Future of the Chilean Energy Sector Workshop – Santiago, Chile

Francis O’Sullivan

December 12th, 2016

Renewables and Value Realization – Challenges

and the Opportunity for Innovation in New Energy

Markets

The new energy landscape – A new balance for conventional fuels and the rise

of wind and solar to energy’s big table

2

3

Source: F. O’Sullivan, United States Energy Information Administration, HPDI Production Database

Illustration of gas production growth from the main U.S. shale plays since 2005

Bcf of gas per day

0

5

10

15

20

25

30

35

40

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Bakken

Eagle Ford

Marcellus

Woodford

Haynesville

Fayetteville

Barnett

Today, shale

supports 50% of

US gas production

The

Marcellus

Shale

alone

produces

more gas

than

Canada,

Iran or

Qatar

The global energy sector is currently bearing witness to a set of dramatic and

unexpected dynamics – Global gas markets are being reshaped, oil prices have

collapsed, and the level of renewables capacity is exploding

4

The past decade has borne witness to tremendous growth for both wind and

solar globally – Together, wind and solar accounted for more than 40% of all

new capacity additions since 2006

0

100

200

300

400

500

600

700

2006 2015

Solar Wind

Global wind and solar installed capacity

GW

Source: National Renewable Energy Laboratory, Lawrence Berkeley National Laboratory, Solar Energy Industry Association

0

50

100

150

200

250

300

350

400

450

USA

China

Europe

ROW

2015 Cumulative capacity

GW

0

50

100

150

200

250

300

350

400

450

USA

China

Europe

ROW

Solar PV

Wind

562 GW

of new

capacity

5

With ever improving economics, global wind and PV capacity is expected

to double over the coming 5 years – Driven by the auction process, Chile is

expected to see a tripling of wind and solar PV capacity by 2021

642

323

322

1287

0

300

600

900

1200

1500

2015 2021

New Solar

New Wind

Projected global wind and solar PV capacity

additions to 2021

GW

Regional distribution of new PV capacity additions to 2020

Source: International Energy Agency, European Photovoltaics Association

1.6

1.2

2.6

5.4

0

1

2

3

4

5

6

2015 2021

Projected Chilean wind and solar PV capacity additions

to 2021

GW

Over the past five years the competitiveness of utility-scale PV in the US has

improved dramatically with PPA prices falling by 70% or more – PV contracts

are now being signed for $40/MWh or less

6

Utility-scale solar PPA prices evolution since 2006

$/MWh

Sources: Bloomberg NEF, “U.S. PPA Market Outlook.” 07/08/15. GTM/SEIA, “US SMI Q1 2015.”

NV Power signed a

utility-scale solar

PPA in August ‘16

for $34/MWh

Internationally, there have been a range of exceptionally low-cost solar PPAs

signed over the past year – Developers are betting on being able to deliver

further appreciable cost reductions over the next several years

7 Sources: LBNL 2016 – Utility-Scale Solar 2015

0

10

20

30

40

50

60

70

80

90

100

Barzil Chile Dubai Jordan Brazil Chile Brazil Peru Mexico Dubai

Recent global solar PPA prices

$/MWh

2014 2015 2016

Transitioning to higher renewable penetrations – Understanding the market

challenges ahead in realizing a more renewables-dependent system

8

Solar economics at all scales have been rapidly improving, and utility-scale

solar is increasingly competitive with new generation – However, in the U.S.

the investment tax credit subsidy remains important

Source: MIT Analysis, U.S. Energy Information Administration

0

50

100

150

200

250

300

350

Gas CombinedCycle

GasCombustion

Turbine

76

CA MA CA MA

Utility-Scale PV Residential-Scale PV

105

158

192

287

123

2014 Photovoltaic Systems

Benchmark Natural Gas

Generation LCOEs

ITC Subsidy Value

After Subsidy LCOE

Levelized cost of electricity

$/MWh

Regional variation

Minimum LCOE

Utility -$1.25

Residential- $2.80

CA Irradiance

2017 online

Capex

74

150

10

However, caution is needed though when discussing the competitiveness of

solar as penetration levels rise – As solar grows to provide a meaningful energy

fraction its relative competitiveness will erode as its value factor falls

Source: MIT Analysis

60

20

55

50

45

40

35

30

25

0 36 6 12 18 24 30

Illustration of how the price a solar generator receives for its output can fall well

below the average market price as solar penetration increases

$/MWh

Solar Penetration

(% Peak Demand)

