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US SOLAR – WHITE PAPER 24 May 2012 Utilities may purchase portfolios of solar PPAs and leases to compensate for lost revenue Across the solar project lifecycle, the cost of financing will fall • Utilities may become active purchasers of distributed solar portfolios. Residential solar installations reduce their customers' power demand, as system hosts which generate electricity therefore buy less from their local utility. As solar becomes more prevalent, utilities may purchase portfolios of solar PPAs and leases to compensate for revenue lost as a result of those very installations. Two avenues are available. The first is via tax equity, such as PG&E's combined $160m in tax equity funding to Sunrun and SolarCity. The second is via the acquisition of portfolios on the tail end of existing tax equity deals, with the utility taking advantage of the cash revenue from leases or PPAs for the remainder of the project lifetime. • The cost of capital will fall. Sector maturation and the entrance of new investors will lower the cost of financing. In particular, the widespread adoption of high-liquidity vehicles could open up solar to an investable base with a lower required return on capital. Widespread adoption of mortgage-based asset-backed securities drove significant decreases in the cost of capital for the homeowners, and a similar effect could happen in solar. 4.3. Barriers to investor participation Our interviews revealed five major barriers to further participation from the broader investment community. • Complexity: Tax equity, necessary in the solar industry through 2016, is not for the faint of heart. The mechanisms necessary to pass tax and depreciation benefits to investors involves complicated accounting and legal structuring. This has limited participation to a select number of institutions with specialised financial expertise, a strong understanding of the energy industry, or both. Theoretically, tax equity should be attracting more investors. As one tax equity provider interviewed for this study put it, "For the measure of risk we are taking, the yields have been exceptional." 5 Thus far, few corporations have been persuaded. Many consider the opportunity, then deem it too complex or far afield strategically from their core business, and too risky. Additionally, the significant time and effort in deal structuring requires either the creation of an internal team or the outsourcing of service providers at significant expense. Finally, it is impossible to start small; investors usually do not consider deals smaller than $15- 30m or more because of the 'overhead' involved. • Immaturity: solar projects – and manufacturers – are not viewed as having a track record of long-term operating success. Investors like certainty. While many active financiers assume that solar panels will operate within a manufacturer's expectations, more risk-averse investors such as pension funds prefer to see evidence first. Panels from newer manufacturers have yet to operate over the 25-year expected lifetime, although the oldest panels, based on the same technology, have been in service for over 35 years now. Another turn-off for potential investors centres on the current wave of consolidations and bankruptcies in the manufacturing sector. To paraphrase one interviewee, "It's difficult to invest in a solar project when you don't know if the manufacturer giving the warranty is going to be in business next year." • Illiquidity: Solar investments are not easily transferrable. Liquid investment vehicles have developed in other capital-intensive industries such as real estate (REITs) or natural gas infrastructure (MLPs), but none have been popularised in the solar industry. Many investors have little interest in assets that cannot be sold at short notice for net asset value. Tax credits are particularly vexing for liquidity-seekers: if a tax equity investor sells a project within five years, the IRS recaptures a portion of the ITC. 5 This is a milder version of other utterances from interviewees who have invested in tax equity deals in the past. While acknowledging the complexity, one investor said, "If I could invest my entire life savings and 401(k) in solar tax equity deals, I would." © Bloomberg New Energy Finance 2012 Strictly no copying, forwarding, shared passwords or redistribution allowed without prior written permission of Bloomberg New Energy Finance. For more information on terms of use, please contact sales.bnef@bloomberg.net. Copyright and Disclaimer notice on page 28 applies throughout. Page 16 of 28
US SOLAR – WHITE PAPER 24 May 2012 • Lack of standards: In the residential and commercial-scale market, there is a lack of standards for payments and services. The numerous third-party financiers have different PPA and lease contracts, and credit quality and maintenance standards. Without standard PPA and lease agreements throughout the sector, it is difficult to rate and issue solar securities. Geographical diversity reduces weather-related risk, but it also brings unique regulatory and market risks, making portfolio evaluation even more difficult. Challenges in bundling assets together may create a shortage of capacity and cash flow required to arrange and issue a solar bond and access capital markets. • Availability of opportunities: Some investors have expressed considerable interest but have been unable to find suitable investment targets. US solar presents a vast potential market – from utility-scale plants in the Southwest desert, to greenfield developments in New Jersey to portfolios of rooftop projects on big-box retail stores across the nation. Yet solar development options inevitably come with assorted challenges: Southwestern utility-scale markets are extremely competitive; Northeast US markets are often beset by SREC pricing volatility; many regions simply do not offer sufficient incentives to make the economics viable; and assembling meaningful-sized portfolios of projects often comes at steep customer acquisition costs. Opportunities abound but identifying and executing on them is rarely easy. 4.4. High-liquidity vehicles The most striking changes in the move from the 'Today' to 'Tomorrow' sides of Figure 15 will only be possible with the emergence of vehicles that make solar project investments a more liquid option and that allow these projects to tap a broader pool of investors via the capital markets. The vehicles identified in the chart are described below. Bonds can be an at attractive alternative to bank loans as they offer higher liquidity, lessrestrictive covenants and lower costs Project bonds For debt financing, bonds can be an attractive alternative to bank loans as they offer higher liquidity (for large issuances with a good rating), less restrictive covenants and lower costs. To date in the renewables sector, bonds have been used primarily by manufacturing companies seeking capital for new lines. There have also been a limited number of bonds attached directly to projects issued by financial institutions or developers. Bloomberg New Energy Finance estimates the clean energy project bond market at $9.6bn globally with the most conspicuous recent offering being MidAmerican's 550MW Topaz solar project in February 2012 (see Case Study 5.1 below). Bond issuance for renewable projects has historically lagged that of the wider infrastructure market, partly due to the sector's relative immaturity, but also because of the lack of projects large enough to actually issue bonds. Another traditional barrier to bond floats has been a lack of standards, though there are recent signs of progress in this area. Rating agencies have grown more adept at assessing solar project risk in order to grade bonds, and the Climate Bonds Initiative, a non-governmental organisation that promotes renewable project bonds, is developing standards to determine which project bonds meet the 'green' criteria. Asset-backed securities Securitisation is the process of pooling together contractual debt and selling the resulting assetbacked securities as notes to institutional investors. Common securitised assets include payments from mortgage loans, car loans and credit cards (more esoteric examples include contracts for home burglar alarms, taxi medallions and music royalties). © Bloomberg New Energy Finance 2012 Strictly no copying, forwarding, shared passwords or redistribution allowed without prior written permission of Bloomberg New Energy Finance. For more information on terms of use, please contact sales.bnef@bloomberg.net. Copyright and Disclaimer notice on page 28 applies throughout. Page 17 of 28
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