Conservation Update: States Explore Financing Options for Solar Photovoltaics

This article was featured in the July-August 2008 edition of the State Energy Program's bimonthly newsletter, Conservation Update.

by Karlynn Cory

When state and local government agencies consider solar photovoltaics (PV) as a meaningful option on their buildings and land, the focus turns inevitably to project economics and financing. How do they meet the challenge of structuring the costs, incentives, and revenues?

As public officials examine an array of financing options that vary considerably from state to state, they are discovering third-party owner financing of photovoltaics on state and local buildings. This type of financing is common in the private sector for investments that require large capital outlays with long-term paybacks, and it allows state and local governments to take advantage of federal tax incentives.

In states with solar requirements and rebates, photovoltaics (PV) are becoming commonplace on public buildings and land managed by state and local governments. It's part of the recent boom in U.S. PV installations.

According to the Solar Energy Industries Association, annual sales of grid-tied PV systems grew by 50% in 2007 to almost 150 megawatts (MW) of rated capacity from 12,714 systems installed. System sizes are also increasing, and those rated at 1 MW and higher now make up 23% of the market. Corporate and government orders accounted for more than half of last year's sales.

State and local agencies may choose PV for a number of reasons:

• Reduce utility bills over the short- and mid-terms
• Fix electricity costs into the future
• Reduce emissions of greenhouse gases
• Provide emergency power during grid disruptions
• Promote local job growth
• Comply with "green" goals or requirements
• Respond to support for solar among constituents.

For the solar industry, the opportunity to install PV arrays on public buildings is enticing. According to the DOE Energy Information Administration, approximately 574,000 buildings were owned by state and local government agencies in 2003, which represents 12% of all nonresidential buildings. If these buildings obtained 1% of their collective demand for electricity from PV, they would require 1,450 MW of capacity (assuming a 14% capacity factor).

Costs and Revenues for Public Sector PV Installations

Despite a downward trend in prices and significant growth in recent years, PV costs remain relatively high. Grid-connected PV systems in California run $9–$10 per watt, and public sector PV systems larger than 100 kilowatts (kW) will cost hundreds of thousands of dollars.

The energy output from a PV system depends on its efficiency and the solar resource at a particular location. Cash flows from a PV system derive from energy savings that reduce payments for utility bills, sales of excess electricity to the utility, and the ability to sell renewable energy certificates. Under the simplest financial arrangements—paying for PV systems with cash from the general fund or a loan—these cash flows result in a payback periods of well over 30 years in all states. (Note that this calculation does not include any incentives or sales of renewable energy certificates).

Cost Savings from Onsite Generation

Utility regulations such as those defining net metering can significantly affect the payback equation. A PV system on a customer's facility connects to the electricity grid on the customer side of the meter. Like all onsite generators, PV systems reduce electricity bills from the utility.

If, however, the PV array produces more electricity than the facility needs at any given moment, electricity will flow from the customer to the utility. Most states allow the utility to buy back this excess electricity through net metering. Under net metering, the utility meter spins backward when electricity from the onsite PV system is exporting. The utility bill typically settles the balance monthly or annually. The question then becomes how much the utility pays: the retail rate it charges customers, the wholesale rate at which it generates electricity, or an "avoided cost" set by regulators that is somewhere between the retail and wholesale rates. Net metering structures differ between states.

In states without net metering, the customer has to purchase a separate meter for exporting PV generated electricity to the grid. This adds cost, and the utility usually pays a lower rate for the electricity. Thus, states with aggressive net-metering regulations are experiencing growth in PV sales, and states with weak or no net-metering policies are experiencing little or no growth at all.

Renewable Energy Certificates Increase Revenues

Without other incentives, offsetting a percentage of a facility's retail electricity purchases with PV-generated electricity and net metering will probably not be sufficient to make an economic case for solar energy. Additional revenue streams are required, such as the sale of renewable energy certificates (RECs).

RECs, which are also called green tags, are tradable commodities that represent the renewable or solar attributes of PV generation separate from the electricity. The definition of attributes varies across contracts, but will likely include any future carbon trading credits, emission reduction credits, and emission allowances.

