The road ahead

The road ahead

February 28, 2022 | By Keith Martin in Washington, DC

The talk at the annual Infocast Projects & Money conference in New Orleans in late January was about the rapidly evolving US renewable energy market. Asset valuations have been pushed sky high by $10.6 trillion in global fiscal stimulus. Is this a good time to be a buyer? Are current supply-chain woes and other difficulties really as bad as the news media make them sound? Is it true that 30% of solar power purchase agreements for development-stage projects have been canceled due to escalating costs? Is the hype about green hydrogen warranted? Three veteran market participants talked about these and other questions on one of the opening panels.

The panelists are Hunter Armistead, chief development officer of Pattern Energy, Kevin Smith, CEO of the Americas for Lightsource BP, and Ted Brandt, CEO of Marathon Capital. The moderator is Keith Martin with Norton Rose Fulbright in Washington.

Headwinds and Tailwinds

MR. MARTIN: We start 2022 with an unusually large number of headwinds: supply-chain difficulties, labor shortages, uncertainty about tax law, Customs seizures of solar panels, inflation and rising international political tensions.

Hunter Armistead, is there anything you would add to that list?

MR. ARMISTEAD: There is also a strong tailwind, which is that people actually want our product. That is not something any of us were able to say in the last 20 years.

I have been doing this a long time, but have never had to operate in an inflationary environment. I was joking with someone before the panel, and he said, "I remember the 1970s." I said, "I was eight."

MR. SMITH: I remember the '70s.

MR. BRANDT: I do, too.

MR. ARMISTEAD: Yes, but this is new. There are two things that are new for me. There is more long-term demand for the electricity we are trying to sell, and the electricity price is no longer falling. It is rising. Those are both new.

MR. SMITH: I agree with that. The difficulty we are all facing is the transitions that we are being forced to make, whether they are moving from panel prices in the mid-20¢ to mid-30¢ range per watt, or an investment tax credit that may be falling from 30%, to 26% to 22% to 10% or may be going back up to 30% or higher. The biggest challenge is the risk of getting stuck on the wrong side of those transitions.

The industry is growing dramatically. There is huge demand for the product. There are a lot of power purchase agreements that are on the wrong side of current costs on labor, panel prices and other equipment costs. The biggest challenge is making sure you are on the right side, or even mostly on the right side, of those transitions.

MR. BRANDT: I view it like a teeter totter. There are the negatives on the one side, but the optimism comes from the massive liquidity. There has never been a time with so much global money from every possible source — the public markets, the private markets, the infrastructure funds — in search of investments. There is a major movement away from non-ESG investments into ESG-oriented investments, and it is accelerating.

MR. MARTIN: I asked about additional headwinds. For the most part, all of you cited tailwinds. Despite the short-term challenges, all of you feel like the renewables market is in a good place.

Lasting Pandemic Effects

MR. MARTIN: Next question: Life is never the same after a period of upheaval. We have all been working from home for two years. Many people say the pandemic has acted as an accelerant, accelerating trends that were already underway. What do you expect to be different for our industry after we reemerge?


MR. MARTIN: Humans? How so?

MR. ARMISTEAD: If you are not forcing everyone to move to the same city, you end up with a much deeper potential talent pool. The pandemic has opened that up for us by forcing us all to be more flexible.

MR. SMITH: Our development teams have always been pretty mobile people, but the rest of us all went remote overnight and it was not really a very big deal.

We are now hiring people across the US. Our head US office is in San Francisco, but we now have offices in Denver, Philadelphia and Austin, and we also have people scattered across the US in such places as Utah, Arkansas, Louisiana and Alabama where I did not expect to have people.

MR. MARTIN: They are working from home?


MR. ARMISTEAD: Another thing to add is I am crazy energized by some of the young people that are coming into our industry right now, and coming up behind the next tier of senior managers that are eventually going to push me out. The passion they bring for renewable energy is wonderful. It makes me excited about the future.

MR. BRANDT: There were three effects of what all of us have just been through.

The first is by having everybody go virtual, execution actually got better. Second, on origination of new deals, we stayed alive with repeat clients and existing relationships. We did not do a great job of meeting new clients.

Third, where virtual just flunks is on the transfer of knowledge to younger generations. We are a knowledge company and an 80-person investment bank. We did not see the senior people teaching the junior people anywhere near the knowledge that they will need to move up the ranks.

