Pathways and Challenges to Institutional Development of On-Site Clean Energy

Institutions seeking to deploy on-site clean energy solutions are facing a number of challenging questions:  How can solutions be deployed under tight budget constraints, with a minimum of upfront cost? What deal and financing structures are available to non-tax paying institutions?  Is it best to build and own a system internally, or use a third-party developer? 

As more institutions look to on-site clean energy generation to reduce operating costs and meet environmental goals, these questions are growing in importance.  In this post, I will explore how institutions are approaching these questions, and provide examples of new financing and development approaches being utilized.  This is my second post based on content from EUCI’s Utilizing Clean Power Development Conference hosted in Philadelphia in the middle January.  My first post detailed the steps organizations are taking to evaluate on-site clean energy solutions and is available here.

Budgetary constraints and the need for a quick return on investment are typically the most challenging issues facing institutions looking to develop on-site clean energy.  With the economic recession and reduced budgets for capital improvement projects, institutions are demanding fast payback periods—typically much less than seven years, which is common for internally financed on-site renewables. Furthermore, many institutions may be assuming that on-site renewable energy is too expensive, and/or requires a large upfront investment.  However, a number of service-based financing approaches, including power purchase agreements (PPAs) or energy services performance contracts (provided by ESCOs) have emerged to help address this problem.  These approaches offer the potential for organizations to reap the benefits of on-site clean energy, minimize upfront investment and shorten payback periods.  

For a given institution, the right deal and financing structure will be a function of the organization’s goals.   As previously mentioned, there are strategies and solutions available to fit a wide range of institutional needs.   One of the most common renewable energy financing mechanisms used today is the power purchase agreement (PPA).  In a PPA, third-party developers own and operate the system, and sell energy back to the institution at rates lower than the local utility.  In the PPA scenario, institutions don’t have to put up any upfront capital and aren’t required to operate the system. 

Yet with this important benefit comes a few drawbacks.  PPAs typically require institutions to give up ownership of the associated renewable energy credits (RECs).  To address this issue, institutions may make arrangements with their PPA provider to maintain some of the RECs, or possibly to buy cheaper RECs from wind projects to replace the potentially more valuable solar RECs. Another more recent issue with PPAs is that changes in accounting rules have categorized PPAs as leases, thus requiring institutions to report the PPA on their balance sheet.

A second popular financing mechanism is the performance contract.  These are offered by energy service companies (ESCOs), also sometimes known as renewable energy service contracting (RESCO).  Performance contracts are based on a shared savings model.  ESCOs determine a range of energy efficiency and renewable energy projects and recommend a package of improvements to be paid for by the energy savings.  ESCOs have been around since the 1970’s, but have evolved and expanded their offerings over the years.  Recently, ESCOs have been forced to become more transparent as institutions.  At the same time, their customers are becoming more knowledgeable and are demanding greater input into the package of energy efficiency and renewable solutions determined by the ESCO. 

Interestingly, some smaller and more specialized ESCOs are emerging, which focus on a few select services.  One example is Skyline Innovations, which is focused on offering guaranteed savings from solar water heating.  As Skyline’s founder Zach Axelrod put it “If you can save companies even a small amount of money and guarantee it, they are happy”.  

In addition to PPAs and performance contracts, institutions are also implementing a number of other innovative strategies to financing on-site clean energy.  One mechanism is to combine and aggregate sites in an RFP to reduce project installation costs and make it more attractive to developers.  The Morris County Improvement Authority partnered with solar developer Tioga Energy to install 3.2 MW of solar at 19 different facilities for 7 local government units.  The project allowed Morris County to receive PPA pricing at $.106/kWh in the first year, well below market prices.  The model is now being replicated in counties throughout New Jersey.  

One of the most fundamental questions facing an institution is whether to own and operate a renewable facility, or rely on a third-party developer for part or all of the construction and operations of a facility.  For most institutions the answer to this question depends on if they pay taxes, and how much.  For non-tax paying institutions, or institutions with little tax appetite, developers are essential for monetizing the potential tax benefits of a project.  This type of monetization can support close to half of a project’s cost, through use of the investment tax credit,  and accelerated depreciation.  Developers also play a key role in taking on many of the risks associated with an on-site renewable solution.  The developer will be responsible for ensuring a system is operating, and also will be responsible for the risk of selling the RECs or solar RECs from a project.  Most institutions lack the capacity to deal with the inherent risks associated with on-site projects. 

Despite the benefits of using a developer, some institutions still see an upside to owning and operating their own systems. In this scenario, institutions can retain the RECs from a project, have greater control over the system, and the ability to directly manage installation and maintenance processes. However, owning and operating an on-site renewable system can require significant internal resource and expertise, which many institutions don’t possess.

Now more than ever, institutions have a range of options available for developing on-site renewable energy solutions.  And some of these options allow institutions to achieve their environmental goals and save money without a large upfront capital outlay.  As these innovative approaches become more common and widely available, institutional on-site clean power development will continue to proliferate.