18 April 2012
Constructing power plants is no small undertaking. The US Energy Information Administration (EIA) put the average cost for a 650,000 kW APC coal-fired power plant at a little over $2 billion, and the cost for a 1,300,000 kW APC coal plant at almost 3.7 billion in 2010. Nuclear construction was estimated as low as $1,300/kW and as high as $3,500/kW for the most advanced, third-generation nuclear plants.
Traditionally, such projects are financed with the cost of construction borne by the utility rate payers for years into the future, so that a billion dollar natural gas plant costs the average consumer just dollars a year on their bill, with no up-front or out-of-pocket costs.
A billion dollar natural gas plant costs the average consumer just dollars a year on their bill.
Compare this to the estimated $30,000 an individual homeowner can pay installing a 4kW solar system. While such solar installations pay for themselves over time, the timeframe can be long; at least 10 years for most home installations. Simply tapping into the grid for electricity is financially less painless for the individual consumer, making incentives and innovative financing structures that much more critical for the future of the solar industry.
The US solar incentives landscape
Financing the 1.7 gigawatts (GW) of solar power the US installed in 2011 was a complex matter for the most part because, unlike solar leaders such as Germany, Italy and Spain, the US has no national solar policy. The upside is that the power of the free market, combined with complex incentive structures, allows investors to strategically place capital where positive returns seem promising. Each state mandates its own rule and rebate structure, while individual utilities and municipalities also remain at liberty to create solar programs and rebates.
In this environment, the current US solar market is dominated by a combination of creative financing and state incentives that have sparked solar gold rushes:
- Colorado’s Excel utility offered a substantial rebate to owners of systems up to 100kW.
- New Jersey created a solar renewable energy credit (SREC) market backed by state mandates for solar power generation.
- Pennsylvania, Ohio, Maryland and Massachusetts created various forms of SREC-based solar incentives.
- California created a requirement, funded directly by the utilities, which was mandated to provide an increasing percentage of electricity from renewable sources.
The result has been considerable growth – and has led to creative financing strategies.
Savvy solar investors have learned that true profit lies in grasping the nuances of the economic models that have been driving solar construction. Right now, the tax equity model, in which a company or high net worth individual invests money in a solar installation as a tax shelter, appears to be the most popular. With this model, federal law allows for accelerated depreciation of invested dollars. If the tax equity investor wishes to fund only a portion of the installation, many developers leverage that investment with traditional debt financing, typically at a lower rate and for a longer term. However, many tax equity investors will maximize the tax benefit available to them by borrowing the required additional debt themselves, allowing for the tax benefit (depreciation benefit) to extend to their total investment (their equity and the borrowed money). This enables the tax equity investor to provide the cash up front. Their exit strategy/take-out partner will continue servicing any remaining debt. With this arrangement, the solar project is funded by a power purchase agreement (PPA) -- the electricity is sold under contract to a utility or, more frequently, to the private party where the solar array is housed.
The future of solar financing
True profit lies in grasping the nuances of the economic models that have been driving solar construction.
Because the primary motivation of the solar investor is to realize a return, financing for solar installation projects will flow only as long as the developer can demonstrate effective rates of return, based on the price of the PPA and the value of the SREC’s, where applicable, in conjunction with sufficient credit worthiness of the electricity off-taker. This model frequently requires accelerated up-front cash flow going to the tax equity investor, along with the accelerated depreciation benefit.
With tens of thousands of solar arrays installed using some form of this financing scheme, and the vast majority benefiting from accelerated depreciation, it’s likely that within a few years a large number of fully depreciated solar arrays will exist in the US. It’s unclear; however, what will happen to this fragmented population of electricity generation after the tax equity investors have exited. Another uncertainty involves the debt-servicing investors and how content they will be to sit on these assets in perpetuity. Will the building owners execute the buy-out clauses available in many PPA agreements? Will the installations that paid a premium, accelerated return to the tax equity investor be upside down in value? The only certainty is that the US will have pockets of distributed solar electricity generation owned by thousands of individual, unrelated entities. As more and more megawatts are installed each year in the US, a multitude of full-scale power plant equivalents will be quickly installed in a distributed fashion.
The question of solar power financing has been one of proving the short-term viability of solar projects. If a developer is able to prove to a tax equity investor that a project will earn a sufficient return, then the capital will flow to the project, and the debt will follow in the case where the equity isn’t sufficient to cover the entire cost. Thinking long-term, the impact of this tax equity model will shape an emerging secondary solar market -- and the future of the solar market itself.
About the Authors
Dan Bedell is Executive Vice President Marketing & Corporate Development of Principal Solar.
Peter B. Dauterman is Director, Pegasus Funds, Advisor to Principal Solar.