We are recommitting to real estate. You clearly have to put up with people living wherever they want, given the talent shortage, but we are recommitting to real estate in our various locations.


MR. MARTIN: The speakers on the panel just before us said that they set record years in terms of deal flow last year. It was no wonder. People are more efficient working from home, to a degree, until exhaustion sets in.

We started with two general questions. Now let's switch to trying to draw out useful facts, starting with the supply chain.

Hunter Armistead, did you have projects slip into 2022? Are some of your 2022 projects already slipping into 2023 due to supply-chain issues?

MR. ARMISTEAD: We just commissioned a 1,000-megawatt wind farm, single build with a transmission line, on time, on budget, without any supply-chain issues. I don't know whether I should knock on wood. It took a lot of attention to send people to the sites to get early warnings. We had issues, but we managed through them.

That is not to say we have not had delays. We have been unable as a company to get the assurances we need from some panel suppliers that their panels were ethically sourced. We have basically said, "No, we are not going to do that." Our main issues have been around panel suppliers in China.

MR. MARTIN: Have any 2022 projects slipped into 2023 due to supply-chain issues?

MR. ARMISTEAD: Not supply chain, but on account of forced labor concerns.

MR. SMITH: Our target for 2021 was to finance 1200 megawatts of solar. We did 1207 megawatts and about $1.5 billion in financings. We also completed construction on time on about 600 megawatts that closed financing at the end of the previous year. We were fortunate with some of our panel suppliers. Everything was on time, like clockwork.

This year does not look like that.

Even though we closed projects on time in 2021, the returns were not quite what we thought they were going to be at the beginning of 2021. Some projects took hits on returns. We made the decision that we were going to power through and close. We do not have access to BP's balance sheet, so our projects are fully project financed with third-party tax equity structures.

Last year was a record year for us.

We are looking this year to build 1500 megawatts or more, but 2022 looks tougher than 2021 to reach those goals.

MR. MARTIN: Due to panel supplies or cost?

MR. SMITH: A bit of both. We did a big deal with First Solar for module supply for about 4,500 megawatts of delivery of solar panels over a multi-year period. The 2023 deliveries will only be about 60% of what we need. We are out in the market looking for what we can buy from other suppliers. Cost issues are also a big deal. EPC prices are going up.

MR. ARMISTEAD: Prices have been moving up and exposures have been moving to the left. In order to manage supply-chain issues, everyone is basically looking for us to commit earlier. It increases our exposure as well as our cost.

MR. MARTIN: We have heard from some solar developers that as many as 30% of PPAs for development-stage projects have been canceled because the costs have gone up to a degree that the electricity cannot be delivered at the originally-promised price. Does that sound accurate?

MR. ARMISTEAD: Yes, but I am not sure whether the issue is the supply chain or the fact that people for many years have been counting on the levelized cost of energy from solar and wind to keep falling over time. That changed about two years ago, and electricity prices have been going up since then. I suspect the PPAs being were entered into more than two years ago.

MR. SMITH: My guess is that more than 30% of PPAs are under water. The question is what should developers do with those.

We have been renegotiating some of our power contracts. We have not yet walked away from anything, but it is a tougher market. I agree with Hunter. People bidding for PPAs were optimistic and bet that the downward curve would continue. There was a pretty steep uptick in contracted electricity prices in 2020 and 2021, and it does not sound like we should expect any relief in 2022.

Interestingly enough, panel prices are coming down internationally. We are bidding on power contracts in Brazil and various markets in Europe. We are seeing some softening of the panel supply markets. The US has all kinds of issues that are specific to it, like solar panel import tariffs and forced-labor legislation that are a lot tougher than in the rest of the world. Panel prices are falling in other parts of the world, but not yet in the US.

MR. MARTIN: Have you had any solar panels seized by US Customs?

MR. SMITH: No, fortunately. We had a big supply of First Solar, and we also had Canadian Solar in our mix. We have not had any issues so far.

Power Contracts

MR. MARTIN: Hunter Armistead, you said that the change this year is that people want to buy more of the product, electricity. Some developers have been telling us that PPAs are no longer the scarce resource; the scarce resource is the ability to interconnect. Do you agree?

MR. ARMISTEAD: Absolutely. I think how we manage the interconnection queue is the challenge for the next generation of solar and wind developers.

