Federal tax credits allow the solar power industry to offer financing options for its commercial customers
As part of its plan to produce 29 million kilowatt-hours per year of sustainable energy, the University of California, San Diego (UC San Diego), will allow Borrego Solar Systems, a San Francisco-based designer and installer of grid-connected solar electric power systems, to install a 1.2MW solar electric system onto the roof of the Price Center, the Gilman parking structure, and other buildings across the 1,200-acre campus. When complete, the $9 million system, consisting of 5,790 solar modules, will supply about 1.5 million kilowatt-hours of green energy per year. The project was financed through a 20-year power purchase agreement (PPA) with Solar Power Partners (SPP), Mill Valley, Calif. “We wanted to put a megawatt of solar on campus, but we obviously didn't have the $9 or $10 million it would cost to do that,” says David Weil, assistant director of facilities management, UC San Diego.
“PPAs are of particular interest to nonprofit organizations that wouldn't otherwise be able to take advantage of federal renewable energy investment tax credits (ITCs) and state-specific financial incentives,” says Richard Raeke, director of project finance at Borrego Solar Systems. Although California offers a performance-based incentive (PBI) — meaning that for every kilowatt-hour produced over the next six years, they will receive a payment, which (depending on what tier the organization is in) will range between 22 cents to 37 cents per kilowatt-hour — this alone is not sufficient incentive for the university to fund the installation itself. “Solar systems are still fairly expensive, so just with that incentive alone, the economics don't work as well,” Raeke continues.
How it works
Under the terms of the PPA, UC San Diego will purchase the resulting electricity from the installation from SPP at an agreed-upon rate. Typically, PPA rates contain an annual set escalator ranging from 1% to 4%. “It's not a huge savings,” Weil says. “The price that we're paying for the energy we get from the grid would be more expensive than what we'll be paying for the solar by about 2 cents per kilowatt-hour.”
Because of the nominal set escalator, most PPA customers are betting on utility energy prices increasing at the same rate as they have in the last five years, with hikes between 25% to 30% in most states. However, even if traditional energy prices experience an unlikely decrease, the PPA rate remains desirable in its predictability. “For municipalities and nonprofits — folks that have to be pretty cost-conscious — it's good because they know what their electricity bill is going to be from one year to the next,” Raeke says.
In addition, the PPA clients are not responsible for the monitoring and maintenance of the solar power system. As the developer, owner, and manager of the UC San Diego solar energy system, SPP assumes the risks and responsibilities of ownership, including the cleaning of the solar panels and providing preventive maintenance services, such as repairing any faults and monitoring the energy production. “There are lots of provisions in the contract that stipulate we don't pay for the electricity unless it's being produced,” Weil says. “So really, the incentive is for them to keep the system working.”
Once an installation goes live, SPP monitors it through its internal asset management division. Its on-staff electrical engineers monitor the systems and oversee long-term maintenance with either the installing company, if they have maintenance capacity, or through other types of contractors. “It could be as simple as hiring a window washer to wash the modules,” says Todd Michaels, VP of project development and marketing for SPP. “But they have to have proper licenses and bonding.”
At the end of the PPA term, the clients buying the electricity have three options: They may renew the PPA and continue buying the electricity from the owner under new terms; dissolve the agreement, and have the owner remove the system from the site; or purchase the system at fair market value, estimated at around 10% of the original value. Under the latter option, a million-dollar system would have a residual of $100,000. “In 20 years, that will probably be the equivalent of maybe $30,000,” Green says. “And you can assume the cost of electricity is going to be close to 50 cents to 75 cents per kilowatt-hour, so it will be quite a nominal cost.”
The future of the UC San Diego system, just in the early stages of construction, has not yet been determined. “We'll just have to see where we're at 20 years from now,” Weil says. “Hopefully, there will be new technology out there so we may decide it's more prudent for us to use that roof space for new technology, or we may just leave it in if it's still making electricity at a good rate.”
Green times two
Unlike the residential market, the impetus for commercial solar power installations is not based solely on environmental concerns (see Financing for the Residential Market). Commercial customers are looking at solar power installations both to lower the cost of their electrical bills as well as give them a break on their taxes. Of the three main financing options — self-financing, lease terms, and PPA — the best return on investment (ROI) comes from self-financed systems. It's simple math, really. For a straight commercial owner that pays taxes and can take the federal investment credit, it would get a 30% tax credit from the federal government. Add to that accelerated depreciation on its federal income taxes, any and all state incentives, and net metering at the retail rate, this may account for at least two-thirds of the cost of the entire system. “They only pay out-of-pocket for one-third,” Raeke says. “The payback time on that can be anywhere from five to eight years, which is pretty good.”