Green tags are purchased voluntarily across the country, mostly by corporate and public sector buyers. In January 2008, Intel became the U.S. corporation with the largest purchase of green tags at 1.3 billion kilowatt-hours (kWh). For background, read an article published in the February 2007 edition of Conservation Update titled "Growth Spurt for Green Power."

In addition to voluntary markets, RECs have become the predominant mechanism for complying with renewable portfolio standards. Currently, 26 states and the District of Columbia have renewable portfolio standards, and 16 of these have specific requirements for solar or distributed generation. The most common requirement is called a solar set-aside under which a small percentage of the overall renewable energy requirement must be met with solar energy (see map on page 1).

A separate solar requirement is needed to protect high-cost technologies such as PV, which would have difficulty competing with more established, lower-cost technologies such as wind. The intent is to foster a market for solar technologies. These states are the origins for trading in solar RECs, which have developed into a separate commodity that trade at higher values than RECs based on generation from wind or biomass (see chart for sample costs of solar RECs per megawatt-hour [MWh]).

According to 3 Phase Energy Services, solar RECs provide 40% of the revenues for its PV projects in Colorado. For some projects in other states with solar set-asides, RECs can make up 80% of revenues.

Example Project: Atlantic County Utilities Authority, New Jersey

In 2006, the Atlantic County Utilities Authority installed 500 kilowatts (kW) of solar PV at five locations within its wastewater treatment facility in Atlantic City, New Jersey. The project cost $3.25 million, which was funded through a rebate worth 57% ($1.85 million) from the New Jersey Clean Energy Program and a low-interest loan of $1.5 million from the New Jersey Environmental Infrastructure Trust Program. The system produces about 660,000 kWh of electricity per year. The authority publishes online minute-by-minute output from its PV system.

Over the 25-year term of financing, revenues from energy savings and sales of solar RECs exceed interest payments. The authority publishes a spreadsheet detailing costs and revenues that demonstrates a net present value of $1.8 million for the project.

State and Federal Incentives for PV

In most cases, avoided electricity costs and the sale of solar RECs will not be sufficient to structure a public sector PV project with a payback period that meets fiscal guidelines. Most state and local agencies will seek incentives to reduce the upfront cost of the system. You can read about the following incentives on this page:

• State tax incentives, rebates, and systems benefits funds
• State and local bond financing
• Federal tax incentives, REPI, and clean renewable energy bonds

Important as incentives are to PV financing, each has specific requirements that will sometimes exclude certain public agencies. A short list of financing incentives follows.

State Tax Incentives, Rebates, and Systems Benefits Funds

State support for PV is substantial. For example, state public benefit funds will collect $6.8 billion for renewable energy installations for the period from 1997 to 2017, a substantial portion of which is expected to help support the solar industry and solar projects.

State tax credits, sales tax exemptions, and property tax exemptions create value for corporate purchases of PV systems. According to the Database of State Incentives for Renewables and Efficiency, 24 states offer some type of tax relief to encourage renewable energy development. In Oregon, public sector agencies can participate in the Oregon Business Energy Tax Credit—worth up to 50% of the installed cost of a renewable energy system—by selling the credit to companies that can apply the credit toward their state tax obligations.

Rebates from system benefit funds provide direct support for PV installations. Sixteen states and the District of Columbia collect a small fee from electricity customers to fund energy efficiency projects or renewable energy installations. Rebates can cover a significant portion of the installation cost of a PV system. In New York, for example, state and local government agencies can receive rebates of $5 per watt for the first 25 kW and $4 per watt for up to 100 kW of installed PV capacity. In Ohio, public sector rebates start at $3 per watt. A standard requirement is that recipients of the rebates be utility ratepayers who pay into the fund.

State and Local Bond Financing

Public entities often finance capital improvements by issuing general obligation bonds and revenue bonds. In return for cash from the sale of the bonds, the bond issuer agrees to repay the principal plus interest on a specific date. The interest paid on municipal bonds is exempt from federal taxes.