MR. MARTIN: Some of the RTOs are trying to sweep the queue of projects that have no real chance of being built. Is that working? Perhaps developers with poorly-conceived projects are now less willing to post high letters of credit to stay in line?

MR. ARMISTEAD: Yes. The challenge is you have a lot of potential electricity customers who still want to enjoy a party that ended two years ago. The revenue side of the equation takes longer to adjust. EPC contractors and equipment vendors are much faster to increase prices to adjust to current conditions.

The conversations that I am sure Kevin and I have both had with electricity customers can be uncomfortable. Some have gone okay; some have not gone so well.

MR. MARTIN: Kevin Smith, where are PPA prices today for solar and wind? Say you are signing a new long-term power contract with a US customer.

MR. SMITH: They vary by region.

To return to the previous question, I think the biggest change over the last several years has been the number of corporate offtakers coming into the market. Our PPAs previously were probably 80% with utilities and only 20% with corporate customers, but that number is more like 50-50 today. Lightsource BP's first projects only went into construction in 2019, so it has been a relatively short period for us. We are signing contracts today with McDonald's, Verizon, eBay and all kinds of players, in addition to the Xcels and other utilities.

We are still seeing low prices in the West — Colorado was under $20 a megawatt hour but is moving up significantly. We are also seeing prices moving up in PJM and MISO. In cases where prices were in the high $20 to low $30 range, we are now seeing prices in the high $30 to $40+ range.

Prices vary by market, but we have seen prices move up in general by at least 20% to 30%.

MR. MARTIN: Hunter, where are prices currently?

MR. ARMISTEAD: When is the industry going to stop talking about power prices? If you go back to the very beginning, we were always competing against our fellow renewables developers for a limited demand.

Now what is getting really interesting is the other components of the product — resource adequacy, capacity allocations, RECs — that are contributing to revenue. Maybe I'm dodging your question, but . . .

MR. MARTIN: Sounds like it. [Laughter]

MR. ARMISTEAD: One of the changes in the industry in the last five years is that we used to get our return principally from the PPA, and there were actually good returns for equity during that period, but that does not exist anymore. You need a view about how markets are going to price a commodity that is not just power.

All of that said, I think PPA prices are up by $4 in almost every market.


MR. ARMISTEAD: That was answer; just remember that. [Laughter]

MR. MARTIN: I will.

MR. ARMISTEAD: Kevin, do you agree that $4 is where things have gone?

MR. SMITH: I think it is higher than that, actually.

It depends on what is included in the power price. The developer usually takes the risk on capacity and reactive power payments. The offtaker wants the energy and RECs. We are seeing prices up by as 20% to 30% and higher in some markets. That is certainly more than $4.


MR. MARTIN: SPACs appear to have flamed out spectacularly. The Wall Street Journal reported over the weekend that about half of SPAC-backed companies' shares are now down by more than 40%. SPAC investors can pull their money out once the target is identified. BuzzFeed went public recently with a SPAC. It was hoping to raise $287.5 million, but ended up with $16 million because 95% of the investors pulled their money.

What new ideas are investment bankers pitching now that the SPAC boom seems to have run its course?

MR. BRANDT: The SPAC idea would not have had much traction if the traditional initial public offering was a great process. The reason that everybody gravitated to SPACs is it was touted as an easier, faster way to go public.

It worked for a while, and then it was broken, and then the way the investment bankers fixed it is they made the SPAC sponsors put in more capital that could be redeemed. And guess what? The hedge funds and individual investors that buy into these IPOs are basically withdrawing their money as opposed to converting into the equity of an overpriced target.

This is a classic case of Wall Street having an interesting idea, but the investors that are behind the IPOs are completely disconnected from the process. SPACs are a great deal for the sponsors who organize them, but there is a misalignment of interests between the SPAC sponsors and the investors, and the chickens are coming home to roost. These are not good deals, and a whole bunch of people are going to lose money.

MR. MARTIN: Hunter Armistead, is there a new idea that investment bankers are already pitching?

MR. ARMISTEAD: I was on a panel with you are few years ago soon after we went public with a yieldco.

There will always be some really good ideas that get pushed to the point that they become bad ideas. This is just the latest example. For a time, everyone wanted to be in SPAC. I was asked to start a SPAC, and I said, "I don't think so." This one had a shorter shelf life than many others.