California is providing an interesting case study of exactly the type of market

impacts that solar can have even at modest energy fractions – Today, solar

delivers about 7% of CA electricity demand

11 Source: CAISO data from 7/17/2016

0

2

4

6

8

10

12

14

16

18

20

0

5

10

15

20

25

30

35

40

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24

Total Load

Net Load

PV - Right Axis

Other Renewables - Right Axis

CA system load

GW

PV & other non-hydro renewables

GW

California’s renewable capacity has reached the point where the merit order

effect is substantial – At prevailing natural gas prices, 50GW of demand clears

at 60% of the case without renewables

12 Source: Bloomberg New Energy Finance, 2016

$16/MWh price

suppression

CA merit order without renewables

$/MWh

CA merit order with renewables

$/MWh

At current penetration levels, the value of solar generation in CA falls well

below its LCOE and the spread is widening – Even with revenue from RECs,

the economics of new solar investment in CA are becoming very difficult

13 Source: Bloomberg New Energy Finance, 2016

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 2016

Merchant Value

Subsidized LCOE

Evolving merchant value of solar generation relative to subsidized

LCOE in CA

$/MWh

Increasing solar

penetration in CA is

now suppressing it

value faster than

costs are falling

Building a sustainable solar business model – The potential for innovation, the

opportunity to reduce cost of capital, and the risks of a regulation-linked model

14

15

The U.S. residential solar business differs entirely from the utility-scale model

and has involved cost decoupling – “Value Pricing” has been key to the growth

of the U.S. residential solar market

Utility-scale PV – ~5MW and above Residential-scale PV – up to 10kW

- Utilities driving market by need to meet RPS

targets

- Strong competition among developers to

secure PPAs

- Pricing strongly linked to underlying cost

base

PV Pricing Mechanisms

- Emerging awareness and demand among

homeowners

- Installers developing innovative business

models reducing upfront costs to owners

- “Value Pricing” linking solar prices to local

utility rates

Source: MIT Analysis

16

The rapid expansion in the adoption of residential solar points to the rise of

a more proactive energy consumer – There are now more than 1M solar PV

installations in the US and more than 900k are residential scale

Cumulative residential-scale PV installations in the United States

Source: MIT Analysis, National Renewable Energy Laboratory, Lawrence Berkeley National Laboratory, Solar Energy Industry Association

0

200,000

400,000

600,000

800,000

1,000,000

0.00%

0.25%

0.50%

0.75%

1.00%

1.25%

1.50%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Number of Systems % of households

Residential PV systems

Single-family detached houses

Though only 1.3% of all US households have PV, in some markets

levels are much higher: HI 25%, CA 7%, AZ 5%

The US surpassed

1M residential PV

installations in Q2

2016

17

Residential PV’s rise has been driven by a few innovators that have focused

on the selling of solar based on its relative value – The combination of “value

pricing” and financial innovation is at the heart of the residential business model

Source: US Department of Energy, Corporate filings, SEIA

67 90

120 149 139

168 203 221

20

37

49

50 46

66

61 59

24

35

34

37 37

42

56 68

138

117

125

174 226

222

242

243

0

100

200

300

400

500

600

Q1 '14 Q2 '14 Q3 '14 Q4 '14 Q1 '15 Q2 '15 Q3 '15 Q4 '15

Quarterly US residential PV installations by installer

MW

Others

Scale is key to the success

of the residential solar PV

business model

The residential lease or PPA is not structured to reflect underlying system

costs, but to offer value relative to utility supplied power – Naturally, the

residential PV model is sensitive to local utility tariff levels and their structure

18

Range of future utility

prices: PU, t

Power Price

¢/kWh

Years 0 1 2 3… …N

Predefined future PV lease

or PPA price: PPV, t

PU, 0

PPV, 0

Source: MIT Analysis, United States Department of Energy, Company filings

Portfolio Average

Metrics:

- Generation: 1,391

kWh/kW

- PPA Price: $0.13/kWh

- PPA Escalator: 2.2%

“We believe that our primary competitors are traditional utilities that supply energy

to our potential customers” – SolarCity 10k

19

Data available for the residential market highlights how effective the “third

party owned” model is at Value Pricing – Though expensive it does help

eliminate barriers like high capital cost and the need for tax appetite

Source: California Solar Initiative and other state reporting systems

Average system price by major state market and ownership type

$/Wp

$0

$2

$4

$6

$8

$10

$12

2009 2010 2011 2012 2013 2014 2015

AZ

CA, Host-owned

CA, 3rd-party

MA, Host-owned

MA, 3rd-party

MD

NY, Host-owned

NY, 3rd-party

Even with falling system costs, prices in markets like

MA have barely moved since 2012

20

Delivery of a third-party owned solar product is very complex and demands

specialized expertise – The hurdles associated with the efficient execution of the

