San Francisco, Calif., USA — It seems as though solar enthusiasm is more abundant than ever before. But with close to 30 GW of solar in the pipeline, and three times more tax equity demand than available, competition is fierce. Many are left wondering what will happen to projects struggling to receive financing. With an uncertain incentive climate what can we expect in the near future? How many of these projects can realistically be financed? What makes one project more attractive than the rest?
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To answer these questions, three leading solar experts took part in a project finance roundtable at Intersolar NA 2011. An edited transcript follows, and the full conversation can be viewed above.
Q. What attracts investors to a new project? What do you usually look for?
Katz: A number of things, one is proven technology — the type of solar panels that have worked before. Second, a development team that has executed before. Third is probably the strength of returns: Is this a good investment, something we can make money on? How do we feel about the geographical region and the incentive system that is in place?
Bush: A lot of those are right and the biggest factor we run into is the credit quality for the off-take host. We have to consider if there is a REC market involved. What is going on that particular area? Who is going to pay the bills? The bank takes a good hard look at those things. The higher tier developers are established and tend to only work with top tier manufacturers, so they are much less of an issue for investors.
Lee: Certainly the projects that this space offers are credits that we would like to bank by themselves. We are attracted to strong credits, customers and off-takes that we would like to be a new customer for East West. And the territory that Borrego covers seems to be a nice footprint and attractive opportunity for us.
There seems to be a race between photovoltaic (PV) and concentrated solar power (CSP). Which of these technologies do you think is most attractive for investment?
Katz: I think most investors will tell you that PV is more proven right now. I think the larger utility-scale projects may be CSP. I don’t think we know yet. My guess would be that PV ends up winning.
Bush: It’s ultimately about getting financing in place. And CSP, while not bad, isn’t proven on a large scale yet — and that is the bigger problem with getting a project started.
Lee: From a tech standpoint we are agnostic. Whether it is between different manufacturers and tech, ultimately what drives a project is the credit of the off-take and the contracts behind it. The third criteria is then the technology. Depending on what is involved in a particular project and how much risk there is, whether it is more project finance risk or service risk, everything gets calculated into the credit decision. But from the projects I’ve seen come across my desk, the majority are silicon PV, and to a lesser degree, thin film. And quite frankly, I haven’t seen any CSP projects.
Bush: I think CSP tends to be the larger utility-scale projects. There are two issues with those: the amount finance is significantly larger and the development cycle is much longer. So I think when you add technology that hasn’t been functioning on a high level for very long in the marketplace, the time period from design to operation in the ground is strung out.
Katz: I think the answer is: we don’t know yet. I read somewhere that 100 years ago there were hundreds of car manufacturers in the U.S., which then consolidated down to five or six. I suspect we’ll see that in the next five years in the solar space.
The 1603 cash grant is set to expire at the end of this year. How do you think this will affect the solar industry?
Katz: Badly, I think. Not just subsidies for renewable energy in general. It has been boom bust since the early ’90s. Some people think Congress does that on purpose just to get us to a milestone and then pull away the incentive. The nice thing about this 1603 program is that even though it expires at the end of this year, any project that started construction can grandfather in. Even if it does go away, you will still have half to three quarters of 2012 with people still working on 1603 projects. We may see a little lag until it badly affects the industry. But this might be the silver lining: If people see that these boom bust cycles don’t work maybe it will make people enact a long-term subsidy.
Bush: Any time there is uncertainty, that’s bad. The 1603 grant has been a really good widget from the government not just solar, but manufacturing and other industries as well. I think when that goes away, and we don’t expect it to be extended, the grandfathering that Eli mentioned is probably going to happen, but the rules haven’t been finalized yet. So we’ll see how that works. Ultimately it will favor large developers and large balance sheets. This will lead to projects that die on the vine or smaller developers will sell out to larger developers. Given the relatively immature level of the industry so far, I don’t think it’s a good thing to have concentration at the development level right now — you want to have more competition. The less competition there is, the higher the prices are — even in a market where prices have been declining as much as they have. I think ultimately it will be a bad thing but who knows what will happen. We all thought it would go away last year and that didn’t happen.
