What will solar energy finance in the U.S. look like in 2013?
While the global market forecast for solar is shaping up nicely, the US market is faced with a series of fiscal cliffs, declining natural gas prices, and a post-1603 world with diminishing tax appetite.
Not good news for financing commercial solar projects.
But Yuri Horwitz, founder and CEO of Sol Systems, for one, is optimistic. Yuri is frequently on the speaking circuit at renewable energy finance conferences evangelizing new sources of solar finance in the post-1603 landscape or raising project finance, educating corporate investors on tax investment structures.
We caught up with him in January after seeing him speak at both the MD-DC-VA SEIA annual conference and the Novogradac Financing Renewable Energy conference in Washington, D.C. in November of last year. We sat down with Yuri at his Sol Systems office in Washington, D.C. to ask him how he sees 2013 shaping up.
What do you see as the state of tax equity as we begin 2013?
Three to four billion dollars in third party tax equity will be needed in 2013 to finance solar projects. The traditional tax equity investors, banks like Wells Fargo, Bank of America, PNC, and De Lage Landen are a small group that has been reduced dramatically since the credit crisis of 2008. They will continue to play a critical role in the industry, but new sources of capital are needed. Raising tax equity, what we term tax-advantaged capital, is difficult. What we see changing in 2013–2014 are new corporate investors coming into the space. They would fit into the non-traditional TE investor group that has tax liabilities.
Well the good news is, and this was a surprise, the 50% first year bonus depreciation was extended for another year for properties PIS in 2013 as part of the American Taxpayer Relief Act of 2012. So that should be an additional selling point to investors, or, at least those who can monetize the depreciation.
What we found interesting is that, yes, that’s true on a project finance, stand-alone basis, it does improve the return. But when that depreciation shows up on corporate income statements, it affects GAAP earnings, which Wall Street doesn’t love, if we’re talking about the Fortune 100 companies we typically approach. It doesn’t hurt EBITDA, the proxy for cash flow that The Street uses though, so that’s good. We still bake that depreciation into our models.
In one of your blogs on the Sol Systems site you say “tax appetite is the limiting factor for solar project development.” Could you elaborate on that?
There is a shortage of TE out there, especially for projects that aren’t your standard 10-MW ground-mount project. In terms of the needed sources of capital for expanding the industry, including construction debt, term debt, sponsor equity, and tax equity, there simply is not enough tax equity given how important it is, and just as importantly, there are not enough “flavors” of tax equity out there. The options are extremely limited and it’s limiting the growth of our industry.
Are you assuming that the ownership structure on projects over, say, 500 kW, are PPAs, rather than owned by the offtaker? What do you think is the percentage split on ownership/PPAs?
Probably something like 60–70 percent of commercial projects are PPAs. Why? Because it’s easier than buying the system outright for the owner-offtaker and it’s typically easier to sell for the solar developer. Now there are exceptions, like WalMart, who will buy a system outright, because they have the tax appetite, and in addition they are willing to dig into the economics and they have additional positive externalities, like shareholder and consumer goodwill, for investing in the environment.
Interestingly, while the PPA structure is generally easier for the offtaker, it may be harder for the developer. Here’s why: The A developer who locks in a PPA, and does not have financial backing, must secure a third-party investor. So suddenly the developer now has two customers, not just one: the offtaker and the investor. That’s where we see our value at Sol Systems. We help developers structure their deals so that they can ultimately secure financing, and when the time is right, actually help facilitate and optimize this financing with our investor clients so the developer doesn’t have to go through all the brain damage.
One of your co-panelists at the November MDV-SEIA conference in November of last year, Jim Duffy, transactional attorney at Nixon Peabody said, “there is a TE shortage in the short-term, one out of seven deals get funded.” What do you think about that?
Duffy knows as much about this space as anyone. And what he’s said is probably true not only because there is a TE shortage, but also because developers are trying to secure funding for deals that aren’t bankable – those that don’t meet anyone’s investor criteria. That’s what we see as our role, we work with our developers partners to structure projects that will pencil for investors and help them screen out those that will not.
So, let’s take that one step further. At one of the conferences I attended in Washington in the fall, both representatives of the financing arm of Washington Gas Energy Services, the Washington, D.C- based energy supplier, and Standard Solar, the Maryland-based developer were panelists. Standard had acted as EPC with WGES financing under a partnership arrangement on several projects. In this case, Standard, as the developer, would almost reverse-engineer projects they originated. In other words, they made the project fit the investor, rather than the investor fit the project. Would that be fair to say?#rewpage#
Yep, Standard has done a great job with that. And again, that’s part of what we see as our role at Sol. We have investor relationships that many developers may not have, certainly in terms of depth, so we are giving our developer clients guidance on what investor criteria are critical for their projects in advance. And what’s interesting is those criteria are analyzed slightly differently by different investors, so we can work with clients to help them develop projects that meet a collective sweet spot.
