by Cedric Brehaut, Executive Consultant, SoliChamba Consulting
As discussed recently in our Top U.S. Utility-Scale Asset Managers and O&M Providers, the future of asset management (AM) and operations and maintenance (O&M) markets will be shaped by large independent power producers (IPPs). Illustrating the appetite of these IPPs for solar assets, a few days ago Brookfield announced the acquisition of SunEdison’s share in the bankrupt developer’s two yieldcos TerraForm Power and TerraForm Global.
If players like NextEra, Southern Power, NRG, and now Brookfield continue to dominate the ownership landscape, they could keep a large share of the AM and O&M market captive, i.e. performed in-house and inaccessible to service providers.
Remarkably, in the months prior to the Brookfield transaction, the TerraForms insourced these activities (previously contracted to SunEdison). Arguably, this move pivoted the yieldcos to a business closer to an IPP like Brookfield and made them a more attractive target.
The pros and cons of self-performing
The ‘Megawatt-Scale PV O&M and Asset Management 2016-2021’ report recently published by GTM Research explores the advantages and disadvantages of outsourcing AM and O&M to different categories of market players. Figure 1 below summarizes the report’s analysis of insourcing (or ‘self-performing’) for IPPs.
Seeking alignment of interests
The key advantage of performing the functions in-house is a complete alignment of the team with the common goal of maximizing asset profitability.
Outsourcing, on the flipside, introduces a service provider whose profits does not follow the same equation as owner’s interests, and often move in the opposite direction. This potential conflict can be mitigated with commercial terms such as bonus/malus and performance incentives, but complete alignment of interests remains very difficult to achieve. In addition, potential penalties incurred by asset management and O&M service providers in case of underperformance are often too small to compensate the losses suffered by the investor if the asset is underperforming, except when the service provider is also the developer or EPC and signed up for substantial liquidated damages tied to the value of the plant itself (rather than the value of the service contract).
Experience and scale matter (but not always)
IPPs can make a strong case for insourcing when they benefit from experience with other asset classes which are often more mature, such as fossil and nuclear power, and wind and hydro power. In comparison, however, most IPPs lack experience with solar assets. This challenge is easier to overcome for commercial and financial asset management than for technical asset management and O&M, which are more technology-specific.
Scale logically drives cost reductions by increasing staff utilization and spreading fixed infrastructure expenses over a larger pool of assets, and IPPs can count on leveraging their current asset management teams and processes, operations centers, and field service infrastructure. This simple notion, however, may be challenged by a complex reality.
Even the largest solar plants are considered small generators in a conventional IPP world: processes and infrastructure developed for coal, gas, or even for wind power plants, may not adapt well to solar facilities. Effective and efficient management of these assets may require new solar-specific processes and even possibly dedicated infrastructure.
O&M cost factors may not favor IPPs
Large IPPs may have higher labor costs than solar companies. For example, some employ union labor, while others simply have been paying higher wages or benefits because the economics in the power generation industry allowed it. Solar O&M providers, however, have been racing to the bottom of the price curve at a breakneck pace, especially for utility-scale plants. This price war is the single biggest deterrent to a potential wave of insourcing by large IPPs in the U.S.: O&M prices are currently so low that the economic benefit of self-performing is questionable.
So… what do most IPPs do?
Utilities and IPPs almost always self-perform asset management for the PV plants they own, and many have the same approach for O&M, because they see it as part of their core business and they are already doing it for other generation technologies.
Despite this philosophy, many IPPs task the original development or EPC firm to perform O&M during the plant’s warranty period, to maximize the benefit of performance guarantees and to avoid finger-pointing if issues arise. But in many cases, their long-term plan includes taking over the operations after EPC guarantees and warranties expire. On the other hand, IPPs that are also developers or EPCs almost always self-perform O&M.
Are we facing a massive wave of O&M insourcing by IPPs?
Probably not in 2017/18, for two main reasons.
First, even owners who intend to insource O&M at the end of the warranty period may not act on this plan: the pragmatic approach is to insource an activity if self-performing increases asset returns (or reduces risk factors while preserving returns). As long as solar assets perform well and costs are competitive, owners have no incentive to introduce a change. If it’s not broken, don’t fix it.
Second, in any given portfolio, some assets are better insourcing candidates than others based on their size, location, etc. Most insourcing efforts will unfold at a slow pace within large portfolios, as warranties and initial contracts expire, starting with regions where plant density allows cost-effective operation, and expanding to more regions once success is proven. IPPs are much more risk-averse than solar companies.
The most dramatic change afoot in the next few years is that solar asset management and O&M will become boring. Hopefully.