Power Purchase Agreements Expand Solar Development

by Cameron Walker

The sun is usually shining across the Hemet Unified School District, which covers 700 square miles of Southern California’s farmlands, foothills, and rugged peaks. Solar power seems a natural fit, and this October the district completed a 4.4 megawatt (MW) solar project that puts photovoltaic (PV) panels at 17 sites—from school parking lots to playground shades. This project will save the district $300,000 annually on its utility bill.

But even though savings will be obtained in the future, how can a school district find funding for projects these days? Using a financing system known as a power purchase agreement (PPA), Hemet did not have to buy the panels at all.

A PPA means that a solar developer or other third party owns, installs, and maintains solar panels for a customer—be it a school, a business, or a local government. In exchange, the customer signs a long-term agreement to buy power from the developer, usually at a lower rate than they would pay a conventional utility.

For states and municipalities, new financing models are becoming increasingly attractive because they can lower financial hurdles for solar projects, according to Carrie Cullen Hitt, vice president of state affairs for
the Solar Energy Industry Association. And PPA-financed projects are one way for states to meet renewable energy goals, particularly during an economically challenging time.

Utilities were the first to buy solar power for their customers from massive PV arrays owned by a third party. In 2004, SunEdison began to use this financing model for distributed installations, starting with a solar project on the rooftop of a New Jersey Whole Foods store. In a distributed installation, PV panels are installed at a customer’s location, whether the rooftop of a business or a public building.

“The PPA started out very large, and has since expanded to smaller and smaller projects,” said David Feldman, a solar technology financial analyst at the National Renewable Energy Laboratory. Incentives and
tax rebates at the federal, state, and local levels, along with changing state and local regulations, have allowed this financing model to grow.

Incentives Fuel PPAs

Solar developers looking at potential projects have an eye out for multiple qualities that allow them to secure funding and get a project built. With the PPA model, the contract to provide power—usually 15 years or more—means that there will be a long-term source of revenue for developers and those who finance them.

To get financing for a project, developers often approach lenders— whether private investors or lending institutions—with either a large project or a portfolio of several small projects, according to Feldman. A sale-leaseback is one way to structure a project like this: the developer sells the project to the bank and then leases it back, using electricity payments from the PPA and getting the benefit of performance-based incentives. As the project owner, the bank gets the federal investment tax credits and the depreciation on the solar project. Other ways of structuring PPA-financed projects include a partnership flip, in which the developer and lender share designated percentages of the income, incentives, and depreciation.

Private investors in these projects often require double-digit rates of return on their investments; for this reason, developers may borrow lower-interest-rate debt to finance part of their solar projects, so that they do not need to provide such high returns on an entire project. In one form of PPA financing, called the Morris model, government agencies issue taxable bonds to finance a municipal PPA project, which can provide developers with lower interest rate capital to invest in solar projects.

For municipal projects, PPA financing offers a way for government agencies to monetize tax rebates that they otherwise would not be able to use. If a school district or public facility works to finance new PV panels through the PPA model, the tax rebates may be passed along to project owners—and the customers see the benefit through lower utility bills. Another attraction for PPA customers, whether municipalities or businesses, is that much of the hassle involved with installing a solar project—from how to connect to the grid to working with the range of incentives—is the developer’s burden to bear.

Incentives powering the project between the Hemet Unified School District and Tioga Energy include the 30% federal tax credit and a rebate through the California Solar Initiative, a program that aims to install close to 1,940 MW of new solar capacity by 2017 throughout California.

In New York, 40% of the applications to the open-enrollment PV program of the New York State Energy Research and Development Authority (NYSERDA) are now for leases and PPAs. A recent package of solar incentives, called NY-Sun, is aimed at expanding solar’s reach even farther—and is likely to fuel more PPA-financed projects as well. Among the new opportunities: starting in 2013, the purchase and installation of PV panels for commercial projects will be exempt from sales tax.

“We have seen the number of power purchase agreements for PV systems soar in New York State over the past few years, and as Governor Cuomo’s NY-Sun Initiative continues to stimulate the PV market, we expect this trend to continue,” said Francis J. Murray Jr., NYSERDA president and CEO. “Solar energy is an important part of New York’s diverse renewable energy portfolio. The State’s renewable energy capacity is comparable to the entire renewable energy capacity of the eight states in the Northeast.”

NYSERDA’s initiatives covered about 40% of the cost of the 51 kilowatt (kW) system that now helps Brunswick Harley-Davidson, in Troy, get 100% of their electricity from the sun. This system, like most PPA-financed projects for distributed installation, is net-metered, which means that when the system generates power, the electric meter runs backward—and for this project, any extra power generated

by the panels on Brunswick Harley-Davidson’s rooftop and carport beyond what they need is credited back to the business.