General obligation bonds are supported by taxes (the taxing authority of the bond issuer) and are usually approved by voters; a municipality is limited by the amount of debt it can carry for bonds. Revenue bonds are usually issued by special purpose authorities such as toll roads that repay the debt from fees. These bonds are not supported by taxes and rarely require voter approval.

A few state and local governments are experimenting with issuing bonds that are repaid from energy savings. In 2007, for example, Delaware announced the creation of the Sustainable Energy Utility to promote energy efficiency. Funding, including $30 million in special purpose revenue bonds, is expected to be repaid through energy savings.

Federal Tax Incentives, Clean Renewable Energy Bonds, and Renewable Energy Production Incentive

The federal government supports PV installations through the tax code and through some direct payments. While state and local governments do not pay taxes, creative market players are figuring out how municipalities can leverage tax credits using third party ownership and power purchase agreements to take advantage of federal tax incentives for PV (see page four of this article).

• The investment tax credit provides a 30% tax credit, which is scheduled to expire at the end of 2008, for a private sector investment in PV. The rules for the credit are complex enough to require legal review before they are submitted to the Internal Revenue Service (IRS).

  The IRS also allows for accelerated depreciation of the value of renewable energy systems and provides a bonus depreciation for PV systems placed in service in 2008. Like all federal tax credits, this depreciation will only affect the tax obligations of private sector investors.

• Clean Renewable Energy Bonds provide a tax credit to the private sector buyers of the bonds in lieu of interest payments from the public sector agencies that issue the bonds. (See the diagram.) Congress created the Clean Renewable Energy Bonds in 2005 and has allocated $1.2 billion for them, which was distributed in two rounds. In the first round, 433 PV projects (of 620) received funding; public sector projects accounted for 93% of the total. In the second round, public sector PV projects received $262 million.

  

  Public agencies must meet IRS rules to participate. The bond must be issued by the end of 2008 and the first principal payment is due in December of the year it is issued. The IRS uses the market rate for AA-rated corporate bonds to determine the tax rate to offer investors. However, public agencies may find it challenging to find a loan at that rate and might have to make supplemental interest payments, or sell the bond at a discount. And the IRS allocates funds to smaller projects first, which increases overall transaction costs. One creative solution offered by the Commonwealth of Massachusetts reduced transaction costs by bundling the financing for 12 PV projects into one package.

• The Renewable Energy Production Incentive (REPI) provides payments to state and local governments, nonprofit electricity distribution cooperatives, Indian tribes, and U.S. overseas territories that produce renewable energy. The program depends on yearly allocations from Congress, which are currently about $4.9 million. Unfortunately, $20 million worth of REPI credits were requested in 2006, so the program was able to pay only 25% of the amount requested. The average allocation for each of the 25 solar projects that received REPI funds in 2007 was $898. Because of the uncertainty with REPI, financiers do not consider the incentive "bankable" and ignore it when considering project economics.

Third-Party Owner Financing Can Pull All the Pieces Together for Public Sector PV

The PV financing option of choice emerging for state and local governments able to work with their utility is third-party owner financing. According to Greentech Media, 50% of the growth in the commercial and institutional markets for PV in 2007 occurred because of third-party owner financing compared to just 10% in 2006. You can link to the following subheadings on this page.

• How it works
• Benefits
• Caveats
• Example project: Denver International Airport

Third-party owner financing is increasingly common in the private sector, but relatively new for financing public sector capital projects. As with any financial structure, there are pros and cons.

How It Works

Of all the models presented here, third-party owner financing is the most complex because it involves cooperation between an investor, a project developer, the power company, and the public agency. (See diagram.)

Instead of owning the PV system, a public sector agency hosts it on a building or piece of land it manages. The system is owned and paid for by a private sector investor that can take advantage of federal tax credits. The investor enters into a long-term power purchase agreement with the host that can last 20–30 years. Typically, the purchase price for the electricity is set at or below the host's current retail rate for the first year and then increases at a fixed percentage every year.

