Climate Change Report : Climate Change Lawyer & Attorney : K&L Gates Law Firm : Global Climate Law, Carbon Emissions

Both presenters foresee flat to moderate growth in 2011 and 2012 with higher rates of growth perhaps following after that. Each pointed to the nascent nature of the industry which can allow for growth opportunities that may not be available in a more mature industry. For example, Pietzsch noted something we have seen with our own clients, when he compared the California and German solar markets: the German residential solar market saw positive effects that resulted from increased efficiency of solar installers which enabled them to bring down the cost of installation and more effectively educate and market to consumers. Similarly, as the US market matures and implements new technologies, such as innovative energy storage solutions, the ability of installers to promote awareness through effective marketing and to drive affordability through efficient installations can be a key support dynamic for residential and small business market segments.

Consistently present in the discussion, however, was the specter of government support and the critical role it plays in the domestic and global solar markets. In reviewing the past and looking toward the future, both speakers acknowledged the obvious importance of governmental action for the continued development of the solar market and noted that with very low or stagnant economic growth and massive budget deficits at both the state and federal levels, nothing is certain.

At a recent program in Northern California, our own policy partners former Congressman Bart Gordon and Daniel Ritter echoed that perspective but also emphasized that advocacy by solar players both large and small can help to educate Congress when they make difficult budget decisions. Mints warned, “what the government giveth, the government can taketh away.” While that is true, we would also add to that the industry does not need to sit on the sidelines and wait for government action (or inaction) to dictate the market opportunities.

Many utility scale and other solar projects currently under development rely on government incentives, such as the energy investment tax credit and the cash grants in lieu thereof, as critical pieces of their financing plan. The uncertainty surrounding the continued availability of those incentives relates also to the timing of any changes. Given the current political and economic environment, significant change could come sooner than anticipated. 

What can developers do to protect themselves? First, they need to carefully monitor developments affecting the government incentives involved in the financing plans to gather as much advanced information as possible and maximize the time available for making any necessary adjustments. Second, developers should explore steps that can be taken to accelerate the pace of development of their projects with an eye toward locking in the incentives before any negative change. Finally, developers should attempt to develop alternative financing arrangements in case the incentives on which they are relying become wholly or partially unavailable.

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.

Currently, the Buy American provision applies only to projects on public works or public buildings but the Schumer legislation would apply the requirement even if the project is on a private building or land.

The exception is when materials used in the project are from countries with which the U.S. has an applicable international agreement would still apply(such as the World Trade Organization (WTO) Government Procurement Agreement). The international agreement exception is not available, however, for projects sized at a little under $8M. 

China is a member of the WTO but not of the Government Procurement Agreement (which has been an issue for Chinese solar companies under the current Section 1605) but the Schumer legislation intends to cover private projects not governmental. The legislation also would require an analysis of jobs that would be created in the "production, installation and operation" of the project to be submitted as part of the application for the cash grant.  

This analysis would be where Treasury could apply discretion on whether to make the payment. The legislation leaves it to Treasury as to the relative weights of each type of job creation. For example, most renewable energy projects in the U.S. would create jobs for installation and operation but not many would create jobs in production. 

Currently, the cash grant payment is required to be made by Treasury if all required information is in the application which has provided predictability for project finance.  The added discretion for Treasury decisions would  likely be worse for project finance than the Buy American provision for private projects. The Schumer legislation would decrease the predictability of a project receiving the cash grant.  Since China is a member of the WTO and the legislation addresses private projects, except for smaller projects, the discretion change is the only way such funding could be denied. 

None of these bills is likely to be enacted as a stand-alone bill, but rather as part of larger energy, tax, climate or possibly jobs legislation.  While extending the Recovery Act 48C manufacturing tax credit and incentives like the Arizona state manufacturing tax credit will have a positive impact on manufacturing in the U.S. but the Schumer legislation could have a negative impact on renewable energy project finance and manufacturing in the U.S. Spending bills are becoming more difficult to get approved in Congress. The best case scenario for the cash grant appears to be an extension late in the year but perhaps the best course of action is to get projects under construction by 12/31 and not assume the cash grant will be extended in any form.