By Tam Hunt, owner of Community Renewable Solutions LLC
The solar market is booming in the US. We recently surpassed ten gigawatts of installed capacity, just a year after we surpassed five gigawatts. The future is equally bright. With this boom in solar we’re seeing new ways for investors to become involved in this exciting business.
California is considered to be the most attractive state in the US in terms of renewables investment opportunities, and the US is considered to be the most attractive nation in the world in terms of renewable investment opportunities (Ernst & Young 2013 Renewable Energy Country Attractiveness Index), rising above China, which held the top spot in 2012. So California is a good place to invest in renewables. That said, it is still a highly competitive investment environment and permitting obstacles are common.
The Renewable Portfolio Standard is the primary policy mechanism guiding renewable energy development in the state. The current mandate is to reach 33% renewables by 2020 and this mandate applies to both investor-owned utilities (like SCE) and to publicly-owned utilities like LA DWP. A number of procurement programs exist under the umbrella of the RPS program, discussed in detail below.
California is roughly on track to meet the 33% RPS mandate but there is plenty of capacity in the later years of this decade that are not yet procured (including expiring contracts). There are also a number of existing programs for smaller solar projects that have remaining capacity, as described below. There is also a growing push for a higher RPS by 2025 and 2030 and it is likely that a 50% or higher RPS by 2030 will be adopted before too long.
I wrote recently about various ways to invest in renewables. This article is a follow-up that focuses in on the new opportunities to invest directly in renewable energy projects.
The advantage of investing directly is the satisfaction and security of owning a tangible thing rather than a piece of a company that could fold and go away entirely. There is now a large ecosystem of project sizes and investment opportunities that includes smaller projects within reach of non-institutional investors. The solar investment arena is increasingly being democratized, with opportunities to invest in shares of projects or to buy projects as small as a 100 kilowatts (turnkey cost at about $300,000 in 2014) up to many megawatts.
There are two categories of project investment opportunities: greenfield and brownfield. Greenfield projects are developed from scratch – a piece of dirt and a dream. Greenfield projects can be very profitable but also very high risk because there are so many things to go wrong. I covered greenfield project development in a previous article, so the rest of this article focuses on brownfield acquisition.
Brownfield projects are projects are generally fairly close to being fully entitled, but the term can also refer to projects that are at some point along the development path. If an investor buys into a brownfield project they are buying into a project that is either fully or nearly fully entitled, which means the project has all the required permits and authorizations, including site control, interconnection authority, a Power Purchase Agreement, and environmental and building permits as required.
To successfully invest in a brownfield project, the following items are important:
Due diligence requires that a potential buyer examine the documentation provided by seller in detail, making sure that it is complete and legitimate. Legal documentation can be complex and you’ll need a lawyer on your team to ensure that i’s are dotted and t’s are crossed. Due diligence also includes a site visit and should include visits with local permitting agencies to ensure that no surprises await.
An equally important part of the purchase process is the financial analysis of the project’s costs and revenue. This requires that cost estimates are double-checked (or taken on faith if warranted) and spreadsheets are triple-checked. It’s also smart to use more than one financial model to make sure that they corroborate. This reduces the chance of mistakes. When potentially millions of dollars are on the line it’s obviously important to make sure that the numbers add up.
There are a number of publicly available financial models. My preferred model is NREL’s System Advisor Model. The RETScreen Excel-based model is also quite good and also free.
Another key feature of financial analysis is determining the appropriate mix of debt and equity financing. Debt financing offers lower interest rates than equity. Typically, however, debt financing is not available for more than 50% of the cost of the project. Tax credits can provide another significant chunk – generally 30% of the project cost. The rest must be financed with equity, which can come from either the investor herself or outside equity. Outside equity can be quite expensive because today’s equity investors generally know how important their contribution is for the success of a project.
If an individual or company investor has the luxury of being their own equity investor, return on investment can be far higher than would otherwise be the case. However, the equity investor must have the tax appetite to absorb the available tax credits. If the investor has the tax appetite already, this is the best of all worlds. The current investment tax credit is 30%, but will fall to 10% by 2017. My feeling is that the 30% credit will probably be renewed, but time will tell.
Making an offer
Investors can generally make an offer for either: 1) the asset as-is, which includes all the entitlements to date, plus reimbursement of any expenses. Payment for the entitlements to date will usually be folded into a developer fee that makes the greenfield development worthwhile for those intrepid souls who engage in greenfield development; 2) a turnkey project that is either built or, more generally, fully entitled but not yet built. The turnkey project will have a clear path to construction and commissioning. Option 1 entails more risk but, as is always the case, higher risk also entails the potential for higher profit. Option 2 is less risky but also presents less opportunity for fine-tuning and value engineering the project.
In sum, brownfield project purchases are the flipside of greenfield project development, because greenfield developers often rely on brownfield purchasers for their exit strategy. Investors can choose where to get into the game – at the starting line with greenfield or at some midpoint or the endpoint with brownfield projects.
As with all investing, it’s a matter of risk appetite. Don’t get into the solar investment game with money that is needed for retirement. Rather, look to the kinds of investments covered here as ways to maximize income from available capital.
About the Author: Tam Hunt is the owner of Community Renewable Solutions LLC, a California- based company that provides consulting and legal advice on project development (brownfield and greenfield) and regulatory advocacy at various state and federal agencies.