This article is taken from the forthcoming issue of Renewable Energy Focus magazine (March/April 2013 issue). To register to receive a digital copy click here. (Note - free of charge to qualifying individuals).
Bank loans, power company equity, federal programmes and tax credits have so far succeeded in growing the US solar market to 6.4GW installed capacity in 2011. More good times lay ahead too, with the US forecast to reach 30GW installed capacity by 2020.
However, to get there, more capital is needed, just at a time when federal loans have run out. The US Investment Tax Credit (ITC) is decreasing from 30% to 10% in 2016 and Basel II regulations have reduced the tenor of loans from 20 years to 10 years, a more natural fit with most solar projects.
So financial innovation will be key to unlocking a trillion dollar opportunity in the sector and bring the industry to the next stage of maturity. Some of these funding mechanisms are unique to solar, and others are transplants from other sectors such as real estate, mortgage debt and the fossil fuel industry.
Dramatic cost reductions in PV panels, from $4 per watt in 2008 to $0.65 per watt at the end of last year, have helped balance the equation for developers as 20GW of oversupply wash around the global market and destroy manufacturers’ bottom line or cause them to collapse entirely. “The cost decline of equipment because of manufacturing overcapacity and technology improvements is the silver lining in the midst of the ongoing rationalisation of the solar sector,” says Partho Sanyal, managing director of the global energy and power group at Bank of America Merrill Lynch. “The cost of delivery of solar power has dropped so dramatically that every day solar power is becoming more cost competitive.”
But rock bottom prices are not enough.
Asset financing for PV projects has grown 58% since 2004 and surged to a record $21.1bn in 2011, according to Bloomberg New Energy Finance (BNEF). However, BNEF analysts estimate that about $6.9bn of annual funding will be required to meet the anticipated growth in the US by 2020.
Michel Di Capua, head of research North America at BNEF, says: “This financing picture is so interesting because it’s a frontier that hasn’t yet been tested. There’s still opportunity in terms of bringing down the costs of capital.”
Solar projects require three types of capital: equity; debt and tax equity. Utilities or independent power companies often provide 20-30% equity, while banks can expect returns of around 6-7% for their loans and tax equity investors can expect a 14-18% yield.
In the utility sector, the ITC has been particularly attractive to investors with a large tax liability, such as banks like Morgan Stanley. But corporations have been slow to grasp the potential benefits with the exception of a few companies like Google.
Over the past couple of years, third-party lease and power purchase agreements have revolutionised the way consumers and businesses finance solar. Under these agreements, a customer will repay a third-party through monthly fixed charges, or based on how many kWh the system produces over 10-25 years.
Demand for SolarCity’s stock after its successful IPO last year proved the economic effectiveness of third-party financing. Its competitor, Sunrun, attracted $200mn in funding from Credit Suisse last year.
But other financial innovations being discussed now in the industry could open up unprecedented access to capital. Securitisation may be a loaded concept after the derivatives from mortgage debt turned sour, triggering the financial crisis.
“If we look at many of the derivatives that were used for the mortgage industry, those structures were abused,” says Tim Keating, senior vice president at SCS Renewables, which is developing software platform to assess the bankability of solar projects. “But they are rational, reasonable financial structures. Like anything else, they are sound if you don’t abuse them.”
Small-scale third-party-owned solar could require up to $5.2bn in financing in 2014, say BNEF analysts. But if all of 2011’s installed residential capacity were securitised, the proceeds from the securitised assets would contribute 32-47% of capital for residential solar in 2012 and 31-42% of commercial build, according to BNEF’s Reimagining Solar Finance report published last year.
Kristian Hanelt is the senior vice president of Renewable Capital Markets at Clean Power Finance, which connects financiers with installers who can draw down from $600m in funds from Google and Morgan Stanley. “Securitisation is going to happen this year. That’s going to be a great step. There will be a lot of momentum to get more volume out into the public market. That’s going to be a great thing for the industry and will get a lot of folks on Wall St excited.”
Some other financing mechanisms are also attracting a lot of interest after success in other sectors. Renewable Energy Trust Capital based in San Francisco is looking to transfer a proven mechanism in real estate to the solar industry.
Real Estate Investment Trusts (REITs) provide investors significant tax breaks and are traded on the open market like mutual funds. The company has applied to the Inland Revenue Service (IRS) to allow it to raise money for large-scale solar facilities in the same way as real estate trusts raise money for large developments such as shopping centres. The IRS is expected to make a decision soon that could potentially lower the cost of capital by 20%.
