In the past two years, the proliferation of YieldCos, and their ability to open new sources of capital for renewable energy projects, has captured the attention of the energy industry. While a YieldCo’s potential to catalyze renewable energy development is immense, the focus on feeding YieldCos has come at the expense of adequate transparency into the underlying assets being delivered into the financing mechanism. However, as U.S. bond yields rise, the long-term viability of YieldCos will necessitate operational improvements amongst their parent companies in order to compensate for tightening market conditions. These improvements must drive efficient compliance and transparency to capital market requirements while also allowing YieldCos to effectively diversify their holdings.
YieldCos’ ability to attract investment is predicated on growth and, consequently, the ability to acquire new assets that can deliver steady cashflows. In the U.S., the effects on solar development are tangible. My company’s distributed energy insight report, which compiles data from 3000+ projects seeking financing, highlights that YieldCos are not only providing low-cost capital to solar projects but are also contributing to widespread competition for project acquisitions. The result has been downward pressure on the economic returns necessary for projects to successfully attract financing. Meaning more projects can find financing and are being sold for higher prices. This has undoubtedly helped grow project development.
However, rapid growth has come at a cost. YieldCos, generally speaking, have been so focused on originating and developing projects that insufficient attention has been allocated to mechanisms that ensure that the projects feeding YieldCos are going to perform as anticipated. This oversight inflates the risk premiums attributed to the investment vehicle.
The early Yieldcos and their performance and reputation pave the way for more Yieldos to enter the market. This puts a lot of pressure on the incumbents to avoid any missteps.
Despite their current risk profile, YieldCos have been able to deliver low-cost capital in the context of historically low U.S. bond yields, but this is going to change. As bond yields rise, so will the risk-adjusted returns expected from YieldCos and — consequently — the energy projects themselves. The result will be a tighter project development market, making it more difficult for a YieldCo to find sufficient cash flows to maintain growth. Additionally, these conditions come at a time when the expected reversion of the Investment Tax Credit (ITC) could have a severe dampening on U.S. solar project development beyond 2016; adding another constraint to adequately delivering YieldCos new assets.
In order to mitigate the effects of rising bond yields, YieldCos will have to address the risk-adjusted returns that will be expected of the asset class. The easiest way to address risk perception is by providing the capital markets with transparency into the underlying assets that are being delivered into the YieldCo. The more project data that can be delivered in an organized methodical way, the less risky the asset class will be perceived.
It’s also critical to feed YieldCos with projects diversified across technologies, geographies and projects sizes. A trend that is increasingly occurring in the market, most recently exemplified by SunEdison’s acquisition of the residential solar developer, Vivint Solar, which helps support the companies YieldCo, TerraForm. Diversification helps expand the base of opportunities for the financing vehicle, while it also ensures that it is not overly exposed to one specific risk.
Here’s the rub. While diversification and transparency are necessary, achieving both requires organizational efficiency that is rare in the growing renewable energy sector. Expanding organizational bandwidth to evaluate a variety of technologies, smaller projects and new energy markets can easily drive up overhead costs. So can organizing, reporting and delivering all the data relevant to the capital markets.
Thus, the operational efficiency of the YieldCo and the parent company becomes critical to the ongoing success of the structure. The YieldCo requires a streamlined investment process that can process a massive quantity of projects while also maintaining a robust capacity to capture and track all the relevant data associated with those projects in such a way that does not explode overhead costs.
While the YieldCo has provided new capital resources to renewable energy projects and could continue to be a boon to the industry, new capital can not mask operational inadequacies forever. The YieldCo, as a financing structure, will face challenges in the near term as the market tightens. Only those that can operate a YieldCo efficiently, delivering transparency and and operating with speed, will have healthy returns.
Lead image: The word risk on US currency background. Credit: Shutterstock.