Thoughts on Solar by Run on Sun's Founder & CEO, Jim Jenal

In Part 1 of this series on financing commercial solar power systems we explored the basics - cash purchases and commercial loans. Part 2 examined the pros and cons of solar leasing arrangements and Power Purchase Agreements (PPA’s). Today we conclude the series by looking at a couple of more novel approaches: Commercial PACE and Crowd Funding, as well as some overall financing limitations.

Commercial PACE

Another option that is starting to appear is PACE financing.  PACE – which stands for Property Assessed Clean Energy – operates in cooperation with a local government, typically a city or county, that agrees to finance solar power systems through the sale of municipal bonds.  Investors purchase the bonds and the proceeds are used to pay for the installation of the solar power system.  The government entity imposes a lien on the property to be paid back over time as an assessment on the annual property tax bills.  If the client chooses to sell the property, the obligation “runs with the land” and is assumed by the new owner (who, of course, also derives the benefit from the solar power system).

Under PACE, there is no personal obligation on behalf of the solar client so neither corporate nor personal credit is at issue.  In theory, PACE has the potential to greatly increase the number of entities that could qualify for solar financing.

Unfortunately, to date PACE has yet to live up to its potential.  Jurisdictions have been slow to adopt PACE programs and even in cities and counties where it has been adopted – such as in Los Angeles County - the pace of PACE-funded projects has been depressingly slow.  Part of that is due to the reluctance of some investors to get up to speed on the benefits of PACE as an investment vehicle, and the (perceived, if not real) inability to resell PACE investments in the secondary market.

Crowd Funding

The latest trend to hit solar financing is that offered by companies like Solar Mosaic which provide an online platform intended to bring together individual investors with selected solar projects.  At the Solar Mosaic website, potential investors can review projects and invest however much they choose, in $25 increments.  However, investors must be “qualified” per SEC rules based on income and/or net worth (without counting autos or residence). Investors who do not satisfy the qualification criteria have their total investment in any twelve months capped at $2,500.

By the end of May, 2013, Solar Mosaic had reported funding fourteen projects worth a combined investment of $2.1 million. The loans being provided by Solar Mosaic, however, are not covering the full cost of the systems being built.  Rather, they appear to be limited to something on the order of 25% of the total project cost.

Solar Mosaic offers an innovative, if limited, model for solar project financing.  It will be interesting to see if the crowd funding model succeeds with solar and expands over time as well as whether competitors, like UVest Solar, can build on what Solar Mosaic started.

Financing Limitations

Regardless of the financing vehicle – other than cash purchases – there are some common limitations as to the applicability of any of these methods.  The most common impediment is the size of the project.  Because all of these financing methods involve some amount of overhead, typically small projects are harder to fund, with project thresholds of $150,000 or even $250,000 being common.  While these limits aren’t a problem for mid-sized commercial projects, they can effectively leave small commercial projects in the 30-60kW range unfunded.

The credit worthiness of the solar client is also a consideration for each of these methods except PACE.  Non-profit organizations might find themselves shut-out of all of these funding methods because of concerns for longevity in some cases or simply because they do not pay property tax bills (a deal breaker for PACE programs).

Since non-profits do not qualify for tax benefits, their cash flow improvement is not as great as it is with their for-profit neighbors.  Moreover, whereas a small commercial customer might be able to secure a loan by making a personal guarantee (indeed, that may well be required), with a non-profit organization there is likely no one in a position to make such a guarantee.

More creative approaches may therefore be needed for non-profits.  For example, some non-profits are fortunate enough to have endowment funds that are restricted in how they can be used, but which might exceed many times over the cost of the proposed system.  Diverting some of those funds into a separate, interest-earning account against which the lending institution can attach a lien provides adequate collateral for the lender, with possibly acceptable risk to the endowed funds.

Non-profits that are not so well endowed, but which have a well-established donor base could consider the possibility of creating a free-standing, for-profit corporation to own the solar power system and to provide a PPA back to the system-hosting non-profit.  Since the for-profit owning entity can secure tax benefits, it can make the venture financially viable even if conventional funding cannot be found.