Meanwhile, Delaware Senator Chris Coons has introduced a bill to extend Master Limited Partnerships (MLPs) to the renewable industry. MLPs are only subject to income tax for shareholders and are exempt from corporate taxes. MLPs have been used extensively in the fossil fuel industry to invest in energy oil, natural gas, coal extraction and pipeline projects and their market capital has grown from $65bn in 2005 to $350bn last year. The Master Limited Partnerships Parity Act would be a “tweak” to the tax code to allow renewables investors to enjoy the same tax benefits as investors in fossil fuels.
Yield companies could see public trading of the operations division of a clean energy company, while the riskier development division remains private. Bond issuance for solar projects may also become more popular after MidAmerican offered the 550MW Topaz solar project last February. Its $700mn offering was oversubscribed with $1.2bn bonds applied for.
Benefits for small projects
Traditional forms of financing such as the 30% ITC are a natural fit with large-scale projects as tax equity investors typically look to invest $15m-$30m. As a result, utility-scale projects are attractive for investors, and residential opportunities have grown thanks to third party financing.
But financing for smaller commercial projects is a real pinch point, says Di Capua: “The ones that are a bit tricky are distributed projects for the commercial sector where you're dealing in the hundreds of kilowatt range. But this is almost the best opportunity for solar growth because there could be so many potential offtakers, it could work in so many markets and there are so many rooftops in the country.
“But the financing piece is sometimes not obvious – the yields aren't big enough to attract the attention of investors and they're not standardised enough to package them into big portfolios.”
Constantino Nicolaou, president of PanelClaw, a mounting systems company, says this is a massive missed opportunity. “We have an opportunity in the US where we have a trillion dollar market that is less than 1% developed.
“If we can get the capital piece right we can capitalise on this trillion dollar market. That's going to take a lot more than words, feelings and thoughts. It's going to take data, analytics and commitment.”
PanelClaw has joined with Mosaic, Standard & Poor's, Assurant, DuPont Photovoltaic Solutions, the National Renewable Energy Laboratory and 10 other organisations and companies to lower capital costs by reducing project risks through the development of uniform standards for solar project screening, rating and underwriting. The TruSolar consortium claims that less than 5% of the 65,000 banks and lending institutions in the US are actively involved in financing solar projects due to lack of data to accurately price risk.
Data would enable solar projects to be given credit-ratings. A cheaper, secondary market or debt market could then be created where organisations buy pools of loans from banks and other lending institutions and sell them as securities to investors, says David Schroeder, vice-president of operations and industry relations at insurers Assurant. “This would be a new market for the solar industry,” he says. “Secondary markets exist for a lot of other products such as automobile loans, mortgage loans, credit card loans, etc.”
Marco Krapels, executive vice president with Rabobank North America, agrees: “In the US, there are hundreds of deals not getting the proper amount of attention because they are not big enough for the big banks.”
Rabobank has an almost zero default rate on its solar portfolio, part of a multi-billion dollar global portfolio, he adds. “Solar PV as a basic technology has been around for more than 40 years and is what I argue to be one of the safest asset classes,” he says.
Sound retirement plan
Solar is “such a solid asset class” that pension funds should start to look at its long-term, low-risk returns, he adds. “The US retirement industry is a $15trn industry and most US retirees have a high level of control over where their 401k is invested,” he says. “Turning solar finance into a note that is eligible for someone on 401k would open up hundreds of billions of dollars of liquidity.”
Krapels has just joined the board at crowdfunding company Mosaic, which was recently named in the world's top five most innovative energy companies after less than a year in business. Mosaic's web-based platform allows anyone with an internet connection and a $100 to invest in solar.
Over $1mn has been invested in its distributed generation projects so far, with average returns to investors of 4.5%. Greg Rosen, Mosaic's chief investment officer says: “It's relatively small, but you have to start somewhere. We're already in diligence on projects that are more than 1MW in size. In a few months we'll have millions of dollars available to invest in.”
Getting more people involved, whether on Wall Street or Main Street, will be the key to solar growth and financial innovation in the sector, says Krapels. “We need to engage the public and speak to their self interest more. While I care about saving polar bears, I'm much more interested in saying ‘OK, how can I get my energy from a cleaner source and make money at the same time’. That will move this discussion and we're getting pretty close to that. The future is bright.”
About: Felicity Carus previously worked on the environment desk at the UK Guardian newspaper. She covers renewable energy technology and clean energy policy and finance out of San Francisco, CA., US.
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