The bigger trend is that ESG investing is no longer just a catchphrase. People used to say "ESG really matters," but actually it really didn't. Now it actually kind of does.

Ted's original point was there is a significant amount of capital that wants to be in this industry. The disciplined ways of putting capital into it are more tried and true.

Asset Valuations

MR. MARTIN: Ted Brandt, let's use that as a bridge to some questions for you. I read in The Economist magazine that there has been $10.6 trillion in fiscal stimulus globally during the pandemic. The money has to go somewhere. It has pushed up asset valuations. Why be a buyer in such a market?

MR. BRANDT: I was on a panel you moderated in March 2020 shortly after the COVID lockdowns started. The markets were crashing, and I made a statement that "I'm worried the wall of money has gone away." The next month, I got lots of calls from people who had raised funds that were dedicated to ESG who said, "We can't go anywhere else. The money has been raised for a purpose. The investors are paying us fees in order to find clean-and-green investments. The biggest sin is not deploying the capital."

Some of this money is on the sidelines, but we are clearly seeing yield compression and record premiums being paid for development companies.

Right now, the perception among investors is, "I can't make any money at the project level. All the money is going to be made at the developer level."

That is translating into premiums for companies that are pretty new but have really great pipelines. That used to be a nine-figure type of appraisal, and now were are seeing ten figures and even moving up from there.

MR. MARTIN: There has been a broad move out of equities. Tech stocks have been battered this year. The tech rout is spreading to other parts of the equities market. Three fifths of the stocks on the blue chip S&P 500 index are down at least 10% from recent highs and a fifth are down at least 20%. Is this starting to affect power sector valuations?

MR. BRANDT: Asset valuations tend to vary by region and are driven by the revenue contract. We are seeing lots of problems in project pipelines. PPAs that were won in RFP processes 18 months ago are ending up in massive renegotiations because nobody foresaw the supply-chain problems. We are watching projects being canceled.

In many parts of the country, we would almost rather sell a to-be-built asset without a power contract than one with a contract.

MR. ARMISTEAD: These cycles tend to repeat. I remember around 2006 when everyone would claim a huge pipeline, and we would view the claims skeptically. Development is more artistry than it is assets.

A lot of times with art, you get really bad art. With a lot of the pipelines that people are peddling today, unless you have developers that have delivered consistently, I think you are going to be surprised when you look under the hood.

MR. MARTIN: That's a warning from a developer who knows what is under the hood.

MR. SMITH: I will echo that. The industry has gone through a few cycles over the years. I have been through a few of those cycles. I remember when I was at Invenergy in 2006, 2007 and 2008, the huge influx of Europeans into the US market pushed up asset valuations. People were buying project pipelines where you had a little bit of land and maybe an application for the interconnection queue. Buyers were paying $50,000 to $100,000 per megawatt for those kinds of projects.

That ended a few years later. People were rationalizing those pipelines. Now we are seeing the same thing again, but on steroids. You talk to people that have not been through a few cycles, and they insist, "This is different." Perhaps they are right. The world has changed. We are going to see continuous growth in this market. Maybe cycles are a thing of the past and it is all up from here. Maybe. Mark me a skeptic. I think people are overpaying a bit.

We did an acquisition with BP of a group called 7X in the first half of 2021. It was a bilateral deal. I think we got a pretty good deal on it. BP made the numbers public; half of it was equipment, and it was in the $100 million range for a 9,000-megawatt pipeline. Who knows what that would go for today.

The market is massively strong, and you still have a lot of people looking to enter.

MR. ARMISTEAD: I love the words "It's different this time." It might be, but those words are painted across history. The one truth is we are still in the early stages of what will be a 30-year transition to renewable energy. Maybe that justifies some of the optimism among buyers. Maybe it is a little different this time.

Bid Metrics

MR. MARTIN: Ted Brandt, what discount rate would you say winning bidders are using currently to discount future cash flows?

MR. BRANDT: We just closed about a month ago on a utility-scale solar project with a 20-year bus-bar PPA. We think from a reverse engineering standpoint, the leveraged after-tax return that the buyer got was below 6%.

MR. MARTIN: What about for wind?