How would you define non-traditional tax equity?
Non-traditional tax equity includes corporate investors, and when I say that I’m talking about the Fortune 500, and banks, that have a tax appetite and haven’t invested in solar yet. That’s who we’re approaching.
Yes, I was at a few RE finance conferences in the fall and I’ve heard it more than once, some savvy structured finance guys too, like Albert Liu at SolarCity says they spend a lot of time educating non-TE investors – Google might be the most famous corporate example of this.
Yes, agreed. Ben Cook and Albert Liu, who head up the project finance team at SolarCity, had a huge success with Google, one of the early non-traditional TE investors. And it’s a long cycle, something like six to eighteen months shepherding new investors through the process and educating them. We usually talk to their tax and accounting folks. They may have experience in tax-advantaged capital, say, low-income or new markets tax credits (LIHTC, NMTC), but the solar Investment Tax Credit (ITC) may still be exotic to them. So they’re familiar with the vehicle, but we are introducing them to the space. We connect the dots. You do it because it’s the long game.
Have you approached the traditional TE investors: US Bank, PNC, Wells Fargo, etc.? Do they have an appetite for the kind of projects you have in your portfolio at SolMarket?
Yes and no. We have approached them and may work with them at some point down the line. That said, these traditional players are very relationship -driven entities, that is they are working out of pre-existing relationships with developers, and expect a sizable pipeline. We are not developers, and never will be. Developers are our clients. If we were to work with the traditional players it would be through a very different, creative vehicle.
Is your principal role at Sol bringing in new investors?
Yes, my role is building funds, educating the non-traditional TE investors we are approaching, and managing those relationships.
So you see Sol as more of a finance house than, say, a developer?
Right, we look at ourselves as an investment bank, transactional. We don’t want to develop or own assets, so we’re very careful not to step on the toes of our developer partners. We don’t compete with developers, but we do partner with them to facilitate financing.
I’ve seen you speak at a lot of finance conferences, you seem to be playing almost an evangelist role, evangelizing new funding sources for the solar energy industry, like, say, non-traditional TE. Would you agree?
I think it’s important that the solar industry succeeds. What drives me is improving the economics of our business. If we are passionate about what we are doing, and I am, and we take it seriously, and I do, we have to ensure that we build a stable and sustainable asset class. If we can identify what’s slowing the industry down, then we can identify opportunities to expand.
Complexity is opportunity for us. From the beginning, or Sol Systems beginning, which is not that long ago (about four years), we have tried to solve industry-wide issues. Initially, that was SREC financing and providing liquidity on East Coast solar projects. We also developed project and PPA standardization through Sol Market to provide a template to developers. Now our mission has evolved into bringing new investors to the space to provide a reliable, scalable alternative to fossil fuel through solar energy.
Here’s a curveball – with all that said, do you think, as an industry, with the ITC expiring in 2016, we should even be focusing so much on having to bake in subsidies to hit target investor returns? Some solar industry leaders have suggested that the ITC should be voluntarily phased out over the next four years.
I think that’s a false dichotomy – the industry will not cease to evolve or mature because of tax credits. Innovation and evolution are a result of competition, and everyone in this industry has plenty of competition. So we’ll continue to evolve. In the meantime, what we want to do as an industry over the next four years is get to a point where we are independent, but I don’t think we need to phase out the ITC to do that. We are trying to optimize on the TE component, the sponsor equity component, and the debt component to help make solar financing more available and affordable. I’m sure (I hope) that the folks focusing on module production are optimizing their own set of components. The players that do that best will succeed.
OK, so wrapping up, you feel good about 2013?
I think it’s an incredibly challenging environment right now for solar. The low-hanging fruit has been picked and SREC markets are oversubscribed. The good news is that this extremely competitive environment leads to less expensive solar and more capable investors and developers. The consolidation we’ve seen in the last year will continue. And while there will still be some vertically integrated companies, SolarCity might be a good example of that, most companies should try to figure out what they do well and not try to do everything. We’re doing what I think we do best, which is working with our partners to help provide them with complementary solutions for success. In the current environment collaboration will be key, and that’s a core value at Sol Systems. We work hard to help our partners. So, to answer your question, yes, I feel good about 2013, especially the role that Sol Systems will play in it.
Lead image: Viewpoint sign via Shutterstock