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301 Moved Permanently

301 Moved Permanently


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Haresh Patel, CEO of California-based Mercatus, says Wall Street does not always communicate with solar developers. Project financing rules are being made up on the fly, and he calculates that only 2% of all solar projects get a green light in the form of money. However, nothing gets the message across to financiers like a signed power purchase agreement (PPA).

Patel’s energy finance software company has identified 570 data points that describe a solar power project proposal. Mercatus has codified these data points into a software program to help developers communicate the aspects of their projects to potential financiers, and for the latter to evaluate risk and return. The goal is to establish price points, terms and conditions and bring the parties together. But not all data points are created equal from a project risk perspective.

“The PPA is the 800-pound gorilla in the room,” Patel says. “If you have a signed PPA, you are 30% of the way to a done deal.”

 

Money for electrons

From a buyer’s perspective, the PPA is cash flow. Principal Solar Inc. (PSI), a budding Texas-based power provider, is in the market for distributed solar projects (see “Texas Firm Building Solar Powerhouse”). Michael Gorton, CEO of PSI, says he views potential acquisitions first and foremost through the value of the PPA.

“Of course, you have to look at the engineering of the system, the panels and inverters, and other balance-of-system elements,” Gorton says. “You have to know what the site lease looks like. But in the end, we’re buying PPAs. We’re buying cash flow.”

Often compared to lease agreements, the PPA provides a mechanism for electricity consumers to benefit from solar power without having to pay the upfront costs of installing a photovoltaic system themselves. Generally speaking, the owner pays for the cost of construction and sells the power to the consumer for a specified time, often 20 years or more. Ideally, the consumer ends up paying below market rates for electricity, and the owner and financiers see a reasonable return on investment.

The PPA is also a way for somebody to take advantage of the investment tax credit (ITC) and other tax-based incentives, such as depreciation, for solar projects involving municipalities, nonprofit organizations and other tax-exempt groups. In these instances, the owner of the system is able to monetize the tax benefits while the off-taker pays for the electricity under the terms of the contract.

The importance of a well-structured PPA to the success of a solar project has grown, along with the availability of private capital to finance solar projects. Indeed, the PPA is often seen as a critical component of mitigating project development risk in that it represents a guaranteed stream of money from the customer into the hands of the owner, and thence to the investors.

“The PPA is about revenue,” says Anthony Fotopoulos, president of Conergy Americas. “Without revenue expressed in a PPA contract, it is almost impossible to get financing. Merchant solar is hard to finance.”

While traditional sources of electric power, such as fossil fuel plants, may find builders willing to bank on the rise of electric rates, developers of renewable power do not often get the benefit of the doubt.

“For us, no PPA means no financing; it’s pretty binary,” says Bill Bush, chief financial officer of Borrego Solar. “In the power markets, [fossil] plants are built using merchant assumptions. For solar, you need to have some security. The PPA is the method for achieving that security.”

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Risk in the details

Fotopoulos says the PPA is one of four major factors governing risk in a solar development deal - with the others being site land use and control, interconnection agreements and approval from regulatory bodies.

A 2012 report by graduate students at the Tufts University Department of Urban and Environmental Policy and Planning found that municipalities in Massachusetts faced a number of risks with their PPA agreements, including concerns that the price of conventional energy would fall below the contracted price, breach of contract by the project developer, instability in the solar renewable energy certificate (SREC) market, site damage (e.g., damage to landfill caps), building codes and cost of removing the solar plant at the end of the contract.

According to the study’s authors, three municipalities that did not sign a PPA with a developer reported that negotiations were broken off over the developers’ concerns about uncertainty in the SREC market. The Massachusetts Department of Energy Resources (DOER) has since moved to revise the solar carve-out portion of its renewable portfolio standard in order to impose stability on SREC market prices. (See “Massachusetts Tweaks SREC Program.”)

The U.S. Environmental Protection Agency (EPA) offers a number of caveats - including SREC stability - to consider when evaluating the suitability of a PPA deal. Some of these considerations are as follows:

The very importance of the PPA makes it a complex document by definition. They run 20, 30, even 40 pages, describing a relationship that can span decades.

Bruce Mercy, CEO of Texas-based PPA Partners, says legal wrangling can easily eat up the economic benefits of an agreement. “A 1 MW project can run up $250,000 in legal costs to get across the finish line,” he says. “Everybody’s contracts are different, and if you go back to the lawyers too many times, the project just won’t pay off.”

Borrego’s Bush says his company has written a hundred PPAs and has developed a standard approach that works well with the majority of its customers, which tend to be municipalities. Nevertheless, the customer will have in-house counsel or a hired attorney, and some amount of wrangling is almost inevitable.

