A new solar industry boom is upon us, and this one is here to stay. Finally widespread, mid-scale commercial solar projects are becoming a reality and the catalyst is third-party ownership, accelerated by innovation in power purchase agreements (PPAs).
To understand this new opportunity in solar, we should first be clear on the purpose of a PPA and look at some examples of how these are being used innovatively in the mid-scale commercial context.
What’s So Special About a PPA?
A power purchase agreement is a financial commitment where a third-party investor owns, operates and maintains the photovoltaic system. A customer agrees to host the photovoltaic system on its property and purchase the power generated by the system over a specific period of time – usually 20-25 years.
The host customer agrees to buy only the power produced by the photovoltaic system, not the equipment itself. The host is billed monthly at the pre-determined rate for the electricity produced, and is not charged if the system does not generate power.
The agreements can be more intricate – the host often will be able to negotiate the price of energy, whether it is fixed over the term or escalates at a pre-determined rate, and if they wish to contribute any initial funding to buy down the rate. Unlike a lease agreement, with a PPA at the end of the initial term, the host customer typically has three options: 1) extend the term, 2) have the developer remove the system, or 3) purchase it for fair market value.
The key to PPAs are that they enable a host customer to bypass the traditional hurdles to purchasing solar power such as high up-front capital costs, maintaining the system and managing the design and permit processes. PPAs also enable the host customer to be cash flow positive from the day the system is installed.
For years PPAs have been the preserve of large commercial entities, including utility companies and Fortune 500 businesses – and more recently at the opposite end of the scale, residential homeowners. Both those segments have one very important factor in common – reliable public debt ratings that easily check off the risk mitigation criteria for Wall Street.
The nuts and bolts of a PPA have been constant over time. The innovation is all in who these PPAs are becoming available to. Suddenly a whole new market segment is able to qualify for PPAs in a way they could not before.
What Does that Mean? Who Is This New Segment and How Are They Getting Access?
The new segment is being driven by Main Street – and how it can unlock Wall Street investment in mid-size solar projects, in the same way large commercial entities and residential customers with readily accessible, standardized, good credit ratings have. The new, innovative application of PPAs has found a way to achieve this, and satisfy the risk mitigation criteria of investors in a way that is no longer a financial burden.
This segment is the mid-scale solar facility and investment space, where host customers can often be non-profits, small regional chains, mom-and-pop businesses – commercial entities who don’t have a public debt rating that fits the conventional mold. Our industry is waking up to the fact that just because they don’t fit the old, established template for evaluation doesn’t necessarily mean they are bad investments. Until very recently, before innovations like Wiser Capital’s Wiser Solar Asset Rating (WSAR™) score, achieving the transparency needed for project finance of these mid-scale solar projects hadn’t been possible.
The Bottom Line Benefits of PPAs
Commercial energy tariffs are complex – much more so than residential – but the key to any PPA is to have a clear and accurate handle on the savings the host customer will achieve and lock it down over a 20 or 25 year term. Broadly speaking there are two key cost items at play: the energy used (measured in kilowatt hours) and demand (measured in kilowatts). This complexity – particularly calculating the impact of demand charges on future utility bills – has been a hurdle for the solar industry. Simply looking at the headline kilowatt hour price, or a simple “blended rate” doesn’t show the true cost of energy and should never be the only basis on which to evaluate a PPA.
To decide if a PPA is a worthwhile investment both the energy user and the system owner should look at the whole picture – the trend of existing utility bills and all charges within it – including usage, demand, taxes and all other fees. Using actual numbers based on historical usage, demand and solar production allows for an accurate prediction of both the PPA and the remaining utility charges in a ‘post-solar’ situation. These numbers should then be modeled against a variety of system sizes and utility rates to determine the optimal size, rate and utility tariff for a host facility (or purchaser of electricity). Doing so significantly reduces the risk for the investor as well – if a host is saving money with a PPA, they are more likely to keep paying that PPA versus returning to a higher rate utility payment.
A synagogue we have worked with in California had been considering solar for many years, approached repeatedly by solar contractors trying to sell them anything and everything, but unable to provide the long-term partner they wanted. Working with us, a 56kW system was installed at no cost to the synagogue, which covers 80 percent of their annual electricity usage. Before solar the synagogue spent over $20,000/year on utility-sourced electricity and in the first year alone saved more than $1,000, and by avoiding planned increases from their local utility company will save even more each year of the PPA.
The financial benefits of the PPA are clear and continue to be enjoyed by the synagogue, unlocking the savings and the ethical benefits of using renewable energy. This would never have been available prior to this new era of innovation in PPAs and risk assessment for the mid-scale solar investment industry. The innovation has standardized and made the investment evaluation and decision process as transparent for this sector as it has always been for large-scale and residential deals.