The preceding is an excerpt from Jim Jenal’s upcoming book, “Commercial Solar: Step-by-Step,” due out in July.

In Part 1 of this series on financing commercial solar power systems we explored the basics - cash purchases and commercial loans.  Now in Part 2 we move on to examine the pros and cons of solar leasing arrangements and Power Purchase Agreements (PPA's).

Leasing

An option that has gained significant traction in the past few years are leases.  (Indeed, it is the explosion of solar leasing in the residential market that has fueled the growth of major players like SolarCity and Verengo.)  But leases can come with unexpected traps for the unwary and a commercial customer needs to look closely at the details before signing on to a lease agreement for a commercial solar power system.

In a solar lease arrangement the right to use the solar power system is transferred from the owner, referred to as the lessor, to the lessee.  From an accounting perspective, all leases are either considered a capital lease (or finance lease) or an operating lease. Generally speaking, “capital leases are considered equivalent to a purchase, while operating leases cover the use of an asset for a period of time.”

When leases are applied to solar power systems, other important considerations apply.

Capital Leases

Under accounting standards, a capital lease is defined as “a lease that transfers substantially all the benefits and risks of ownership to the lessee.”

Therefore, with a capital lease, as with a cash purchase or loan, the solar client is treated as the owner of the system and receives the benefits of ownership: utility rebates and tax incentives (if applicable).  The capital lease is often for a longer term – the basic criteria is that the lease must run for at least 75 percent of the estimated economic life of the system – that is, between 15 and 19 years or longer.

The longer term can keep payments lower, but because the solar client lessee receives the rebate and tax incentives, the capital lease might carry a higher interest rate than does an operating lease.  At the end of the term, the lessee can typically purchase the system at below market cost, perhaps for as little as a nominal one dollar.

Operating Leases

In contrast, with an operating lease the solar client lessee does not effectively own the system and the lessor retains the utility rebate and the tax incentives.  Rather, the lessee is simply acquiring the right to use the system for a limited time in exchange for periodic rental payments.  Typically an operating lease will be for a shorter period of time, and potentially at a lower interest rate.  However, at the end of the lease term the lessee either has the system removed by the lessor, enters into a new lease arrangement, or must purchase the system for fair market value.

Power Purchase Agreements

A related, but different vehicle for making use of a solar power system is a Power Purchase Agreement or PPA.  As with an operating lease, the solar client under a PPA does not own the system.  Rather, they purchase the electricity that the system produces from the system owner.  (Presumably at a price lower than what they would be paying their utility for the same quantity of energy.)

Since the solar client under a PPA only pays for the energy actually produced by the system, the system owner has a greater incentive to maintain the system at peak efficiency and the solar client may receive more of the “benefit of their bargain” under a PPA than they would under an operating lease.

PPA’s typically contain “escalator clauses” by which the price paid per kilowatt hour generated may increase over time.  As long as PPA costs increase more slowly than do utility rate increases, the solar client’s savings will grow over time.  However, it is possible under a PPA to actually end up paying more for energy to the system owner than the client would have to the local utility.  (Indeed, this possibility is what gave rise to a class action lawsuit against Sunrun.)

Federal Trade Commission Concerns

The Federal Trade Commission (FTC) is the federal agency charged with regulating false or deceptive marketing claims, and solar leasing options can surprisingly lead to unwanted scrutiny from the FTC.  The FTC’s concern is  “double counting” - multiple entities taking credit for the same environmental benefit.  This sort of double counting can occur when a company hosts a solar power system, but does not own it.

The FTC provides this as an illustrative example:

A toy manufacturer places solar panels on the roof of its plant to generate power, and advertises that its plant is “100% solar-powered.” The manufacturer, however, sells renewable energy certificates based on the renewable attributes of all the power it generates. Even if the manufacturer uses the electricity generated by the solar panels, it has, by selling renewable energy certificates, transferred the right to characterize that electricity as renewable. The manufacturer’s claim is therefore deceptive. It also would be deceptive for this manufacturer to advertise that it “hosts” a renewable power facility because reasonable consumers likely interpret this claim to mean that the manufacturer uses renewable energy. It would not be deceptive, however, for the manufacturer to advertise, “We generate renewable energy, but sell all of it to others.”