Others agree on the ROI for self-financing. “If a company is profitable, self-financing is a very wise decision,” says Ezra Green, chairman and CEO of Clear Skies Group, Mineola, New York. “With the performance-based incentives by the utilities and the accelerated tax depreciation, along with the ITC, the ROI can be anywhere from four to seven years.”
Compared to the average length of a PPA — 15 to 20 years — this seems like the blink of an eye. However, there are many conditions that can prevent companies or organizations from self-financing. First, companies may not be able to come up with the cash for the initial investment. “It's a large outlay,” Green says.
In addition, many organizations, particularly nonprofit associations and municipalities, don't have what's referred to as the “tax appetite,” which is the ability to take advantage of the tax credits and incentives. “There's just no way to get a decent ROI without all those components in the right order,” Green notes.
Regardless of the type of financing, there are certain conditions that must be met for a substantial ROI on commercial solar power installations. A recent report, “Solar Power Services: How PPAs are Changing the PV Value Chain,” by GreenTech Media, Cambridge, Mass., says solar financing works best for customers that own their building or have a long-term lease. This may explain the growing popularity of solar installations on the rooftops of big-box retail stores and corporate campuses. Yet despite reports of zero penetration in the leasing market, leased buildings represent 60% or more of the solar installations in the United States. In fact, some third-party solar financing parties have even started to offer PPAs with shorter ownership terms to tenants of leased buildings in order to break the “lease barrier.”
Other necessary conditions for a meaningful ROI on commercial solar installations include: significant federal and state subsidies; high electricity rates (around 14 cents per kilowatt-hour or higher); and state and local policies that support solar installations around 200kW or larger. “It's very hard to finance anything that's under 200kW, or roughly around $1 million,” Green says. “We try to use the million dollar figure. You can go down and make it a little bit smaller, but usually it's about seven figures.”
Michaels agrees. “Most PPA providers typically focus on larger systems,” he says. “Everybody has a different threshold of what they need but, for the most part, you're not seeing PPAs on systems under 200kW.”
In fact, Michaels is seeing system sizes increase by 20% every six months. On projects funded by his firm in California, the average system size is about 400kW, but getting closer to a megawatt in size. “Investors are looking for anything greater than 250kW,” Raeke agrees. “Hopefully, in time, as the model becomes more refined, they can offer PPAs on smaller and smaller systems.”
Most commercial solar power installations are grid-connected. “They don't have to be connected to the grid, and involved in net metering but it helps with the ROI,” says Green. “The whole trick to a solar energy system is to come to as close to zero as humanly possible without overproducing. If you do overproduce, net metering helps you out with the averaging. You can always draw it out and spin your meter the other way and recapture your electricity.”
Prior to net metering, designers of the solar power systems had to carefully size the systems. “We also had to account for losing Sunday's production because most companies aren't open on Sunday,” Green continues. “Anything they produced on that day, they lost.”
Because of their differing policies regarding solar power systems, some states are more hospitable to the conditions of meaningful ROI on commercial solar power systems than others. For instance, Washington State's low electricity rates exclude it from prime commercial solar financing arrangements, as does the cap on systems larger than 50kW in New York City, despite its high power prices and available subsidy. “With state laws changing almost on a monthly basis, we have to move fast to get through these loopholes to make enough money to stay afloat,” says Christopher Quinn, president and CEO, Electron Solar Energy, Miami.
With a 35% tax credit and the highest energy prices in the nation, Hawaii seems like prime real estate for solar energy systems, but there are restrictions on how much PV-generated energy can be put back on the grid. “There's always something,” says Michaels. “All you need is one variable to not be there for something not to happen.”
So far, California seems by far the friendliest to these types of financial arrangements. “It's made a 10-year commitment to see this happen,” Michaels says. “Other states that have renewable energy laws have small solar incentive programs, and they don't have some of the other mechanics there for the market to mature from a commercial perspective.”
A new lease
More than any technological advances in photovoltaic (PV) engineering, financial techniques — such as PPAs — are being reported as the driving force behind the growth of the solar power industry. In 2007, 148MW of solar capacity came online, up 46.5% from the previous year, according to the Solar Energy Industries Association, Washington, D.C. Of the national commercial and institutional solar market in 2007, an estimated 50% was developed under PPAs, up from 10% in 2006, according to the GreenTech Media report, which predicts that in 2009, PPAs will be established as the standard way American businesses pay for onsite green power, with yearly additional growth of 30% to 50%. Thus, in 2008 and 2009, PPAs will account for three-quarters of U.S. commercial and industrial solar sales. “The bulk of the major commercial installations are now done with PPAs,” says Raeke of Borrego Solar Systems.
