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Successful project finance depends on making the ROI numbers work for investors with a high degree of predictability. The only predictable revenue stream for utility projects in California in 2011 will be payments for electricity under long term power purchase agreements ("PPAs"). For non-utility projects, the California Solar Initiative production based initiative will provide an additional revenue stream for five years at about $0.05 per kWh. Renewable energy certificates ("RECs"), which are bundled with the energy in utility projects, will not be a predictable revenue source for California projects in 2011 nor will the implementation of AB 32 have any impact on financing in 2011 even if there is no litigation over the impact of Proposition 26.

The federal Section 1603 30% cash grant is the single most important financing incentive in California and throughout the U.S. but is not sufficient by itself. Even a temporary expiration will delay new solar project financings. The opportunity for a Congressional extension of this cash incentive beyond December 31, 2010 without any lapse is nearing the end. The results of the 2010 mid-term elections should send a strong message to Washington that the American people want jobs created. Solar and other renewable energy projects create jobs so there should be support in both political parties to continue some federal incentives for solar but politicians may not respond to this logic.

Distributed generation solar projects can be completed faster and are less risky to investors but the numbers won’t add up to satisfy California renewable portfolio standards ("RPS") requirements through such projects alone. The consequences of failing to meet RPS need to be more severe in order to have a meaningful impact on financing. To date, only a tiny percentage of projects are actually producing electricity of those contracted for by the California investor owned utilities. Because of their lower cost of capital, the right to use actual cost factors in cost determinations and the need to meet RPS requirements, there will be more utility financed and owned projects but ratepayer impact will require other financing structures. The financeability of large utility scale projects by independent power producers ("IPPs") remains difficult because of PPA pricing, sheer size of such projects, transmission line improvement requirements, siting and technology risks and other factors. The best business model for developers may be to build, own and sell to a utility once the commercial operation date is visible.

Even after the October 21, 2010 Federal Energy Regulatory Commission decision that permits greater flexibility in the calculation of avoided costs, California Public Utility Commission ("CPUC") tariff pricing will develop cautiously because of the concern over ratepayer impact. The CPUC seems enamored with the reverse auction approach to pricing but this method causes low PPA pricing and makes financing very difficult or impossible for IPPs, particularly for small projects.

Decreased demand and lower pricing for solar modules will likely result in more module vendors being involved in financing projects in 2011 to help create the demand for their modules. While Suntech has withdrawn from project finance, many other module manufacturers are adopting a strategy to assist in financing as a differentiator and to help margins in their sales channels.

Financing challenges require that project developers have a strong working capital position and project execution record which means that larger players will likely become more consolidated, vertically integrated and prevailing in 2011.

The California legislature could create many jobs in 2011 by enacting legislation to compel the CPUC to establish tariffs for solar using a more flexible avoided cost calculation, to require more projects to be sited in California in order to be eligible for RPS requirements and to establish a manufacturing tax credit similar to the successful program in Arizona.

My recommendation to lenders evaluating such projects is to obtain these basic agreements as part of initial due diligence, to identify problems in them and then to determine quickly whether the offtaker will accept the amendments needed to provide revenue and land rights certainty. Otherwise both the lender and its advisers may be wasting a lot of time.

Many of the financing issues I see are not rocket science. For example, for a lender to have a predictable revenue stream for debt service requires that the offtaker not be able to terminate the PPA easily. Some PPAs I have seen have very vague obligations, may be terminated for any default and lack a cure period for the alleged default. In drafting and reviewing PPAs, developers and lenders should be sure that only a material breach of the agreement can lead to termination and, if there is an alleged default, the offtaker must give both the power provider and the lender notice of the default and adequate time to cure the alleged problem.

I have also seen a PPA where the lender had a right to step in and cure, but didn't need to be given notice of a default. Of course, the lender needs notice in order to be able to step in and operate the facility to continue the revenue stream. The value of the facility is the continuation of the revenue stream, not just the right to sell what may be junk on the roof. This means the PPA and SLA should both be assignable to the lender without additional approval by the offtaker.

A poorly written SLA is another flag for lenders. I sometimes see an SLA that is very different from the PPA for the same project, as if one form came from one website and the other from a different website. It is critical for the agreements to be closely coordinated. For example, the SLA needs to run for the same time period as the PPA and must be extendable for the same periods as the PPA. Provisions relating to cure rights, permitted assignments, force majeure, etc. need to be the same under both agreements. Such inconsistencies can leave gaps and therefore jeopardize funding.

While agreements can sometimes be amended during the financing process to the satisfaction of the lender, it is a less risky path to securing financing if attention is given to the financeability of these agreements at the outset of the process.