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Going Solar: Why Power Purchase Agreements Are a Low-risk Choice
By Richard Raeke
Although the prices for solar electricity have plummeted in the last year, it is still an expensive technology. The panels alone comprise half the costfollowed by the inverters, the wiring, the racking and the labor to install it all. These systems have lifespans of 35 years or more and make financial sense over the long term, but many companies still do not have the ability to front that cost.
Instead, they are turning to a Power Purchase Agreement (PPA), a new financing option by which the customer does not pay for the system. Instead, the customer agrees to buy the power generated from the solar system from the financier over a term of 15 to 20 years. The cost of the electricity is often at a cost that is lower than the current market rate, and it includes a set annual escalation that lends predictability to power costs.
PPAs are a solar financing mechanism in which private companies, public entities and non-profit organizations can pay for the energy a solar power system produces instead of buying the technology itself. For investors, PPAs represent a low-risk investment in a proven technology where the U.S. federal investment tax credit for solar and state subsidies make the deal work for everyone.
PPA providers pay for the system, manage its operations and maintenance, bear the risk of its performance and deal with the paperwork of reporting to state and federal agencies. These investorsusually large financial institutionsare motivated by the generous federal tax incentives that come with buying a solar electric system. The benefits include a tax credit for 30 percent of the cost of the system, which can be taken as cash this year, as well as accelerated depreciation.
Why would a customer choose a PPA?
PPAs enable organizations to harness the many economic, environmental and marketing benefits of solar energy without having to come up with the capital investment or debt financing.
With a PPA, customers replace a portion of their utility bill with a bill for the power generated by the system. The remaining energy is still paid to the local utility, and in cases with a tiered rate system, solar can bring a host customer into the lower rate schedulereducing the cost of any traditional electricity used.
Volatile electricity rates tend to throw an operating budget off considerably. With a solar PPA, facility managers can reduce the cost of energy and accurately predict what energy costs are going to be for the next 20 years.
PPAs are also relatively risk-free. The sun is always going to shine (even when it is gloomy out) and the host customer only pays for the energy the system produces. The technology chosen is not a concern of the host customer as long as it produces the energy proposed in the contract. In the unlikely case where the system is not optimally producing energy, the customer still only pays for the energy that is produced.
Solar electric systems and PPAs take away the uncertainty that comes with utility billsallowing for cost control and predictability. The systems are a highly-visible signal of the owner's sense of responsibility to the environment. Since they own the system and only get paid for the energy it produces, PPA providers make sure a customer's system is producing optimally. Maintenance and operations are the PPA provider's responsibility.
Tax exempt entitiessuch as public schools, universities and municipal buildingsmust use a PPA to take advantage of the federal tax credit and accelerated depreciation. These incentives are otherwise unavailable but when processed through a third-party owner and a PPA, they are reflected through cheaper power rates. Without financing mechanisms like the PPA, municipalities would find it much harder to sell bonds or raise capital to buy the system outright.
As a rule of thumb, a solar electric system costs US$5,500 per kilowatt (kW), with roughly 1.5 kW being enough to power a one bedroom unit. More than one-third of the system cost will come back to the owner in the form of the Section 48 Investment Tax Credit and accelerated depreciation. If the project starts construction by December, that tax credit can be taken as a cash grant from the U.S. Department of the Treasury for 30 percent of the cost of the system.
In addition to the healthy federal incentives, there must be a secondary incentive at the state or local level for the system to make fiscal sense. This incentive will typically comprise another third of the system costalthough it is typically paid out over time. Third-party investors front the capital for the entire system cost.
In return, the investors have requirements for PPA customers. PPA deals are ideal for large users of energy. The resources necessary to structure these deals is too great to focus on small users of electricity. Depending on the technology that is best suited for the installation, customers with parking structures, places for shade structures/carports or more than 100,000 square feet of roof space can utilize a PPA.
If customers have strong credit, a good site for solar and a willingness to sign a long-term contract, a PPA is an excellent financing option for solar energy. Because these are long-term contracts, most PPA providers are looking to work with host customers that are going to occupy a space for the length of the contract and have investment-grade credit. Solar is cheaper if it is done across a portfolio, allowing the customer to negotiate for lower pricing.
The perfect spot
Some locations are simply not conducive to solar energy because of shading, roof obstructions or the orientation of the site. Even with a generous local incentive, solar electricity may not make sense if the utility rates are excessively low.
Contrary to some public perceptions, solar arrays do not have to be located in the middle of the Mojave Desert to make economic sense. Germany, for example, has the most megawatts (MW) of solar installed in the world. Germany also has the equivalent amount of sunlight to Anchorage, Alaska. This illustrates a central point to solar projectsthe viability of solar does not depend so much on the system's physical location as much as the available incentive programs. Germany has a successful solar feed-in tariff which pays system owners cash for each kW-hour of solar electricity that they put into the grid. In the U.S., the viability of the solar electric system often comes down to its financing before its location.
Unlike Germany, the U.S. has a fragmented market with a myriad of incentive programs. In California, for instance, the production-based incentive pays the system owner US$0.15 to US$0.22 for each kW-hour produced in the first five years. As more systems come on line, that rebate steps down. Municipal utilities within the statewhich are not eligible for the production-based incentivemay have their own programs.
The state of New Jersey has compelled its utilities to buy a portion of their electrical supply from solar. This is called a Renewable Portfolio Standard. Utilities meet this Renewable Portfolio Standard by purchasing Solar Renewable Energy Certificates (SRECs). For every kW-hour of electricity produced from a solar array, there is a SREC, which is a carbon offset. Owners of the solar array own the SRECs and can sell them to utilities. In New Jersey, these SRECs can trade from US$0.30 to US$0.60/kW-hour. Additionally, Massachusetts recently adopted a program similar to New Jersey.
These programs have evolved and will continue to do so. In a PPA model, the risk of the changes in the local incentive programs and the uncertainty of SREC values fall on the third-party owner, not the customer.
In order to work through the maze of local policy and programs, solar integrators/installers are the best resource. They should know the programs inside and out. On the project level, an installer will start by looking at a satellite photo of the roof and with this first pass, look at shading, roof obstructions and site conditions. If the roof appears unobstructed with a clear face pointing from southwest to southeast, they will schedule a site evaluation to look at the roof condition and electrical service. This also involves an analysis of 12 months of past electricity bills to gauge the typical annual usage. Ideally, a system will produce 80 percent of the building's electrical load but this will depend on the site conditions and available space.
In order to quote an accurate price, a PPA provider should have an installer undertake a thorough evaluation of the properties to ensure the system can meet production and installed cost estimates. The final PPA price will greatly depend on these variables.
Now is the time
With this confluence of market forces, federal policy and state incentives, now is a great time for solar electricity. By taking a closer look at a property's solar feasibility and available state and local incentive programs, organizations can quickly decide if solar energy financed through a PPA makes long-term financial sense. FMJ
About the author
Richard Raeke is the director of project finance at Borrego Solar Systems (www.borregosolar.com), a leading designer and installer of grid-tied commercial and public-sector solar energy systems. Based in Berkeley, Calif., Raeke helps customers negotiate their financing options for funding solar electric projects. He can be reached at +1-510-849-5414 or via e-mail at email@example.com.
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