“A lot of the attorneys we deal with tend to be litigators,” Bush says. “Part of their process is to call ‘baloney’ on you.”

Because PPAs are not a function of too many law practices, Bush says part of his company’s process is educating customers about what they are getting into and how they are calculating the rates and values. This is where a standard company document comes into play, as there are precedents and examples to show.

“We have done a lot of ground-up development,” he says. “The key for us is we use standard documents. For us, that is really critical.”

Mercatus’ Patel says that creating some transparency in the process of negotiating solar deals is one of the reasons for developing a data-driven, score-based approach to project assessment. If both sides understand what the issues are, there is less need to call for the lawyers. Plus, if both sides are working with the same information, it is easier to determine what key component was missing from the deal without having to renegotiate a new contract or just walk away.

“Perhaps one party is willing to go back to the table if there is a 2 percent escalator,” Patel says.

The provision for annual increases - an escalator - is often the key point of contention in the negotiation of a PPA agreement. Conergy’s Fotopoulos says the key is for all parties to understand long-term power prices. In rare instances, he says, the escalator can be zero - a fixed-price PPA - or even negative, if the initial rate is set high enough. The important point is for the revenue stream itself to be a known quantity throughout the life of the PPA in order to secure financing.

“Escalation has the ability to make projects interesting for both sides,” Bush says. “Utility rates are going up. The PPA shows that the municipality is saving money. It provides certainty. The terms are long-term and predictable.”

Fotopoulos says off-takers regard the PPA as a hedge against electricity prices. The PPA sets a price per kWh that typically has provisions to increase at a certain percentage - usually 2% to 3% per year - that will ideally keep the off-taker paying less than the current market rate for electricity while providing the project owner with a predictable revenue stream and reasonable return on investment. From the perspective of the bank or other lender, the steady revenue stream is what they are lending against.

Bush says a key component of the PPA is that it covers all of the output from the proposed project. “The PPA should be a contract to buy all of the power,” he says. “If the plant generates more than expected, the off-taker should have to buy that power as well.”

This is not to say that the PPA must be limited to a single off-taker. In November of last year, First Solar Inc. signed a PPA with member cities of the Southern California Public Power Authority (SCPPA) for electricity to be generated at the 40 MW Kingbird photovoltaic solar power plant in Kern County, Calif. First Solar is developing the project and will also provide construction services. The cities of Pasadena, Riverside, Colton and Azusa signed 20-year PPAs that will supply 20 MW of power from the solar plant to the cities’ municipal power utilities. A separate PPA for another 20 MW was jointly signed by Riverside, Colton and Azusa.

In a twist, First Solar signed dual PPAs to cover output from another PV plant it is developing in Kern County.

The company signed one PPA with the City of Roseville, Calif., for 32 MW of solar electricity to be generated at the Lost Hills photovoltaic power plant. First Solar says the 10-year PPA, which goes into effect in 2015, is its first such agreement with a municipal utility. The company had previously signed a PPA with Pacific Gas and Electric (PG&E) for the output from the Lost Hills plant, which goes into effect in 2019.

Under the agreement, Roseville will receive 100% of the Lost Hills power plant’s output for the first four years, after which the percentage will decline. First Solar says PG&E will then pick up most of the remaining percentage.

 

A less risky future

PPA Partners’ Mercy says his company’s business focuses on distributed generation solar in corporate campus environments, and in that market, the importance of the PPA is waning.

“There was a time when 80 to 90 percent of our projects involved PPAs,” he says. “Now, it is more like 20 percent.”

The reason for the change is that the decline in the cost of solar power has made ownership more attractive for many businesses. Right now, at current utility rates and solar prices and with incentives such as the ITC still available, it makes economic sense to purchase the system outright. Of course, if the customer is a school or other organization that cannot use the tax benefits, then the PPA is the way to go. But for-profit concerns have to wrestle with the purchase versus PPA decision.

“If you could qualify to buy, you could qualify for a PPA,” Mercy says. “Then you have to run the analysis and do your solar forensics.”

Again, the relationship with the client is an important element of this decision. Mercy says if you are a company in the solar business for the long haul, then you want to do your best for the customer because the customer recommends you to other customers.

Borrego’s Bush says the time of the PPA is still upon us. As a mechanism to save money and have certainty, the contract has no equal - although it would be nice if it were slimmer.

“We haven’t seen a better widget yet,” he says. S

Industry At Large: Project Risk Management

A Solid PPA Takes The Risk Out Of Solar Projects

By Michael Puttré

A creditworthy off-taker is a developer’s best asset.

 

 

 

 

 

 

 

 

 

 

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