∫ Solar Project Finance – Part III

Where it Doesn’t Work

In previous entries ([1], [2]), we’ve looked at how solar project finance works from the perspective of homeowners and building owners as well as how project financiers earn their returns on investment.

Given that solar project finance works and solar energy is much desired, why isn’t solar everywhere? Here we consider some of the biggest bulwarks that leave solar projects dead on the roof.

Regulatory Vicissitudes: The regulatory environment is critical to solar. Through its feed-in-tariff, the German government guarantees any producer of solar power 31 euro cents per kWh for 20 years. Germany is the world leader in solar. By contrast, despite the extension of the ITC for solar until 2017, the long term contractual clarity enjoyed in Germany and elsewhere is missing in the United States. We examined the alphabet soup of federal and state solar incentives in the US, but while federal incentives are critical, it is state incentives that make or break the vast majority of solar projects. Given that the US comprises fifty states, DC, and a confusing number of territories, it can be a difficult operational environment.

This is especially true because in any given state, incentive programs come and go as rebate programs exhaust their funds. This intermittency kills many solar projects ready to be built and stifles any long-term industry from forming. Solar distributors, engineers, installers, developers, and salespeople become an itinerant lot: constantly prepared to move on to greener rooftops in other states. Despite the efforts of smart regulators in California, New Jersey and elsewhere, many solar financiers worry about when incentives will dry up since state level incentives are subject to the whims of politicians and, increasingly, to defunct state budgets as well.

In addition to regulatory challenges, funding poses hurdles to solar project development. In 2009 in particular, funding presented a real challenge because so many financial institutions had lost money and did not have the “tax appetite” to be “tax equity” partners on solar projects. That has changed, but financiers are always looking for the best solar projects, not just marginally profitable ones and that means lack of funding can still be an issue. The upshot is that as partnership-flip, sale-leaseback, inverted sale-leaseback, and other solar finance structures have proliferated, institutional investors have become more comfortable with solar project funding. This has allowed the development of solar projects at both utility scale (think big solar arrays out in the desert) and for distributed generation (think rooftop solar panels).

Even if a fund is excited by the return on a project, however, that does not mean they will pursue it. Since solar project financiers are signing 15-20 year Power Purchase Agreements with building owners, the lender wants to be sure there is little credit risk. If the property owner fails to pay or goes into bankruptcy, the financier will not be paid and will lose money on the project. Credit therefore becomes a key factor in project development.

If a major utility is the power purchaser, then the financier knows it is selling power to an investment-grade credit. Similarly, if Coca Cola is installing solar on one of its manufacturing facilities’ rooftops, its AAA credit will satisfy investors. So, too, if a homeowner with a FICO score of 720 wants financing for a residential solar array, that would satisfy most investors (despite known shortfalls of FICO scores, they are considered reliable).

But if a small company owns a 50,000 square foot one-story commercial office buildings that is 30% vacant, and on which it has substantial debt service, credit could easily deter investors. The size of the potential profit could be too little for investors to do the substantial amount of work required to assess credit risk, or even if investors do run their own credit assessment, the credit risk over the next 15 years may seem too great for investors and they will not want to finance the project.

Roof condition presents yet another potential death knell for solar project finance. Though ground-mounted and parking-lot mounted systems have become more common, roof mounted structures are usually still the best available real estate. This makes roof warranties critical. Roof warranties for built-up and modified bitumen roofs are only 15 years, and more advanced thermoplastic TPO and PVC roofs are also only about 20 years. In either case, if a building is in year 15 of its roof warranty, an investor is unlikely to spend $2 million dollars installing solar panels without the property owner first putting in a new roof. Since roof replacements can cost upwards of $4 per square foot, this additional expense is often beyond the capacity of the property owner. If the re-roofing is included in the solar project cost, it generally overwhelms the positive economics of the solar project.

Shading from nearby buildings or trees can also adversely impact solar energy production. This would diminish the returns to the investor by decreasing the kWh sold and thus cash flow earned.

Other factors that may shut down a solar project are problems found in any construction project: structural engineering requirements, environmental impact issues, and fire safety problems.

These are just some of the reasons solar project finance has yet to really take off in the United States. So the next time you’re baking the sun while discussing ever-increasing electricity bills – as so many people do – you can inform your friends and family about why the whole world is not yet solar powered.

Despite these challenges, however, solar project finance is alive, well, and growing. It may take longer than industry experts predict for solar to become a major energy source, but the combination of technological innovation and project finance has already earned solar the same treatment given to other power assets: capital flows in, returns flow out. As long as the sun is shining.

If you have questions, you can always comment below or write to us at info {at} carbonlighthouse {dot} com.

2 Responses to ∫ Solar Project Finance – Part III

  1. Modesto Parrillo says:

    I don’t think people realize just how important alternative energy and solar energy in particular is. Just wanted to say thanks for posting this.


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