Authors: Carlo Montella, Partner, Orrick - Daria Buonfiglio, Senior Associate, Orrick
Last year, Italy installed nearly 1.5 GW of new renewable energy capacity, of which 886 MW came from new solar plants. Only 9% of these plants exceeded a size of 1 MW1. Utility-scale plants have suffered a significant pause in development due to a variety of reasons, including a scarcity of authorized projects and of lack of materials. While we can expect that the lack of materials will still be an issue in the coming months - with expected consequences for the costs and timelines for the construction of new solar plants - we estimate that, in the next 12-18 months, the number of authorized solar projects will increase significantly. Overall, we believe that 2022 will be a turning point for renewables, considering the increasing pressure on governments and investors all over the world to redirect public and private funding towards the energy transition. This is amplified at a European level, as a reaction to the Russian invasion of Ukraine. PV technology will play a leading role in the global energy mix, as it is the cheapest form of electricity2 and one of the fastest to build.
In recent years, the Italian solar M&A market has been focused on assets realized through the old incentivizing schemes (i.e. the feed-in premium scheme set forth under the Conto Energia). The combination of several elements - including the scarcity of this kind of utility-scale plants (both on the greenfield as well as on the brownfield side), an excess liquidity, and favorable financing terms (with extremely low interest rates) - led to an overpayment of these assets in the context of a market driven by the seller’s side.
In the next three to five years, we expect that there will be a significant shift in the Italian M&A market. The focus will be redirected from these kinds of assets to new generation plants, incentivized by the DM FER 1 (and, once published, the DM FER 2), which will contemplate new incentivizing schemes based on a “contract for difference” approach, and on merchant projects, with or without supporting power purchase agreements.
In fact, while the “old” plants are becoming less and less available on the market, we will witness a strong influx of the “new” plants. As mentioned above, in the current context, there is a strong need for new renewable energy generation assets to face the energy crisis and the challenge of energy independence. Solar will play a leading role in this transitional phase (not only in Italy, of course). We predict that, in the coming years, we will have several new GWs of solar available in the Italian market3, part of which will remain in the hands of those who are developing these new plants (utilities, for example), but the majority of which will be transacted with medium/long term investors.
In terms of capacity, we believe that there will be a surge of large solo-plant transactions (with an average of 30/40 MW per plant), quite opposite to what happened in the past when investors needed to aggregate portfolios of plants due to the average capacity of around 1 MW per plant.
Considering the increasing cost of capital, the price of these new assets will be more in line with their actual value, opposite to what happened in the past five years, due to the elements mentioned above. However, a key element to consider is that, progressively, it will no longer matter that much - in terms of pricing - whether one buys at a “commercial operation” or at “ready-to-build” stage. In fact, while during the Conto Energia era, the tariff was secured only at commercial operation - with the GSE playing a very decisive role in determining whether the relevant applicant could or could not benefit of the tariff for which it had applied and in which amount - now the tariff (and its precise amount) is secured before construction begins. So, while in the previous “era” investors were able to offer a much higher price to buy the plant at a commercial operation stage to cover the “tariff risk”, now the “only” risk to cover from ready-to-build to commercial operation is the construction risk, which is low, considering that PV technology is extremely mature. Therefore, we believe that the Italian solar M&A market will progressively extend its focus on ready-to-build plants and that the price for a new plant will not significantly differ if it is bought at a ready-to-build stage or at a commercial operation stage. This leads to a new consideration: the Italian solar market will be composed of a “project development” market, with transactions bearing the “development risk”, and an M&A market composed of all those transactions focusing on authorized projects, without further difference between ready-to-build projects and plants that have achieved commercial operation.
Another consideration about pricing: while, in theory, it is true that the PV technology is extremely mature and, therefore, characterized by very accessible costs, the current context does not allow for the expectance of a significant decrease in the capital expenditures in the next months. There are several external factors, including the scarcity of materials and the Russian invasion of Ukraine, significantly impacting the capex and such effects cannot be precisely predicted. On the other hand, investors cannot just wait until these external factors die down because construction permits set forth precise deadlines in terms of construction start and completion, and if these terms are not met, the construction permit may be revoked.