Brunswick Harley-Davidson may see additional savings if it continues to use less than 2000 kWh monthly of conventional electricity 12 consecutive months, said Steven Erby of Monolith Solar Associates. Then they will no longer have to pay the utility’s demand charge, which is a monthly fee charged to businesses so they can access a designated amount of power. “The added savings are tremendous,” Erby said.

California and New York are just two of many states where incentives are fueling PPAs. Standard Solar has worked to develop a range of projects along the mid-Atlantic, as well as a recent one in New Mexico. When it comes to state incentives, “the stability of the program is just as important as the value,” said Standard Solar president Scott Wiater. One of these consistent states is Maryland, where Standard Solar has installed a range of projects, including a PV system that provides 80% of the electricity for its host, George Washington Carver Elementary School.

Another thing that can interest developers and those who finance them are the solar renewable energy certificates (SRECs) that can be gained from a project. In particular states, known as compliance states, these SRECs can be generated by installing a solar project and then be sold on the market to those needing to meet renewable portfolio standard goals for solar. SRECs can drive the economics of a PPA-financed project if the market price is high enough.

Regulatory Help for PPAs

For areas looking to embark on solar projects through PPAs, the biggest step is to ensure that these projects are permitted, said Hitt. As of August, 22 states, along with Washington, D.C., and Puerto Rico, authorize third-party solar PPAs. In some states, such as Florida, third-party solar PPAs are explicitly forbidden.

Even in states that do permit them, local restrictions may prevent their use. One question often revolves around whether a developer, rather than a utility, can supply power to customers. But in this and other areas, changing regulations are opening doors for new financing mechanisms.

In 2010, the Arizona Corporation Commission ruled that SolarCity could provide solar panels through PPA to governments, schools, and nonprofit customers without being considered a utility, opening the door for other third-party PPA projects as well. Following this, the town of Gilbert, Arizona, worked with SPG Solar on a 2.3 MW project at the town’s Neely Wastewater Reclamation Facility. The town paid nothing of the $10 million in capital costs to design, build, and install the project, and estimates that over the project’s 20-year contract, Gilbert may save as much as $2 million.

Regulatory steps to pave the way for PPA growth can also be applied to other aspects of a project—from net-metering regulations to how solar projects are permitted.

In Vermont, a law went into effect in January 2012 that replaces permitting with a streamlined registration process for small systems of 5 kW or less. The result is a much speedier time between purchase and installation—these PV systems can now get on the grid as soon as 10 days after they have been registered. Anyone hosting a net-metered system—whether commercial, nonprofit, municipal, or residential users—will get an incentive estimated between $0.01 and $0.06 per kilowatt-hour, or $0.20/kWh less the local utility’s rate; net-metered projects can now be as large as 500 kW.

And just this October, California governor Jerry Brown signed Senate Bill 1222, which caps the permitting fees a city or county can charge for solar project permits.

Preparing for PPAs

Preplanning can also help pave the way for future solar development. In New York City, Sustainable CUNY and a range of partners, including the mayor’s office, Con Edison, and the New York City Fire Department, have been implementing an extensive solar program since 2007.

Although the enormous solar arrays of the West’s wide-open spaces are not possible, this partnership has already made an equally critical determination: finding where solar has the most value. An extensive, interactive map of the five boroughs takes into account everything from the sun’s position in the sky to shading to estimate solar’s potential, and also includes incentives available for every rooftop.

Sustainable CUNY and its partners are also working to make solar permitting and installation more efficient. With the New York City Department of Buildings, they are putting together a process for streamlining electrical inspections. This summer, in-person sessions between Department of Buildings plan reviewers and solar installers resulted in nearly 115 approved solar project applications.

Another method of speeding the process for reaching a PPA agreement and reducing transaction costs—lies in the paperwork.

“What we need in the industry is what the mortgage industry has—a standard set of contracts,” said Marc Roper, vice president of sales and marketing for Tioga Energy. Some PPA providers, including Tioga Energy, offer a contract template on their websites for those interested in solar PPAs.

Bond Financing for PPAs

Behind California, the second largest solar state is New Jersey, thanks to an aggressive renewable portfolio standard and incentives. New Jersey is also the birthplace of a financing mechanism for third-party solar installations called the Morris model, which combines the PPA structure with government-issued bonds. The approach gets its name from New Jersey’s Morris County, where in 2010 the Morris County Improvement Agency issued bonds for a 3.2 MW solar energy project that put panels on 19 schools and county buildings.

