Solar for Rent

Oct 1, 2008 12:00 PM, By Beck Ireland, Staff Writer

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.

Third-party financing offers an economical alternative for commercial solar energy customers.

“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.”

Power purchase agreements (PPAs) allow nonprofit organizations to take advantage of solar tax credits.

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.”