Price, Risk Standards Required for Scaling U.S. Commercial & Industrial Solar
By most measures, the U.S. solar industry is doing very well with gross installation rates, growing by at least 2x per year for the past several years.
Yet, sustaining recent growth rates—or even accelerating the market’s pace—is far from guaranteed. If we want solar to become a significant contributor to our electricity generation in the future (today it’s only ~0.2% of annual U.S. electrical generation), we have to overcome significant challenges. Unreliable, unavailable, and uncertain photovoltaic system performance data; widely disparate business and finance practices; and the lack of real standardization for project evaluation stand in the way of a market eager to scale and mature now.
In short, solar needs a set of winning rules.
The Prize and Its Problems
The commercial/industrial (C&I) solar PV sector has enormous market potential to create tens of thousands of new domestic jobs, spawn billions of dollars in business enterprises, and provide cleaner, renewable, and more affordable electricity. Today, this potential remains largely untapped.
Aggregate C&I rooftop capacity potential in the U.S., as estimated by the National Renewable Energy Laboratory (NREL), may exceed 100 gigawatts by 2030, significantly more than is projected for residential rooftop PV. Unlocking this economic opportunity hinges largely upon the solar industry adopting common practices that establish a de facto or official financing standard within the commercial segment.
Without standard screening, selection, and scoring criteria, the C&I PV sector is encumbered with too many complexities that impede efficient and reliable project development and finance. This overly complex business environment increases acquisition and transaction costs and stymies market growth.
The residential solar PV market has been revolutionized by innovative project structures and systematized financing schemes like the solar lease, but similar lease programs have been very slow to gain hold in the C&I market. The residential PV sector benefits from a longstanding standard credit rating system in the FICO score, and residential solar deals are rapidly being standardized and turned into a very consumer-friendly product with few options for bilateral negotiations. When residential deals get complicated or fall below certain standard criteria, disciplined vendors are well prepared to cut the line and move on to the next customer. Unfortunately, leasing structures for C&I PV projects still require protracted negotiations over almost all the terms, which minimize the potential for lease standardization.
What’s more, finance sources often apply the same transaction, diligence, and underwriting processes required for large-scale utility investments to much smaller sized C&I projects. These deal structures and related transaction costs work at utility-scale (>10 megawatts) where millions of dollars in capital expenditures can bear these costs and customization. However, these same costs can be, and often are, crippling to the smaller projects (generally ~0.1 to ~2 megawatts) found in the C&I market. For the C&I market, deal related costs can contribute as much as $1/watt to total installed costs or over $100 billion if applied to the 100GW potential in C&I rooftop PV.
Separating the Hype from the Bigger Picture
To be fair, the C&I PV market has done well in the U.S. when compared to other segments. In total, the C&I market had more PV installed than the residential or utility markets in six of the past ten quarters. Yet, the vast majority of these C&I installations are on rooftops owned by the highest credit quality entities, such as Fortune 500 companies, governments (state, local, and federal), or entities that carry the credit backing of those governments (typically termed the “MUSH” market, for “municipalities, universities, school, and hospitals”).
Just take a look at the size of the assets on the balance sheet of those companies that are on the top 20 PV installed list: #1 Walmart ($193B), #2 CostCo ($27B), #3 Kohl’s ($14B), etc. These companies can finance the PV systems themselves due to their available cash reserves, or enjoy attractive leasing terms when hosting a system owned by a third-party.
So, while recent growth in C&I PV Installations is exciting, it represents the “low hanging fruit,” a mere fraction of C&I potential for PV. Currently there’s only two gigawatts of C&I PV installed in the U.S., so there’s still 98 percent of NREL’s 100 gigawatt mark to go. Probably about 90 percent of future C&I capacity would need to be installed with hosts that have unrated and non-investment grade credit.
A Credit Screen: Key Piece to the Solution
To address this challenge Rocky Mountain Institute and Distributed Sun, a C&I PV developer, financier, and platform-services provider, are assembling a collaborative group of leading PV value-chain stakeholders to create an affordable and transparent credit screen. The group is being assembled under the belief that an open-sourced credit screen can provide multiple benefits toward greater C&I PV financing. They are:
- Reducing deal dropouts: Financiers can select to review deals that have passed a screen. This should reduce the cost of projects as financing fees can be lowered.
- Providing industry-based feedback: Developers will have a clear signal from the requirements built into the screen as to what the broader industry believes is integral to quality projects.
- Improving investment returns: Better deals lead to safer investments. No market can succeed unless capital providers earn reasonable, reliable, risk-adjusted returns.
- Streamlining full-blown credit evaluations: Currently, the expensive costs of an assigned project ratings team from agencies such as S&P, Moody’s, and Fitch are inhibiting C&I projects. A simpler, much more affordable rating, specifically suited to the C&I PV market, can be built with a standard credit screen as a front-end input to the larger set of tools involved in the full credit evaluation. There are already entrepreneurial providers of such C&I PV credit evaluations, but our belief is that a transparent, front-end screen would go a long way toward improving adoption rates, trust, and reliability of such credit evaluations.
Together, RMI and Distributed Sun are looking to leverage the work begun last year with Distributed Sun’s truSolar™ effort, an underwriting process that rigorously tests and identifies higher yield, lower risk solar investment opportunities, and expand it to become a public resource through collaborative engagement and development.
A transparent, consortium-built, affordable credit screen for C&I PV projects should streamline project selection and financing, while mitigating defaults. The most effective screen would live on in perpetuity, regularly updated and maintained by a standards organization.
Virtually all financing within the C&I PV market has been with rated credit counterparties, which represent only a small fraction of commercial real-estate owners and tenants. The development and deployment of a C&I credit screen and the credit evaluation tools that will utilize it can open up financing to a much larger pool of viable C&I projects. Opening these doors is a critical step toward realizing the C&I PV market’s substantial potential.
Chase Weir is the CEO of Distributed (www.distributedsun.com)