MR. BRANDT: I actually think the number I just gave you is an outlier. For wind, I think 7.5% to 8% is the right discount rate for leveraged returns. Solar is probably 50 to 75 basis points tighter than that. It is really important, given that these are 35-year assets and that most of the contracts are 12 to 15 years, to realize how critical your out-year electricity price assumptions are. If your power curves are off, the math just goes out the window because you have 20 years on the back end. With low discount rates, the power curves mean everything. If you are 30% below Ventyx or the equivalent, you are not going to win anything, even with a 5% discount rate.

MR. ARMISTEAD: We have transitioned to thinking of contracts as a percentage of the net present value of the asset. For example, if you have a 15-year contract and you discount it, even if you have sold 100% of the electricity during the contract term, you have really only sold, I don't know, 50% to 60% of the future revenue. The discount rate discussion is interesting, but not super interesting. The assumptions are way more interesting.

A perspective on the post-contract revenues and a perspective on whether you are in a place where it will be more expensive to interconnect might be more important. I believe very much in the residual revenue, but I don't believe necessarily in projecting 35 years of revenue when you only have 15 years under contract.

MR. SMITH: We have not talked much about interconnection queues. They are the biggest reason why we will see 2022 projects move into 2023, not only supply-chain disruptions, although they are a big issue as well.

As a developer, we can see returns much greater than what Ted is talking about. If you are buying the rights to a fully-developed project with a 20-year bus-bar PPA, you are going to see discount rates well below 6% to buy — into the 5% range, and some people are even looking at buying below that.

Developers can still see pretty decent returns after developer fees, structuring options and sell downs are taken into account. But, as Hunter said, there are all kinds of issues on assumptions. For example, is it a hedged project in Texas, which you don't often see anymore? Is it a project in PJM or MISO where you are taking capacity risk, reactive power risk, and risk tied to other revenue streams, and maybe only 50% of the revenue is coming from a fixed contract?

Is it a 12-year, 15-year or 20-year contract? The projects with 20-year bus-bar PPAs that Ted mentioned are the stars in the portfolio, and those are the ones where returns get driven down into the 5% range by buyers.

MR. MARTIN: Ted Brandt, people used not to assign any value to a project until it had a PPA. Is that still the case?

MR. BRANDT: No. If the project is in an area where people are confident that they will be able to get a power contract, where there is access to transmission and the developer has land control, those are assets that are being sold for as much as 20¢ a watt right now.


MR. MARTIN: All three of you, last topic, maybe starting with Hunter Armistead: Is the hype about green hydrogen warranted? If so, when do you see green hydrogen changing the renewable energy market, and how?

MR. ARMISTEAD: The biggest challenge with the transition to renewables is how we manage not just shifting surplus electricity from daytime to the peak load in the evening, but also how to create a reliable, long-term grid that supports true de-carbonization. That is where I think hydrogen has its most obvious play.

Hydrogen today is still a wonderful industrial gas that is used for manufacturing, but the idea that it is going to be combusted to generate electricity is really kind of like burning your food. It is not an awesome application. I see it as one of several possible responses over time to the need for long-duration storage.

MR. MARTIN: So there is an issue that needs to be addressed, but it may not be addressed ultimately by hydrogen. Kevin Smith?

MR. SMITH: New technologies do not really take off until they become cost competitive. Solar and wind did not take off until they became cost competitive with conventional energy.

I think we will see that with green hydrogen. There is lots of talk about it. There is more talk internationally than in the US, largely because we still have a very plentiful supply of low-priced natural gas. That makes it hard for green hydrogen projects to compete in the US. When hydrogen becomes cost competitive, it will ramp up dramatically. Until then, the market will be slow to develop.

MR. BRANDT: We are bullish and see it largely as an inside-the-fence phenomenon because of the difficulty moving hydrogen through pipelines and the size of the molecules. I understand that it leaks like a sieve. Moving hydrogen is hard with our existing infrastructure. The fastest-growing part of our business is the energy transition and helping companies think through what will happen next.

I don't know a single heavy natural gas user who is not thinking it is going to have to supplement its local natural gas supply with some amount of hydrogen.

MR. ARMISTEAD: Maybe to bridge all three of our comments, I think we all see a need for hydrogen. The question is when and on what scale. It is just like batteries. Batteries were hyped for years and years before they took hold. One question is how far away are we before hydrogen takes hold. The other question is when do you have to start participating to make sure you are well positioned when it really does take hold. When will it be too late to have ignored it and hope to catch up?