There are several market trends emerging in the current context. Please find below a short selection of the ones we deem to be of most relevance and interest.
Expansion of the PPA market
A further boost to the solar market will come from the PPA market. The huge rise in energy prices will mark a turning point for the PPA market in Italy this year and, we believe, for the years to come. We are witnessing a trend inversion in the PPA market with respect to the previous years, as utilities and companies are now actively looking for opportunities to execute long term PPAs, both direct and financial, able to guarantee a stable energy price and, at the same time, a return in terms of “green reputation”. With an increase in the number of authorized projects and a more mature approach by banks in financing long term PPAs, we can expect a definite launch of the PPA market this year.
Utilities and traders will be favored in the negotiation of PPAs - at least in the beginning - considering their greater level of knowledge and know-how, built up in the past years. But we expect that the medium and large companies will catch up quickly, as these are the most vulnerable entities in this energy crisis, especially for those most energy-intensive, long-term PPAs can be a long-term solution that can be implemented in the short term. Such companies are, therefore, prepared to pay a higher price compared to that offered by utilities and traders. Furthermore, banks and financial entities now have a more mature approach towards the financing of long-term PPAs (and, in general, towards the financing of merchant projects), and we believe the insurance market will also kick in to mitigate the insolvency risk of the buyer side.
Italy’s Green Hydrogen Potential
The Italian National Integrated Energy and Climate Plan gives great attention to green hydrogen, which will require deployment of massive renewable capacity for its implementation. The Ministry for the Ecological Transition has recently signed a decree which allocates 450 million Euros to the development of an Italian production chain for green hydrogen. We believe that green hydrogen’s potential in Italy, at least in the beginning, would be best exploited at a local level. Green hydrogen could be produced by renewable units connected to a local distribution point through local micro grids (not connected to the national grid) and could supply energy, for example, to the local public transportation system.
There is huge potential for the development of the agrivoltaics sector in Italy, especially in the southern Italian regions, considering the high irradiation level and the numerous presences of drought-stricken lands. Many investors have already started deploying capital towards this technology in Italy (including Edf, Falck and NextEnergy Capital) also because the relevant authorization process seems faster than the “standard” one for PV plants. More than half of the authorization applications filed in 2021 are related to agrivoltaics plants and the success rate for the completion of the relevant authorization process is particularly high. Data shows that 30% of the applications for agrivoltaics plants have been approved since 20184. Recently, Mr. Patuanelli, head of the ministry for Agriculture, has declared that the government’s intention is to deploy 1.5 billion Euro to accelerate investments in the agrivoltaics sector.
Energy Communities and Rooftop PV Plants (SEU)
We believe there will be an increased interest with respect to investments in energy communities and rooftop plants part of SEU systems. However, these will most interest industrial players, such as the big utilities, which have the capabilities to manage and operate a fragmented production system.
The main trend we are seeing is that, in the next three to five years, the Italian solar M&A market will gradually be shaped by the features of the new assets entering the market, causing some interesting variations when compared to recent years, especially on the pricing side. There are also specific market trends to watch for in 2022, including an expected boom of the PPA market.
2 IEA's World Energy Outlook 2020
3 With respect to solar, Italy should authorize 3 GW each year of new utility-scale plants for the next 8 years to reach the 2030 targets set out by the PNIEC (Data supplied by Public Affairs Advisors and Elemens published in the R.E.GIONS 2030 report). The President of the Italian Council of Ministers has repeatedly declared that Italy must cut the red tape to facilitate the spread of renewables in Italy and the Italian Parliament and Government have put significant efforts to simplify renewables permitting processes over the past months (for example through the provisions of the so called Energy Decrees, through the direct authorization of almost 1.5 GW since the end of 2021, for which the relevant permitting process was stuck because of conflicts between local authorities, and through the DL Semplificazioni-bis by which the Italian’s cabinet has centralized at the state level the environmental impact assessment procedure for plants exceeding 10 MW which is the step of the permitting process where solar projects often get stuck).
4 Data supplied by Public Affairs Advisors and Elemens in the R.E.GIONS 2030 report