U.S.: The California Solar Market in 2011

Posted on December 13, 2010 by K&L Gates

By Fred Greguras, Palo Alto

The California solar market – utility, commercial and governmental – will be a primary focus for global players in 2011 as growth in the major feed-in tariff markets in Europe slows. I made two presentations on California solar project finance 2011 in early December with an emphasis on the revenue and financing sources and other factors which will drive growth in 2011.

The first presentation was at the Solar Praxis PV Utility conference in Las Vegas and the second at a firm event in Silicon Valley. The powerpoint slides can be accessed here. As a special bonus, the participants were able to hear insights from Don Danh of East West Bank, John Huber of Wells Fargo and my colleagues Dirk Michels and Aaron Schapiro. Participants in the Silicon Valley event expressed optimism over the continuing availability of current financing sources, including tax equity, as well as new financing sources entering the project finance market.

Click below for the presentation highlights:

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.
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The Devil is in the Details: Financing of Solar Projects Starts with the Terms

Posted on August 2, 2010 by K&L Gates

By Fred Greguras (Palo Alto)

I see a number of press releases about large pipelines for solar project development. But many of these projects may never be built because they can't get financing. There are a number of important considerations involved in obtaining financing -- including the creditworthiness of the offtaker -- but the terms of the power purchase agreement (PPA) and site lease agreement (SLA) for the solar facility are the starting point for legal review.

A key economic consideration for the lender is the certainty of the facility’s revenue stream. And yet, PPA terms may not provide enough certainty that revenue will actually be received from the offtaker. Similarly, the terms of the SLA may not provide enough certainty that the facility will have the land rights needed to operate throughout the duration of the PPA. The terms in these agreements vary widely and each agreement must be carefully reviewed. Based on my experience in working with lenders, it seems that many developers sign these agreements without careful review -- either because they hope that changes can be made later using the leverage of an investor or because they simply don't realize the terms present financing risks.

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.
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When is a Power Purchase Agreement Provider Regulated as a Utility?

Posted on July 12, 2010 by K&L Gates

By Fred Greguras (Palo Alto)

The June 30, 2010 Arizona Corporation Commission (ACC) decision to permit Solar City to sell electricity under a power purchase agreement (PPA) to government, schools and non-profit customers without being subject to regulation as a public service corporation highlights the state law issue facing PPA providers.  The AAC decision does not address whether electricity may be sold by Solar City or other PPA providers to residential and for-profit (commercial) customers.  That will be the subject of a separate ACC decision. Solar City’s petition to the ACC only asked for a ruling on government, schools and non-profit customers.  The ACC decision ignored the recommendation by an Arizona administrative law judge that such PPA providers be defined as a regulated utility based on the statutory definition.

The PPA structure is an important financing stucture needed to accelerate the pace of deployment of solar energy. Customers of all types like the approach because they pay for electricity as used at a kWh price less than they would pay to a utility. The PPA provider incurs the  capital and operating costs for the solar facility and bears the responsibility under the PPA for delivering electricity for a period of 20-25 years.

There are four basic sets of customers that PPA providers target: 

  1. utilities;
  2. government, schools, and non-profit entities;
  3. commercial or business customers such as a grocery store and
  4. residential customers. 

Each state's law controls whether a PPA provider may sell electricity in the state. As in Arizona, as a historical matter to protect the public, most states laws have a broad definition of what is a  utility and either a public utitities commisssion (PUC) ruling or statutory change is needed in order for a PPA to be used with other than a utility customer.  Some states laws may be so broad as to bring a lease arrangement within the definition of a utility. Most if not all states would permit PPAs to be used in a solar project when the purchaser under the PPA is a utility because the utility is between the PPA provider and the general public.  Florida, an important solar market, only permits  PPAs to be used when selling to utilities. California, Colorado, Hawaii, Nevada and New Jersey permit electricity sales under PPAs to all 4 sets of customers. The legal position of a number of states on this issue is unclear. (survey of the current status under state laws).

PPA providers targeting residential customers must also comply with both federal and state consumer protection laws such as the Song-Beverly Consumer Warranty Act in California. 
The U.S. must  rapidly speed up the deployment of renewable energy. This requires a portfolio of solutions including solar PPAs. State PUCs need to move into this century and authorize solar PPAs for all types of customers.

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U.S.: What the USEPA's Findings Could Mean for Business

Posted on December 21, 2009 by K&L Gates
Written by Fred Greguras (Palo Alto, CA)
 
In 2007, the U.S. Supreme Court held that greenhouse gases are air pollutants covered by the Clean Air Act.  On December 7, 2009, the USEPA issued two findings on greenhouse gases under the Clean Air Act:   
  • The endangerment finding is that current and projected concentrations of six key well-mixed greenhouse gases (carbon dioxide, methane, nitrous oxide, hydrofluorocarbons, perfluorocarbons and sulfur hexafluoride) in the atmosphere threaten the public health and welfare of current and future generations.
  • The cause finding is that the combined emissions of these gases from new motor vehicles and new motor vehicle engines contribute to the greenhouse gas pollution which threatens public health and welfare.

The findings alone do not impose any requirements on business but are the next step in finalizing USEPA’s greenhouse gas emission standards for light-duty vehicles proposed on September 15, 2009. While the findings apply only to these vehicle emissions, even if Congress fails to act, the precedent will almost certainly result in regulation for other sources since vehicles are not major sources of all of these greenhouse gases. 

The USEPA actions will pressure Congress to act, which could provide more certainty for business as to source category priorities, timing, minimum emission and other requirements. It could also provide tax incentives and create a revenue opportunity (cap and trade) as well as a cost burden. Source categories such as coal power facilities will likely be targeted first, but other sources will likely follow. The treatment of natural gas will also be important since many utilities and other businesses have moved to this lower cost, more scalable source of power. 

How will business finance these requirements?

At the utility level, the costs will be borne either directly by rate payers in new or reconstructed utility-owned power plants using cleaner power, or indirectly by renewable energy generated power purchased at a feed in tariff (FIT) under PPAs.

Compliance will require balance sheet financings in many cases, but some businesses with power plants may have the opportunity for project finance of renewable energy facilities depending on the creditworthiness of the offtaker. It is unlikely that renewable energy facilities can scale fast enough for compliance purposes even with a meaningful FIT.  For example, to replace one central coal fired plant may require a GW of electricity. 

While the USEPA regulations may be slowed by legal challenges, it seems clear the US will act in some way to reduce greenhouse gas emissions.

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