Because of the required conditions for a substantial ROI, commercial solar sales' upward mobility depends on the continuation of government incentives. The big question for the future is the status of the federal ITC, wrote the GreenTech Media report's authors Jon Guice and John D.H. King. The current ITC is set to expire at the end of the calendar year.
Fortunately, the Emergency Economic Stabilization Act of 2008 — the package that allotted $700 billion to the banking industry — includes an eight-year extension of the 30% ITC for solar installations. This was a great relief to many in the solar industry who worried about having to put projects on hiatus until the credits were put back into place. Previously, Michaels believed the federal tax credit wouldn't be renewed to the current level until spring of next year. “I don't think anybody could have predicted the events that would create a climate for this to pass,” he says.
Therefore, SPP planned on timing out its remaining 40 projects for the end of the year. “Our contracts were developed in a way that they all stipulated the projects must be done before the end of the year,” he continues. “We set our benchmark at the end of November to allow for a month of interconnection and testing — the things that must be done to take something live officially.”
Now, because of the renewed tax credits, the solar industry will be able to continue with business as usual. “The industry is going to be able to move forward,” Michaels says. “A lot of customers who were waiting to see if they should proceed will be able to determine how they want to move forward. It's going to create a significant amount of the market coming to the table to move things along for next year. It's prevented a potential six-month lag.”
Because of higher overhead costs, those that would have felt the pinch of that six-month lag the most would have been the installation and construction side: the solar contractors. “Nobody was going to start building the project until they knew the tax credit would be there,” Michaels says. “For us, as a developer, we don't have the trucks and the large overhead that installers do, and so it's largely those types of organizations that were going to be the most burdened and troubled by this delay.”
However, even with the renewed federal ITC, embarking on new projects in such a newly popular industry is not without risk. One unfortunate aspect of the solar industry is that sometimes its customers aren't always serious about going through with the installation or experience sticker shock and end up pulling what they consider a non-essential project. “If you get three month's work into a project, and then the customer declines to pull the trigger, you're out a lot of money,” Quinn says. “I have a number of projects that we have $3,000 to $5,000 invested in each, with engineering, that the customer has yet to close.”
Therefore, says Quinn, down payments are a necessary proof of the customer's commitment. “It's a fledgling industry, and it's all happening right now,” Quinn says. “There are four different ways to go with technology, and there are three different ways to go with financing. It's important to get a down payment up-front before even engineering or financing options. You need to get a commitment from the customer.”
Sidebar: Financing for the Residential Market
Unlike the commercial solar industry, residential solar is driven less by a return on investment (ROI) and more on concern for the environment. “Half the sales that are happening in the residential space are an emotional sale,” says Todd Michaels, VP of project development and marketing, Solar Power Partners, Mill Valley, Calif. “It's not necessarily for cost benefit.”
Although residential solar systems can pay for themselves in as little as five to seven years, up-front costs have been a major barrier to installation on the majority of America's rooftops. Formerly, residential tax credits were capped at $2,000, resulting in a stunted residential market. For instance, in solar-friendly California, fewer than 1% of homeowners have solar power. However, in addition to renewing the 30% investment tax credit (ITC) for commercial and industrial applications, the Emergency Economic Stabilization Act of 2008 also removes the residential cap. “Finally, the federal government has implemented a set of policies that will spur the long-term growth of the solar industry,” says Barry Cinnamon, CEO of Akeena Solar, Los Gatos, Calif. “Our customers can now achieve a payback on their solar investment in five years instead of 10, with a 20% ROI. In today's uncertain economy, rooftop solar power may be the very best investment a homeowner can make.”
Even so, several companies have set up financing options to combat the large up-front costs to ease homeowners into solar investment. For instance, Electron Solar Energy, Miami, manufacturer of wire, cable, and solar panel mounting hardware, as well as a commercial and residential service installer, recently partnered with Clean Power Finance, San Francisco, to provide estimates and financing options to the company's home and commercial solar energy clients. Prior to this arrangement, Electron Solar's residential customers had to provide a down payment between $40,000 and $50,000. Under the terms of the new financial arrangement, the up-front payment can be reduced to as little as $10,000.
“The customer can come in with a down payment, similar to buying a vehicle, and then just give us a several hundred dollar monthly payment,” says Christopher Quinn, president and CEO of Electron Solar Energy in Miami. “The loan can be stretched out over different time periods: 10 to 30 years. Also, it can be rolled back into a complete refinance of the house, so the up-front cost is greatly reduced.”