The county improvement agency issued taxable bonds for the project and entered into a 15-year lease-purchase agreement with PPA providers. Through the agreement, the county improvement agency holds the title to the PV panels, but all the “benefits and burdens” of ownership go to the PPA provider, which can now take advantage of tax rebates and other incentives, said Stephen Pearlman, a partner at Inglesino, Pearlman, Wyciskala & Taylor, and the driving force behind the first Morris model projects.

Morris County is now in the midst of a second round of projects financed through this model. The system provides financial benefits for schools and municipalities, said Morris County administrator John Bonanni, and allowed the county to take important steps to “go green.”

Several other New Jersey counties have since issued requests for proposals for solar projects. In Somerset, some schools are already saving as much as 60% on their average utility bills with Morris model–based projects.

Sunlight General Capital is one of the PPA providers at work on four of these New Jersey projects that will be completed by spring 2013.

The other significant advantage of this model for solar developers is the low rate of return required, compared to private-investor-funded solar projects. The average interest rates on the municipal bonds for these projects hovered around 3.8%. In comparison, Sunlight General Capital must often provide 10% or 12% returns for projects funded by private investors.

The New Jersey Morris model projects provide substantial savings to their customers. Mercer Community College, one of Sunlight General Capital’s customers, will have electricity rates of around $0.03/kWh from their under-construction 8 MW solar array, while many in the state pay close to $0.17/ kWh. “They have more money in their operating budget that they can use to have classes,” said Jay Mann, Sunlight General Capital co-founder and general counsel.

Some think the combination of PPA and bond financing is the next step in creating a workable system for solar projects that can take states all the way to their renewables goals. Multiple factors may affect whether this model will be adopted in other states. A recent National Renewable Energy Laboratory report looked at 10 states and concluded that there are no significant legal barriers to the hybrid model in the states studied. Yet if a state doesn’t allow municipalities to issue requests for proposals for solar projects that let them include other considerations beyond price—such as developer experience and financial stability these programs might have more trouble succeeding.

The New Jersey municipalities that have backed the bonds issued for these projects all have strong credit ratings. Also smoothing the process: county improvement agencies can issue bonds without a voter referendum.

Convincing other municipalities to commit to using their good credit to support these projects can be difficult. “Whenever you’re talking about a guarantee, that’s something that governments don’t take lightly,” Pearlman said.

Another thing that powered these recent Morris model PPAs was the price of New Jersey’s SRECs. Now that prices have fallen, developers have been wary of pursuing new projects. But this does not have to be the case, according to Pearlman. By the time a project moves from initial stages to completion, the SREC market may have changed again— and once it is earned, an SREC can be cashed in at any time in the subsequent 5 years.

For other states looking to attempt the Morris model, having experts in municipal bonds and contract law can help the negotiation process. Bonanni, the Morris County administrator, said the process took the willingness to form partnerships across a range of agencies.

One of the rewarding aspects of these projects, beyond the energy savings, has been the kiosks placed inside the newly solar-powered schools, where kids have been thrilled to see how much of their classrooms’ energy is coming from the sun. And since the projects have been in place, Bonanni reports that “we’ve heard nothing but positives from our partners.”

Military PPA

The U.S. military has also begun to turn to PPA financing to reach its renewable energy goals.

Recently, developers have started working with the military on solar power projects with long-term contracts of up to 30 years, thanks to 10uSc 2922a, which allowed long-term energy contracts for military installations. one of the first projects of this nature, a 13.78 Mw solar installation for the U.S. navy in china Lake, California, broke ground in January 2012. the project, owned by SunPower corporation, will power an estimated 30% of naval Air weapons Station china Lake and could save the navy as much as $13 million over the 20-year contract, during which the navy will pay below-retail rates for power.

In August 2012 the U.S. Army, which aims to be using 25% renewable energy by 2025, issued a final Multi-Award task order contract RFP for up to $7 billion in PPA-financed renewable energy projects, which include solar projects. As of early October, contractors had submitted proposals to be awarded a contract under MATOC; only developers with these contracts can bid on projects at army facilities around the country.

Chad Marriott, an attorney with Stoel Rives, said the Army may begin awarding contracts to developers as early as the third quarter of 2013. once these awards are made, developers will have the right to bid on projects.

These 30-year contracts, and the long-term revenues that result, will appeal to potential lenders—as will their client’s financial stability. “we know the department of defense is credit-worthy,” said Marriott, whose firm represents independent power producers. “So if we get a contract, we know they can pay.”

As a state, California already has a stake in this new military push for PPA. in September, governor jerry brown signed Senate bill 1409, which directed the governor’s office to establish a relationship with the U.S. department of defense as it pursues its renewable energy objectives. the bill creates a liaison office between the state and the federal agency to ensure that state policies do not impede these renewables projects.