(Image Courtesy of Julie Chen)
There is no denying that the solar industry is growing at an incredible rate. The Solar Energy Industries Association (SEIA) estimates 723 megawatts (MW) of photovoltaic (PV) capacity was installed in the first quarter of 2013, representing a 33% increase in deployment levels over the first quarter of 2012. This has been bolstered by falling prices, which have decreased by more than 24% for a complete installation in the past year and over 60% in the price of panels since 2011.
However, now the price of photovoltaic cells only represents a small percentage of the cost of the entire PV system, increasing the difficulty of lowering system costs as a whole. For the solar industry to maintain its rate of growth, especially in a post subsidy environment, it is necessary to reduce the costs of balancing system components, inverters, sales and installation or to innovate in other areas. One area open for innovation is solar finance, and to reach the monumental levels of investment needed to reach climate goals, there needs to be new investment vehicles to make solar investing desirable for a larger range of investors.
Solar as an investment has a long payback period, modest returns, and is comparable to traditional long term infrastructure projects. But unlike large infrastructure projects, the size of typical solar installations is much smaller. Solar projects are too large for many organizations to fund on their own, but too small for banks to pay much attention to. This has made financing solar one of larger barriers in the industry, but new investment vehicles are emerging to help raise investment dollars. The three most popularized ideas are Master Limited Partnerships, Solar Securitization, and Real Estate Investment Trusts.
Master Limited Partnerships
Master Limited Partnerships (MLPs) are investment vehicles that protect profits from corporate taxes with the condition that the majority of the profits from the venture are distributed to investors. MLPs are traditionally used in the energy industry, mostly pipeline businesses, which earn stable income from the transport of oil, gasoline or natural gas. In June 2012, U.S. Senator Chris Coons introduced the Master Limited Partnership Parity Act that allows energy-generation projects like solar and transmission companies to form master limited partnerships, giving them favorable tax status and access to low-cost capital.
(Courtesy U.S. Senator Chris Coons)
Although MLPs are fundamentally ideal for solar projects, due to the stable predictable returns solar projects produce, the passage of the MLP Parity Act requires congressional approval. And with oil and gas lobbyists spending over $140 million in 2012 to protect the energy industry status quo, it is doubtful the bill will pass.
Securitization is the process of pooling contractual debt such as mortgages, car loans and potentially solar project debt into large investment offerings. This offers multiple advantages to prospective investors. One of the advantages of securitization are the sizes of the offerings that allow large institutions to participate. Another advantage is the ability to create multiple products offering different returns, depending on risk. The last main advantage is the diversification inherent in securitization. Instead of having all of the invested money contingent on one projects success, instead the investment is spread out between thousands of projects so the default of one project will not substantially affect returns.
Large banks might invest in solar projects if cash flows were securitized because the risks would be clearer and the offering size would make it desirable. However, this is difficult for a variety of reasons. One issue is the lack of standardization in Power Purchase Agreements (PPAs) and the complexity of solar projects compared to mortgages. Unlike mortgages or commercial leases, where contracts are all very similar and there is a clear credit rating system, the current solar industry doesn't have the same level of standardization in its contracts. One way this is being addressed is through the TruSolar working group of which Mosaic is a founding member. TruSolar’s goal is to establish universal criteria of evaluation that should lower transaction and capital costs, and improve project finance liquidity within the commercial and industrial solar segment.
Another issue is the volume of solar projects. According to a Thomson Reuters report, a $200 million bond issuance will be more favorably priced than a $50 million bond issuance, but as of now, there isn’t enough volume to float these type of issuances. Credit Suisse sees securitization happening sometime during 2013 and predicts the first issues will be in the $50 million range and that later investments, in the $150 million range, will increase liquidity and provide returns in the 5 percent to 6 percent range. Credit Suisse also believes “that rating agencies and insurance companies are receptive to solar securitization, and they anticipate investment grade ratings on solar project securities.” Although securitization hasn’t occurred yet, it is likely it will be a large part of funding projects as the industry develops.
Real Estate Investment Trusts
Real Estate Investment Trusts (REITs) are tax protected companies that own income-producing real estate. To qualify as a REIT, a company must distribute at least 90 percent of its taxable income to shareholders annually in the form of dividends. In some ways, this organizational structure seems more unlikely to be used versus the MLP because it traditionally has focused on commercial and residential properties and not on energy. However, luckily all that is needed for solar to qualify as a REIT is a re-interpretation of the tax code, instead of congressional approval.
Currently, energy generated by PV panels is considered operating income instead of rental income. To get around this, REITs can lease rooftops or land to PV developers to get rental income for a previously unused space. However, to change this indirect way of investment and to allow for REITs to directly invest in solar, all that is needed is for the IRS to designate income from solar PV as rental income instead of operating income. Even without the ability to directly get operating income from PV panels, REITs have been finding ways invest in PV.
One REIT that utilizes PV is Hannon Armstrong (NYSE:HASI), albeit in a limited fashion. Hannon Armstrong finances permanent energy efficiency improvements to buildings that save considerable amounts on utility bills. Some of these energy efficient retrofits include PV, which Hannon Armstrong can get income from if they are deemed to be integrated into the buildings themselves. Another REIT investing in solar is Power REIT (NYSE:PW). Power REIT has used the strategy of buying the land under a solar farm and leasing it out to the solar farm. While this strategy isn’t actually direct investment in solar PV, it is as close as can be achieved while direct investment in the panels is prohibited.
Even though these financing structures currently face many obstacles, as the industry evolves regulations will be forced to change to become more permissive. If governments want to be serious about promoting renewable energy they need to start looking past grants and subsidies and instead look to reducing regulations so private capital can begin to finance solar more effectively.