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2013 Solar Industry Trends: A Playbook for Tax Credit Investors

Published by Dan Yonkin and Yuri Horwitz on Friday, March 1, 2013

Journal cover March 2013   Download PDF

The solar industry continues to promise potential tax-driven investors a growing and stable asset class in which to deploy their capital. However, for new entrants – or even experienced players – continued success in 2013 and beyond requires an intimate understanding of the solar industry and market’s changing topography.

The solar industry continues to expand at a record pace as one of the United States’ fastest growing electricity sources. In 2012, the number of solar project installations increased by approximately 60 percent year over year, while the costs of the technology itself dropped by an estimated 10 to 20 percent. Not withstanding a recent election dustup regarding a now-discontinued federal loan program, there is strong political and policy support in a majority of states and on the federal level for incentivizing solar. This year promises to be another growth year for the industry with an estimated expansion of $11 billion in capital investment, representing a significant opportunity for investors that are interested in diversifying their tax-driven portfolio.

Behind solar energy’s growth, there are important geographic and strategic trends. Certain new geographic markets will grow tremendously this year, while other previously active markets will falter. Similarly, a number of solar development companies will struggle in an evolving environment, with some closing their doors and others employing creative approaches to blossom. Part one of this article explores the national trends within solar project development, and a second article in next month’s Journal of Tax Credits will review geographic trends in the industry.

Solar Developers Are Consolidating
Power purchase agreements and other incentives are increasingly offered through competitive procurements, such as reverse auctions, which bring pricing down and makes the economics of developing solar projects more difficult. Electricity buyers and state program administrators are looking for the best economics possible, and are asking developers building solar to provide electricity at the lowest feasible price. The result is a more competitive landscape where solar projects have thinner economics and developers must adapt and innovate to create attractive project investment opportunities.

Larger companies can typically leverage their access to less expensive capital and procurement channels to develop solar projects at a lower cost, and are, therefore, generally better situated in these highly competitive procurement programs. They also tend to have greater access to debt, either at the project level or corporate level, which lowers their weighted average costs of capital to build these projects, enabling them to build at lower prices.

Mid-tier developers that want to continue to build and sell projects must be agile, creative and fast moving. Since they cannot compete on costs alone, these players are staying out in front of the industry by monetizing non-conventional incentive programs, building portfolios and leveraging other benefits (as discussed below). These mid-size leaders are often on the cutting edge of the industry, and larger players will ultimately employ similar strategies as they attempt to gain even greater market share.

Inevitably, though, the solar development community is consolidating, with a number of smaller and less efficient players either going out of business or being acquired by larger competitors. Tax-driven investors should pay close attention to their solar partners and ensure that they have contemplated backup operations and management partners on any projects or project portfolios in which they invest.

Solar Developers Are Building Project Portfolios
Developers can also reduce project costs by lowering transaction costs, and one of the most promising strategies utilized by solar developers is to aggregate project portfolios. In general, larger solar projects are preferable to smaller ones because the associated transaction costs are diluted and the pool of potential investors broadens with investment size. In 2013 and beyond, this will change, and aggregated portfolios of either residential or mid-size commercial projects will dominate the solar market due to a number of converging factors summarized below.

First, the U.S. Department of Energy’s loan guarantee program, which helped finance a significant number of the largest solar projects developed in the last four years, is now winding down. Large solar projects, such as the 230MW Antelope Valley project or the 550MW Desert Sunlight project, will be much harder to finance without this program. Separately, these large projects have met with significant pushback from environmentalists and the federal government because of environmental, permitting and interconnection issues.

Second, as regional incentives become more competitive (and less rich) solar projects will be forced to secure a larger proportion of their cash flows from the electricity offtaker instead of renewable energy credits or premiums secured through feed-in tariffs. Smaller projects that qualify for net metering programs (because they are “behind the meter”) can sell their electricity at retail rates rather than wholesale rates. Retail rates generally provide more stable and more robust cash flows for a project, and are much more favorable for project finance structures as a result.

Third, the industry is generally learning that smaller projects may have fewer permitting or regulatory hurdles, which means more stable pipelines for solar developers and investors. It also means a more stable deployment of capital for both parties. Solar developers, to whom capital velocity is critical, can design, develop, build and get paid on a steady flow of projects as they build out their portfolios. For solar investors, to whom a stable pipeline and capital deployment strategy are critical, building smaller project portfolios makes sense. Smaller portfolios also enable solar investors to cross-collateralize risks across an asset pool, rather than taking on the operational, geographic and regulatory risk of one larger solar project.

The portfolio approach enables small-project developers to compete for tax equity and debt with Antelope Valley-sized projects. These larger portfolios are attractive to the capital markets as they allow for a large deployment of capital in one transaction and can support higher transaction costs.

The challenge to the portfolio approach is standardizing across multiple projects to ensure that the portfolios provide the required consistency. Good portfolios should utilize, among other documents, some combination of identical PPAs, leases, system design plans (if possible), components, as well as engineering, procurement and construction agreements. Portfolio revenue should also be fixed and contracted for, providing a relatively level cash flow for investors, and the credit of the offtake counterparties should be investment grade or better.

Solar Developers are Utilizing Non-Conventional Benefits
As the margins for solar projects shrink, innovative solar developers are turning to non-conventional incentive programs to boost returns. Developers are increasingly approaching Sol Systems with portfolios of new markets tax credit (NMTC)-qualified projects, partially because of the success of a 5MW project in Celina, Ohio that we helped finance. These developers plan to combine the NMTC and the ITC to maximize project returns. For this model to succeed, however, the solar industry will have to continue to build partnerships with the community development entity (CDE) community, and specifically CDEs with rural allocations.

In addition to NMTCs, developers are quickly adapting to (and utilizing) other potential incentive vehicles. For example, the federal government provides a number of programs to subsidize bond securities for solar project development. These bond programs have billions of untapped allocations, and can reduce borrowing costs for a project by up to 600 basis points (BPS). For savvy developers, these affordable debt sources will be a key to success in 2013 and beyond.

Over the next two to three years, the solar industry will continue to grow, mature and consolidate. As the dust settles, leaner and larger companies will make up the majority of the industry, and mid-tier developers will help lead the innovations that drive solar into the next decade. Many of the trends and strategies discussed above will help drive this evolution, in parallel with others that have yet to appear. Familiarity with these changes is critical for tax-driven investors, as well as those developers hoping to utilize tax-driven capital.

Dan Yonkin is director of regulatory affairs for Sol Systems; Yuri Horwitz is president and CEO of Sol Systems. They can be reached at [email protected] and yuri@

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