A professional project developer designs and builds the PV system and is usually responsible for arranging all aspects of the transaction, including financing. The developer will operate and maintain the system over the lifetime of the agreement. Often, the developer will receive income from the sale of solar RECs to keep the host's power price low.

There are many ways to structure the contracts. For example, the host may have the option to buy the PV system at the end of the agreement.

Benefits

Third-party owner financing provides numerous benefits for state and local governments and agencies.

• Ability to monetize federal tax incentives.

  Chief among the benefits is the ability of the company financing the PV installation to take advantage of federal incentives that are unavailable to public sector organizations that do not pay federal taxes. The net effect is to lower the overall cost of the installation.

• Low or zero upfront costs.

  For public sector agencies with strict budgetary limits, the ability to finance a long-term capital investment without affecting its short-term cash flow can be an important benefit. The third-party ownership structure allows the project developers and investors to deal with the initial cost.

• Predetermined electricity price for 20–30 years.

  Having predictable electricity bills for a portion of electricity demand is a real benefit for public agencies, as their budgets do not have the flexibility of private sector organizations.

• Shift operations and maintenance responsibility to a qualified third party.

  An attractive feature of the third-party ownership structure is that the operation and maintenance of the PV system can be assigned to professional organizations. The host thus streamlines its day-to-day interactions with the PV system to a single organization.

Caveats

As with any ownership structure, several points must be considered when evaluating a specific project for third-party ownership. Contracts can be complicated and must be structured with care. As a result, transaction costs can be higher than for other arrangements.

Another issue can arise if a public agency sells the solar RECs. This means the agency no longer owns the "green" attributes of the PV system and cannot make public claims that it is powered by renewable energy. Only the owner of the RECs has the right to claim the renewable attributes of the electricity produced by the PV system. (Some public agencies purchase other RECs at a lower cost than the solar RECs they sold in order to make green power claims.)

Some public agencies will have difficulty with not owning a power system that is sited on the agencies' grounds or providing ongoing and long-term access to agency facilities.

In Nevada, there are questions about the legality of using third-party owner financing for onsite projects. The Public Utilities Commission of Nevada is investigating this question and is expected to issue a ruling late in 2008. (Colorado utility Xcel Energy has provided an answer to some of these legal concerns by waiving its right as a monopoly electricity provider as part of the solar REC contract with the developer.)

Example Project: Denver International Airport

Some state and local agencies are not allowed to use—nor do they find desirable—third-party owner financing. Nonetheless, this financial structure has supported some of the largest PV installations in the United States in the last two years.

For example, Denver International Airport entered into a 25-year power purchase agreement with MMA Renewable Ventures to install a 2-MW PV system in front of the entrance to the main terminal. The project is under construction and is expected to go online before the end of 2008. The system will produce about 3.5 million kWh per year.

Xcel Energy, the local utility, provided a rebate for the installation and will buy the solar RECs. The agreement helps the utility meet its solar requirements under the Colorado Renewable Portfolio Standard. The agreement also contains a buyout option after year six at the fair market value—estimated at $8.1 million—that will allow the City of Denver to own the PV system.

This article is based on a technical report published in May 2008 by DOE's National Renewable Energy Laboratory titled Solar Photovoltaic Financing: Deployment on Public Property by State and Local Governments.

 

About the Author

Karlynn Cory serves as an energy analyst at the DOE National Renewable Energy Laboratory (NREL) in Golden, Colorado. Cory has 12 years of experience analyzing renewable energy policies and U.S. electricity markets. She has an in-depth understanding of investor requirements to get renewable energy projects financed, as well as policy tools that can be used to encourage increased capital for renewables. She has extensively evaluated renewable energy certificate (REC) markets for renewable portfolio standards and voluntary green power markets.

Before coming to NREL, Cory was a business development manager at the Massachusetts Technology Collaborative in Westborough, Mass. She holds a Masters of Science Degree in technology and policy Massachusetts Institute of Technology and a Bachelors of Science Degree in Mechanical Engineering from Tufts University.