Deceptive claims are actionable under the FTC’s mandate and offending companies could be subject to enforcement actions and fines.  Under either an operating lease or a PPA (though likely not under a capital lease unless the Renewable Energy Credits (RECs) associated with the system are assigned to the utility), the solar client does not own the solar power system and any claim to be “solar-powered” or “using green energy” would be deceptive under the FTC’s guidance.

The series concludes with Part 3 - Commercial PACE and Crowd Funding.

The preceding is an excerpt from Jim Jenal’s upcoming book, “Commercial Solar: Step-by-Step,” due out in July.

Installing a solar power system is a major investment, and part of what determines your return on that investment is how the system is financed.  In this three-part excerpt from our upcoming book, Commercial Solar: Step-by-Step, we explain the most common methods for financing a small to medium-sized commercial solar power system.

In recent years a great deal of creativity (some would say perhaps too much creativity) has been brought to bear on the subject of how to finance solar systems resulting in the introduction of myriad financing schemes from the terribly simple (straight cash purchase) to the terribly complex (e.g., flips and swaps) - and as the amount of money at stake grows, the more complex the schemes become.

Fortunately or unfortunately, in the realm of small to mid-sized commercial solar systems, the options are more limited and include cash purchases, loans, various types of leases, Power Purchase Agreements (PPA’s) and a handful of more novel approaches.  In Part 1 today, we will look at the pros and cons of cash purchases and loans. Part 2 will explore leases and PPA and Part 3 will conclude with a handful of novel approaches and overall limitations.

Cash or Self-Financed Purchases

The simplest financing method is the cash purchase – simple, that is, if you have the cash on hand and it isn’t needed elsewhere.

When a company self-finances through a cash purchase, they own the system outright and receive the rebate payment from the utility and all of the tax benefits. For those entities with the cash on hand, a cash purchase may be the best possible option since, unlike all of the other methods available, there is no added cost to the price of the system.  Instead, a solar power system that is purchased outright should be looked at in terms of its opportunity cost. That is, what advantage/disadvantage does the solar investment provide compared to where the same capital could have otherwise been invested.

These days, with interest rates at historic lows, capital invested in traditional savings instruments - savings accounts or certificates of deposit (CD’s) - provide safety, but returns in the 1-2% range - not terribly attractive.  On the other hand, investments with higher returns - individual stocks or stock funds - come with substantial risk, as the crash of 2008 painfully reminded us.

As a result, a solar power system - with next to no risk and an IRR of 12-19% - compares quite favorably. Put most simply, a safer investment will provide a far, far worse rate of return whereas an investment with a higher yield will be far, far riskier.

When viewed through such a lens, a solar power system becomes a very attractive investment indeed.  In fact, when analyzed in that fashion, investing in solar even makes sense as a way of employing endowment funds designated for the maintenance of non-profit organizations like private schools and churches.

Loans

Unfortunately, not every entity that would like to add solar is in a position to self-finance.  For those who must seek other financing sources, a conventional loan is the obvious alternative — if it is available.  While interest rates remain at historic lows, many banks are historically reluctant to make loans at all, let alone for “exotic” projects like solar power installations.  Or if they are willing to consider it at all, they may impose onerous terms or prohibitively restrictive conditions that keep solar loans more of a theoretical option than a practical one.

Bankers are focused on collateral and cash flow considerations, with solar being strong on the latter but notoriously weak on the former.  Normally a loan for an equipment acquisition could be collateralized by the equipment itself — if you don’t pay on your car loan, for example, the bank simply repossess the car.  But repossessing a solar power system is a complicated project and, unlike a used car which has a known resale value, the resale value of used solar equipment is uncertain, at best.

On the other hand,  solar power systems significantly enhance the cash flow situation of the loan customer since the combination of remnant electric bill and loan payment will be substantially less than the old electric bill, with that difference only improving over time.

In the end, it comes down to a question of the banker’s comfort level with solar.  Does the reduced risk that the customer will default thanks to the improved cash-flow prospects outweigh the downside increased risk of poor or no collateral?  Some banks are starting to emerge with a specialized practice in solar loans but for the moment, loans for small to mid-sized commercial solar projects remain painfully hard to come by.

