, including both large rooftops and ground installations

· Large systems of above 10MW will receive no FIT starting on March 9.

· Tariffs will decrease monthly by 0.15 euro cents/ kWh starting on May 1, 2012. This regulation will replace the annual FIT cut that typically occurs in January.

A so-called market integration model will be introduced, under which only 85 percent of the annually produced electricity for systems up to 10 kW—and 90 percent for all other systems—will receive the FIT. This clause affects mainly the institutional investments of PV power plants, and is driving PV power plants toward local consumption or Power Purchase Agreements (PPA) with buyers.

The government confirmed the target range of 2.5 GW-3.5 GW of annual installations for 2012 and 2013. From 2014 on, the target will be reduced by 400 MW annually. Table 2 below summarizes the FIT system proposed by the German ministries.

ROI on the decline

After the change in the FIT, IHS iSuppli calculates that residential systems in Germany will still generate an ROI of 10 percent on equity capital (20 percent) if system prices are at €1,850/kW, even though the self-consumption bonus will be omitted. Prices have already fallen to this level in the market. Therefore, the residential segment will continue to offer attractive investment conditions even after the reduction in the FIT.

However, for large rooftop systems up to 1,000kW, attaining a worthwhile ROI will depend on how much of the generated electricity can be consumed locally or sold via PPAs. In case of a supermarket or manufacturing site consuming about 30 percent of the PV electricity it generates, solar systems can yield a 10 percent ROI if the system price doesn't exceed €1,400/kW. Such a scenario approaches the limits of what is possible today.

On the other hand, if the PV electricity is not consumed locally and is subsidized entirely by the FIT, system prices have to drop to keep ROI rates stable. For large rooftops, system prices must be €1,250/kW to attain the key threshold of 10 percent return on equity capital.

For a positive ROI, ground installations should cost €1,050/kW, a low level that is not yet foreseen in 2012. However, if PV electricity can be sold via PPAs at rates of €10 euro cents/kWh, and prices are linked to average electricity price inflation of 4 percent per year, the investment can justify the cost of 1250€/kW. An inflation adjustment of PPAs will make this business model beneficial soon compared to the fixed FIT.

Table 2 presents the targeted system price needed to reach a 10 percent ROI on equity capital.

Investment case

A major question for the future growth of the German PV market is the level of investor interest amid declining ROI. Do installations really require a 10 percent ROI to attract investors' attention?

During 2008 and 2009, PV investments in Germany reached ROI rates of 7 and 8 percent. Assuming an ROI rate of 7 percent instead of 10 percent, PV systems for large roofs can cost €1,500/kW, which is feasible today.

Will investors accept these lower rates? The answer is yes, although not with the same vigor as seen in the past. PV investment in Germany is still expected to attract financial support even when the ROI declines to a reduced level of 7 percent.

Free market solar

The traditional PV business case of producing and feeding electricity to the grid will have to be modified and reoriented toward local consumption and PPAs.The new FITs will most affect engineering, procurement and construction (EPC) companiesin Germany. To facilitate the investment case, the EPCs must take care of local consumption or PPAs. Undoubtedly, it will be more costly to develop large PV projects, so the system hardware—i.e., modules and inverters—must cost less.

Only the lowest system prices will be accepted, and it will be incumbent upon the European suppliers to reach competitive low prices. Modules made in the European Union EU are 20 percent more expensive than for Chinese first- and second-tier suppliers. Chinese modules now are offered €0.65/W, compared to European ones at €0.75/W.

Government targets create market uncertainty

The German government has confirmed a target of 2.5 to 3.5 GW for new annual installations, which is bad news for PV. To strengthen its position and to squeeze the market into that target range, the German Ministry of Environment intends to take the sole authority to change FIT tariffs without consultation and agreement of the parliament and upper house. Under this clause, the ministry would be able to change tariffs on very short notice to any desired rate, which will create uncertainty for all investors.

Both the tariff cuts and the potential volatility of tariffs are severely affecting two of the three market segments in Germany: the large roofs and the ground installations.

How will the PV industry get out of the dilemma? It will be up to the EPCs to transition from incentives to free-market dynamics, including PPA agreements and local consumption. Once the supply chain—and in particular the EPCs—has modified its services, large installations can pick up again. The German PV market is not nearly saturated in terms of space and rooftops. Roughly estimated, only 10 percent of suitable rooftops are equipped with a PV system.

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