business model are central to the relative lack of competition in the space

21

One of the salient challenges of the third-party solar business is its very high

capital intensity relative to free cash flow – The extreme asymmetry in cash

flows demands an off-balance sheet approach be taken

Source: MIT Analysis, US Department of Energy, SolarCity Public Filings

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

Vivant Solar City Sunrun

General & Admin

Sales & Marketing

System & Installation

Breakdown of Q1 2016 residential PV system costs for

three main US installers

$/W

0

100

200

300

400

500

600

700

800

Capital Requirements Cash Flows

Free Cash Flow

Opex, Debt & TaxEquity

Breakdown of Q1 2016 investment requirements for SCTY

versus portfolio cash generation

$M

Quarterly free cash

generated from

1,500MW portfolio

is $17M

22

Securitization of solar leases allows third-party solar providers move to

move assets off balance sheet – The ubiquity of asset-backed securitization

(ABS) has been forwarded as a vector for lowering solar’s cost of capital

23

Over the past several years two residential solar providers have led solar ABS

issuances – There has been appreciable interest among those who facilitate these

deals but ABS investors appear to be relatively cautious

Source: F. O’Sullivan & C. Warren, Solar Securitization: An Innovation in Renewable Energy Finance

24

The success of securitization is ultimately linked to how effectively it proves

as a mechanism for lowering solar’s cost of capital – To date the results have

been mixed and the likelihood of longer-term success remains uncertain

25

Risks abound for the solar ABS, and many other solar financing vehicles that

will only be mitigated by future cost reductions – To date the results have been

mixed and the likelihood of longer-term success remains uncertain

26

Net metering subsidies are central to the US residential PV business and most

tariff redesigns negatively impacts the business model – An issue alreay

Wholesale

energy price

Retail price

including

network

costs

Utility Customers

A B C

Network cost paid by customer per kWh

Energy cost paid by customer per kWh

System before A installs solar

…N

Wholesale

energy price

Higher retail price

with cost shifted

Utility Customers

A B C

Network cost paid to customer A per kWh

Energy cost paid to net-metered customer per kWh

System after A becomes a net solar seller

…N

Net-metered rate

paid to Customer A

Additional network cost paid by customers without solar

Utility Rate

$/kWh

Utility Rate

$/kWh

- When A sells power, she gets the retail price, while utility-

scale sellers get the wholesale price, often much lower

- When A stops covering any network costs, the retail rate

must go up so the other customers cover those costs –

plus the network cost paid to A!

27

Some concluding thoughts

- Wind and utility-scale solar PV are now at or very near the competitive frontier for new generation

investment in many US markets

- The continuing rapid growth in zero-marginal cost generation (particularly solar PV) will place further

downward pressure on wholesale power prices over the medium term

- DER innovation has yielded a set of technologies that provide new options for optimizing the grid, both in

terms of technical performance and cost effectiveness

- The economic and technical benefits that DERs offer only arise in operational circumstances that are

specific to the conditions of local and regional grid

- The rise of consumer-level DER adoption, and particularly that of smaller-scale solar PV systems has

come about through a combination of technology cost reductions and very generous deployment support

policies that often fail to appropriately reflect the cost-benefit balance of such technologies

- The business models that have driven rooftop solar adoption rely heavily on “value pricing,” and are

exquisitely sensitive to tariff structures, the ability to maximize cash yield from investment tax credits, and

the availability of counterparties interested in cash-yielding asset-backed security products

- The efficient realization of the benefits that DERs offer requires that tariffs are structured in a

disaggregated manner that accurately reflect the costs

- Cost reflective tariffs will enable the efficient realization of the broad set of benefits that DERs offer in a

manner that reduces conflict between traditional utilities and new energy service providers.

Solar providers use their “value priced” leases to maximize the benefits of

the ITC subsidy to them – Using this “income method” can amplify the subsidy

by 50% or more

28

UnsubsidizedCost

Lease PV Subsidy PV Total IncomePV

Lease PV Subsidy PV Total IncomePV

Subsidies:

ITC: $0.98/W

MACRS: $0.26/W

$4.24/W

Cost Method Income Method

$3.00/W

Subsidies:

ITC: $1.45/W

MACRS: $0.39/W

$3.00/W

$4.84/W

$3.25/W

Source: MIT Team Analysis

29

The timing of cash flows is also a major weakness of the third-party solar

model – The bulk of value is entrained in cash flows from the later years of the

contract

Projected portfolio cash flow breakdown for SCTY’s current solar portfolio

Source: SolarCity Public Filings