The series continues with Part 2: Leases and PPAs.

The preceding is an excerpt from Jim Jenal’s upcoming book, “Commercial Solar: Step-by-Step,” due out in July.

UPDATE - We just learned that the Board hearing to discuss changes to the Solar Incentive Program has been rescheduled to Wednesday, June 19th at 9:00 a.m.  (Still at DWP HQ on Hope Street in downtown LA.)  We will not be able to attend due to a prior commitment with the USC Solar Decathlon team.  Anyone who does attend, feel free to pass on our thoughts below to the Board.

Solar is a great fit for non-profit organizations - environmental awareness and good stewardship of resources go hand-in-hand with the mission of churches and schools.  But because non-profits are unable to take advantage of tax incentives, their sole sweetener for going solar are utility rebates - and in the City of the Angels, those rebates are about to drop dramatically before they go away entirely.

Will Churches and Schools in LA be Shut-Out of Solar Soon?

LADWP’s Solar Incentive Program (SIP) has been divided into two pieces: Residential and Non-Residential, the latter of which was further divided between Commercial (applicable to taxable entities) and Non-Profit/Government (i.e., tax exempt organizations).  The Non-Residential program is being phased out in favor of the Feed-in Tariff program (about which we have written extensively).  The thing is - the price paid for energy under the Feed-in Tariff program is just too small to pencil out for entities that cannot avail themselves of the 30% federal Investment Tax Credit and depreciation - and unlike under the existing SIP which offers higher rebate rates for non-profits, the FiT only provides a single payment level regardless of the tax status of the entity.

Most non-profits are looking for modest-sized solar systems in the 30 to 150kW range.  That is too small to attract lots of financing options and the boards of many non-profits are reluctant to commit to long-term leases for a depreciating asset.

Bottom line - without the help of a generous rebate, many - if not most non-profits - will be left on the sidelines of solar.

Which makes the news coming out of LADWP all the more troubling.  We have learned this week that when DWP goes before its Board on June 18th, it will seek a final re-authorization of the Non-Residential SIP with a requested budget of $15 million and rebate rates of $0.70/Watt for Commercial and just $1.45/Watt for Non-Profits.  As bad as that reduction is, when that $15 million is gone, that is it - no further funding of the SIP is planned.

How big is the shortfall caused by the lowered rebates?  Assume two neighboring entities, one commercial the other non-profit, that want to install a 100 kW solar power system on their respective buildings.  If we assume that the install cost comes in at $4.50/Watt, they are looking at an initial outlay of $450,000.  The commercial entity will get a rebate of $70,000 and a federal ITC of $135,000 leaving an out-of-pocket amount of $245,000 - and that is before figuring in depreciation.  The non-profit qualifies for a larger rebate, $145,000 under the proposed rates, but that’s it - leaving them with an out-of-pocket expense of $305,000 - $60,000 more than their for profit neighbor.

This is curious and troubling since the LADWP website has indicated - at the same time that we were being given this information - that when the SIP program resumed in July it would offer non-profit rebates of $2.25/Watt - a rate which would actually make our hypothetical non-profit come out ahead.  A more modest rate of $2.05/Watt would allow non-profits, at least at this level of project size, to break even.

Rebates are intended to serve a number of purposes but one of those is to help make solar commonplace - to insure that systems are installed where they will be seen and understood to be reliable components of our future.  Given that, where should limited rebate dollars be spent: assisting cash-strapped schools and churches to install solar where congregants and students can learn the lessons of sustainability - or simply to aid some company in lowering its operating costs and boosting its profits?  (Don’t misunderstand - we are all for commercial rebates, but if it comes down to a choice, surely the non-profits are in greater need of the support.)

On June 18th DWP staff will present this proposal to their Board and perhaps these rates can be adjusted to give more help to non-profits.  That would be a welcome outcome, but even more welcome would be an acknowledgement by DWP that as their program plans presently exist, there will soon be no way forward at all for non-profits to adopt solar.