Lee: I see the expiration of the grant having a cooling effect on the marketplace. Getting financing is the critical component of successfully completing a project. If the grant goes away it will limit the amount of capital in the market and make it more expensive for participants to get their deals done. And given all the bickering in D.C. right now, I really don’t see the grant being extended past this year. It will be a more difficult environment for manufacturers, developers and investors to continue the pace of transactions we have developed. It would be a shame to see all that hard work cooled down to a place where we struggle to figure out how we get these transactions done and funded.
How has this uncertain incentive market affected projects currently?
Katz: There is a spectrum of incentives and the uncertainty around them affect the market differently. One example is a European market that has a feed-in tariff system where the government promises that they’ll pay a certain rate for electricity that comes from renewables. That was a huge market for Spain, Germany, Italy, but then the government changed their mind quickly. That scared a lot of people. It’s hard to do deals there because people don’t trust the government. In the U.S. there are REC markets (renewable energy credits) in various states, but people are skeptical. It’s difficult for people to raise capital and start new solar companies or investment funds because many will ask, “What’s the time horizon? How long will this last? What will it look like in 2012 or 2013?”
Bush: When you think about a level of uncertainty, the problem becomes figuring out a time for retraction. On the pure debt side, it’s more of an issue with tax equity. Investors looking for more equity like returns. The cost of tax equity drives up and projects become more difficult to do. Ultimately development timelines get extended or projects stall. If market were to change dramatically investors will walk away — there are a lot of alternatives. Then manufacturers won’t be able to sell product, construction slows — there are a lot of potential negatives. We’ll see what the government does to soften the blow.
Lee: Uncertainty does not help the situation. The country needs an effective energy policy direction — more than what’s going to happen in next six months. From a financial or planning standpoint, this direction would be very helpful, increase business and dedicate resources. But policy changes happen, incentives go away, which makes planning difficult for investors and prevents them from increasing staff and resources.
Can you give an example of a recent project that encountered significant finance challenges and how you overcame them?
Katz: A project in Puerto Rico had interesting jurisdiction. As a territory, a lot of people were saying the government didn’t want to pay the grant. We helped the client get a ruling from the IRS that said they would pay for the project if they satisfied certain criteria. It was a big win because the client was able to use the ruling to go to banks and investors.
Bush: There was a large project we worked on with East West that was on an extremely good site. But people involved were inflexible about what they were willing to use and agree upon. You have to be obstinate — most projects get done largely due to the developer’s ability to be flexible in a particular structure. The developer’s ability to fix problems makes a deal financeable. That project took time and elbow grease but we were able to get it finished.
Lee: Different government agencies have unique peculiarities with how they like contracts put in place. The best thing to have is a patient partner with capability and tenacity to stick with a problem and figure out a sensible solution for all parties. It took a lot of time and consultations with lawyers to figure out where to push and pull, but that ultimately got everyone comfortable with the end result. All parties involved have the same goal: to complete the project and have a set of documents and contracts everyone feels good about.
Where are the hot locations for development in North America right now?
Katz: New Jersey has an SREC program where developers can sell credits for six or seven times the price they can sell electricity. Massachusetts has a great new program. It becomes state-by-state analysis. You want good sun, installation factors and hospitable state policy. In Canada, Ontario enacted a favorable feed-in tariff and many developers have gone there.
Bush: New Jersey, Massachusetts and California are three primary markets in the U.S. Up-and-comers include Texas and many Northeast markets including Connecticut, New York and Vermont — there are pockets of opportunity scattered everywhere, and if we get incentives straight we can do a lot.
Lee: We’ve seen most activity in sates such as California and New Jersey, where they have high electric rates and aggressive rebates and incentive programs. Areas with municipal utility districts don’t have many projects. Most projects are in states and regions with high electric rates and utility rebates or SREC programs.