Stakeholders Say Credits are King, Residential Solar Heating Up

Published by Teresa Garcia on Tuesday, October 1, 2013
Journal thumb October 2013

Cash grants were once at the helm of the renewable energy market while renewable energy tax credits took a back seat. The tide has turned with the expiration of the 1603 cash grant in lieu of investment tax credits at the end of 2011. “A couple of years ago, it was all grants, all the time,” said Gary Goldman of Meridian Asset Finance. “Now it’s very much the other way. Even if there are grant pieces around, credit is seen as the preferred route.”

When asked about current renewable energy market trends in August and September, industry participants agreed that there’s been a noticeable increase in tax credit appetite across the board, with experienced investors staying active in the market and several new investors showing interest in renewable energy. Stakeholders reported stability in the market, but are uncertain about what the market will look like after potential tax reform.

Interested Investors
The number of active investors varied, according to stakeholders. David Kunhardt of SolEd Benefit Corporation, which aims to lower the cost of renewable energy for schools, nonprofits and municipalities, estimates that there are about 25 active renewable energy tax credit investors in the market. Goldman said he has seen 20 to 25 actively engaged investors, with another 10 to 15 potential new investors that range from beginning to explore and “poking at it” to being close to investing in renewable energy. Eli Katz of Chadbourne & Parke agreed that there are about 20 tax equity investors in the market, but only eight to 10 have multiple deals across sectors.

Most energy tax credit investors are banks and insurance companies, such as Wells Fargo, U.S. Bank, MetLife, JP Morgan Chase, Citigroup, Union Bank and PNC. Corporations in unrelated industries, such as Google or Intel, have invested in renewable energy in the past few years. However, Kunhardt said, corporations still tend to favor investments in oil or gas because of an “unleveled playing field” where renewable energy investments get less risk protection.
Goldman said the keys to increasing investor interest are greater regulation clarity and educating investors about different asset classes so they can better understand the economic risks. He said the allowance of renewable energy projects to fulfill Community Reinvestment Act (CRA) requirements would be a big benefit to the market without increasing the federal budget. Goldman added that greater program stability at the state level would also boost investor confidence because state incentives have proven to be volatile and unclear in some instances. As a result, he said, investors try to shift risk exposure back to the developer or deal sponsor.

Developers who have trouble finding tax equity for their projects have turned to reducing capital costs, such as those associated with retail money; finding better ways to back-lever cash flow through securitizations; and using master limited partnerships (MLPs) and real estate investment trusts (REITs), said Katz.

Project Types and Deal Structures
Reduced project costs and increased production capacity in wind energy have led to an increase in the number of projects opting for the production tax credit (PTC) than in previous years. Greater use credits have required more creativity in using different deal structures. “The sale leaseback, prepay, pay as you go — we’re seeing absolutely everything and people are exploring every option,” said Goldman.
Overall, stakeholders noted investors shifting to solar investments as solar technology has become more predictable. “Solar is a proven technology and the risks have been run out of it,” said Kunhardt. He said that solar projects shouldn’t be priced at the 25 percent plus levels, or two to three times (the) capital necessary to attract venture capital investors.

The residential solar market, in particular, is expanding rapidly. Industry participants attribute it to the lowered cost of solar, a compelling value proposition to homeowners and large growth potential. “Residential solar is attracting a lot of capital,” said Katz. “There’s so much room to go, theoretically … there’s no end on the horizon as to how much capital they need.”

In terms of scale for utility projects, smaller and medium-sized projects are becoming more prevalent. “‘Bigger is better’ is valid only up to a certain point,” said Goldman. “Interestingly enough, the monster solar utility projects are proving to be more challenging.”

He said that because the permitting process for undertaking projects that are about 100 megawatt (MW) or larger can be challenging and time consuming, there’s been a shift to produce more moderate scale (20-50MW) projects that can be aggregated later because “people can feel more nimble with those.”

Among municipal deals, power purchase agreements (PPAs) dominate because municipal debt is in limited supply. However, as lower natural gas prices have caused PPA prices to tighten, more developers are exploring merchant options so they don’t get locked in delivering energy at low PPA rates.

Debt Availability
“Large projects (more than $50 million) have plenty of competition from large lenders,” said Kunhardt. “Smaller projects can be orphans.” Industry participants said that fortunately, regional and local banks are starting to become more active in lending to smaller energy projects.

When several foreign banks withdrew from the U.S. energy market after the national recession in 2008, U.S. energy lenders tightened terms and shortened tenures. Matthew Wright of NCB, who provides senior debt to renewable energy projects, said he looks for developers who have strong pipelines and ready tax credit equity investors. He also looks for projects in states with good incentives, such as Massachusetts, North Carolina and California. Wright said the bank finances many 15-year, self-liquidating loans on a 20-year PPA.

Future
Stakeholders predict underlying costs will continue to decrease. With this, they expect to see continued consolidation of manufacturers, more vertical integration and greater specialization. “2013 is the year of the M&A (merger and acquisition),” said Goldman. He credits this to greater capital availability and an increase in the number of players in the market.

Although the renewable energy market has great potential for continued expansion, industry participants said legislative uncertainty about whether incentives will be renewed each year makes it difficult to plan renewable energy projects in the long term. Kunhardt said, “The annual guillotine that may fall on a long lead time project makes the folks capable of doing them reluctant to even start.”

Wright agreed, “From a growth perspective, regulatory reform is keeping people on the sidelines and keeping liquidity out of the market.”