Surely that cannot be the desired outcome.

Nothing like a piece in the New York Times questioning the reliability of some solar modules to get tongues wagging and some pointing fingers at "Chinese dumping" while others tell us that solar technology is just not ready for prime time.  To us it raises a different question - does quality sell?

The article, titled Solar Industry Anxious Over Defective Panels, points to installations as close as the Inland Empire, having shockingly high failure rates after just two years of being installed. "Coatings that protect the panels disintegrated while other defects caused two fires that took the system offline for two years, costing hundreds of thousands of dollars in lost revenues." Wow - that is shocking.  So who made those defective panels?  The reporter doesn't say.

Nor are any of the problem panels alluded to in this story ever named, citing, in some cases, confidentiality agreements.

Which raises a serious problem with the article: if you cannot identify any of the solar module manufacturers that are having these problems you leave the impression that all solar modules are suspect. (Our analysis on who the guilty party might be is below...)

A quick perusal of the comments to the article reveals the predictable factions: those who echo the Fox News line that solar is a failed technology that only exists because of the Obama Administration's foolish indulgence in Green Tech; claims that all problems in the solar industry are a result of "Chinese dumping" and the associated China bashing; countered partially by a handful of comments from people who actually know something about the industry.

We find the Chinese bashing particularly problematic - after all, the Chinese are not putting a gun to any project developer's head and forcing them to use third-tier panels.

Greed is what is causing that.

We have been in business since 2006 and there have always been high quality solar panels available from reputable manufacturers - and they have always cost more than many of the panels offered to us for use in our projects.  Scanning the CSI data (see below) reveals that many projects - including many of the largest projects - were built using those "bargain basement" panels.  Why?  Because it maximized the project developer's profit.

This is not a new problem, despite it getting a major splash in the "Paper of Record."  Indeed, we wrote in the Spring of 2012 about how the decision by project developers to focus on the lowest cost per Watt "will continue to put undue pressure on quality manufacturers around the globe - whether in the US or China.  Consumer demand for quality is the ultimate way to improve this situation - and that means educating consumers as to what quality means in this market."  A year plus has gone by, but where has that educational effort been?  The need is as great - or greater than ever, but sadly, the NY Times piece fails on that score.  (If you want to read an earlier, and far more comprehensive article on this subject, check out this piece by the great Felicity Carus: Quality Issues Threaten to Give Solar a Black Eye.)

What's Up in the Inland Empire?

It's a Friday morning so we decided to indulge in one of our favorite pastimes and go diving into the CSI data to see if we could identify the guilty party alluded to in the NY Times piece.  Here is all they gave us to go on - the project has been in place for roughly four or more years (failed after 2 years, offline for 2 years), located in the "Inland Empire" and its downtime resulted in a loss of "hundreds of thousands of dollars" in revenue.  From that we concluded that we needed to look at systems from 2010 or earlier, in the Inland Empire - which we took to mean anywhere in the counties of Riverside or San Bernardino - and of at least 200 kW.  Those criteria provide us with 28 potential systems, built with solar panels from just seven manufacturers.  Here are our results:

What can we say about these manufacturers?  Well, certainly BP Solar, SunPower, Kyocera and Sanyo would all be considered top-tier manufacturers of solar panels - although BP is exiting the solar industry and Sanyo is now owned by Panasonic.

As for the others, Evergreen Solar was a US manufacturer that filed for bankruptcy in August 2011.  Solar Integrated Technologies was a subsidiary of Michigan-based Energy Conversion Devices which itself filed for bankruptcy in February 2012.  Solar Semiconductor is a vertically integrated systems provider with manufacturing facilities in India.

So who is the guilty party?  No way to know for sure, but a little online searching reveals other problems for one of these companies.  A September 14, 2012 article on the San Diego Union Tribune website documents problems with "Flawed Solar Panels" that were manufactured by Solar Integrated Technologies.  According to the article, the panels manufactured by the company, "had a manufacturing defect that allowed water to seep into crevices of the panels, which in some cases created corrosion and in the worst-case scenario could cause a short that could start rooftop fires" - which sounds a great deal like the problem cited in the New York Times piece.