Report Release: Financing Community-Scale Solar
Download Financing Community-Scale Solar here.
Effective financing approaches have been fundamental to the solar industry’s exponential growth over the past 15 years. The first solar power purchase agreement (PPA) in the early 2000s enabled customers to spread their upfront costs for solar over time, just as home mortgages do. Starting in 2005, federal tax credits for renewables helped to reduce overall costs and encouraged new investors to enter the market. These and other innovations spurred the commercialization of residential and utility-scale solar photovoltaics (PV) in the U.S. by transforming a once-marginal energy asset into a product that households, companies, and local governments can more easily access.
A NEW DAY FOR SOLAR
The same trend is beginning to take hold today with community-scale solar (CSS). These systems, ranging between 0.5 and 5 megawatts in capacity, are located on the distribution grid with potential for a more than 30 percent cost savings relative to other distributed solar installations. CSS is an emerging multigigawatt market opportunity because of its ability to serve all types of load profiles, whether those of distribution utilities, businesses, local governments, or the more than 50 percent of households estimated to have inadequate roofs for PV panels.
Although certain risks and technical challenges remain, CSS can enable new and more attractive value propositions for these customers through its unique attributes and a number of effective financing options. In the process, it can create value for multiple industry stakeholders and address slowing rates of growth in the utility-scale and rooftop solar markets.
Bloomberg New Energy Finance forecasts that annual utility-scale solar additions, in particular, will plateau over the next two years amid signs of stress from continued strong competition and uncertain demand. At the same time, a growing quantity of new speculative development assumes financing will be available for 10-year PPAs—leaving later cash flows uncertain—based on expectations of continued availability of low-cost debt, even as interest rates are expected to rise.
Within the residential solar industry, national leaders are beset by local competitors advantaged by lower customer-acquisition costs. Underlying that local advantage is a shift away from third-party ownership to upfront purchases, either by cash or third-party-provided loans, as households’ familiarity with solar increases, system costs decline, and interest in direct ownership drives a shift away from demand for PPAs and leases. The decline of those offerings creates new opportunities but uncertain implications for the medium-term growth in residential solar.
UNDERSTANDING RISKS AND OPPORTUNITIES
As a result, efficiently financing and developing CSS projects can help pick up the slack and accelerate solar market growth. But the huge market opportunity created by CSS won’t be realized without listening to the “community”—in whatever form it takes. The most successful financing and business models will leverage the flexibility of CSS to pilot solutions and iterate quickly. The time to act is now. In the past 18 months alone, the number of states with CSS projects has increased by nearly half to 37, as pilot projects help improve knowledge of what works and what doesn’t on the road to scaling this market.
But among developers, financiers, and communities, coming to a shared understanding of the risks and opportunities of CSS can be challenging. Rocky Mountain Institute’s Shine program and Sustainable Finance practice have collaborated on a report outlining project structures that address key risks and opportunities for stakeholders interested in developing and scaling CSS projects. The report, Financing Community-Scale Solar: How the Solar Financing Industry Can Meet $16 Billion in Investment Demand by 2020, is based on recent on-the-ground community and industry experience.
Reasons to prioritize CSS, relative to other solar segments, include the many benefits of this approach, such as:
- Customer retention: Significantly lower electricity costs relative to PPA prices for residential or commercial and industrial rooftop solar are likely to reduce long-term customer default rates.
- Diversification of customer credit risk: Aggregating various types of customers into one offtaker pool improves the overall credit quality of each project (which, in turn, reduces the cost of capital) and eases the reallocation of contracts if a customer defaults.
- Strong alignment of local interest: CSS can create significant goodwill among authorities that utility-scale solar may not, especially when electricity from a project is made available to a broader swath of a community.
- Professional management: As a relatively centralized generation asset, CSS is likely to generate solar more predictably than would many distributed projects, providing more stable cash flows for project owners and their financing partners.
- Scale of deployment: CSS’s size advantage, unparalleled among other distributed solar assets, can attract capital at more attractive rates.
INNOVATIVE STRUCTURES CAN ENHANCE ACCESS AND REDUCE COSTS
To highlight innovative CSS financing structures, the report first provides the landscape of established models for financing distributed solar. These include projects with creditworthy counterparties, whether MUSH entities (municipalities, universities, schools, hospitals) or utilities (distribution cooperatives, municipal, or investor-owned). In addition, households can subscribe to and/or purchase ownership in these centralized CSS systems. Both of these structures permit significant levels of debt financing and monetization of tax benefits (such as the Investment Tax Credit and accelerated depreciation), based on the diversity of offtakers and/or historically low levels of payment default.
Harnessing federal regulations and tax benefits
Just as the Low-Income Housing Tax Credit has helped fund the construction of more than four out of five affordable housing complexes nationwide since 1986, CSS stakeholders may be able to utilize existing federal programs to reduce the cost of financing. Commercial bank appetite for Community Reinvestment Act credits or equity investor interest in New Markets Tax Credits can provide low- and middle-income communities access to projects with improved economics that can afford additional credit enhancement for broader access. Such practices can pay additional dividends by easing screening criteria and reducing customer acquisition costs.
Community solar with community ownership
Over the medium term, some CSS developers may turn to new financing models, such as crowdfunding and investment platforms, to reduce finance costs and improve community participation. In one hybrid model, community investors may acquire an economic interest in operational projects over time, after tax attributes have been exhausted and the value of shares in the project decline to a more affordable level. In another, community-based owners (such as an urban cooperative) can apply an “inverted lease” structure from the outset, permitting them to adopt a preferred governance and debt structure while enabling tax equity investors to capture tax benefits and reduce overall project costs.
Credit pass-through and securitization
MUSH or utility offtakers can also reduce the risk of household default to project owners (and, as a result, the total energy cost to local households) by acting as the PPA counterparty, “backstopping” those households’ contracts in what is often called a credit pass-through transaction. Alternately, for projects specifically serving households or other community customers, as the number of projects and household offtakers increase, one or more developers may, in time, (together or separately) access the asset-backed securities (ABS) market to reduce the cost of financing, as in residential transactions.
MANY OPTIONS EXIST TO MITIGATE RISKS
Several key finance-related risks to project owners are highlighted in the report, some of which are particular to projects located in retail electricity markets. These include customer acquisition, short-term subscription agreements, engagement with distribution utilities, market electricity price risk, and regulatory risks (including federal tax policy). As the report details, each of these can present challenges for investors and financiers and should be considered carefully. Where appropriate, CSS stakeholders should act to address these risks in the course of engaging capital partners.
In addition, regulators, developers, financiers, and interested communities should be aware of other nonfinancial barriers to scaling the CSS market, including:
- Interconnection: Nontransparent distribution grids, especially where a large difference exists between CSS rates and local grid tariffs, can waste millions of dollars in CSS development efforts and put project investments at risk.
- Data management: High standards of data transfer and management between CSS providers and electricity distribution companies are necessary to ensure that utility bill crediting (where applicable) is done in a timely and secure manner.
- Permitting and zoning, property taxes: Improved awareness of the benefits of CSS at the local level, as well as streamlined permitting processes and model zoning ordinances, can help direct new investment more efficiently.
RMI is interested in hearing from communities, developers, and financiers about what has and what has not worked in efforts to finance projects. We are actively working to pilot new models that can help unlock segments of the CSS market by addressing the needs of various stakeholders, including project investors. We encourage readers to review the CSS financing report in its entirety, and we welcome collaboration to drive the CSS market forward.