By Jake Seligman

Community solar projects are emerging as a new asset class, distinct from residential, commercial, industrial and utility-scale projects. It is still early, but lenders and tax equity investors are beginning to invest.

Like any new asset class, community solar projects have new risks to understand and allocate. This article explains some of the risks and how community solar works in a typical program, recognizing that community solar programs differ by state and utility.

Community solar programs are cropping up around the country. Eight states plus the District of Columbia have enabling legislation in place. Colorado and Massachusetts lead in installations. Minnesota has also had significant activity. A handful of other states are working on community solar legislation.

Enabling legislation is not always necessary. A study by the Solar Electric Power Association counted 58 programs in 22 states, including those initiated by utilities and third parties in partnership with utilities.

What is Community Solar?

A community solar project is a solar photovoltaic array, typically around one megawatt in size, to which customers buy in or subscribe. Projects are either ground mounted or located on large roofs, like a commercial or industrial building.

A customer owns or subscribes to a portion of the project. Customers can be residential, municipal, commercial or industrial customers.

There are two main models. In a “subscription model,” the customer pays the developer for its share of the output, usually a fixed price per kilowatt hour per month or a fixed lease payment, escalating with inflation. The customer can also prepay the developer for all of the expected output from the customer’s share of the project. In a “purchase model,” the customer makes an upfront payment to buy a panel or series of panels.

The electricity from the project is delivered to the local utility. The utility then credits each customer for that customer’s share of the electricity output. The customer pays its normal bill to the utility, reduced by the credit.

Before building a community solar project, the developer will sign subscription agreements with customers. Subscription agreements are similar to power purchase agreements in commercial projects. A typical term is 20 years from commercial operation. The customer agrees to pay for all the electricity produced by its portion of the project. Unlike a power purchase agreement, the customer does not receive electricity from the project. Rather, the customer is credited for the output to which it subscribes.

Customers sometimes also sign reservation agreements, if the project will not be built for some time. A reservation agreement simply reserves the customer’s spot (typically for a deposit) for a period of time. The customer signs a subscription agreement before the project begins producing electricity.

A key element of the subscription agreement is the accounting and billing arrangement. The developer reports each customer’s share of the electricity output to the utility. The utility credits the customer’s bill at a price set out in the state or utility’s community solar program guidelines, similar to a net metering arrangement. In the subscription model, the developer retains the environmental attributes, which it can sell to the utility in a separate agreement. The developer also retains the tax benefits.

The utility and developer have a separate arrangement for interconnection and electricity offtake. Many programs require the utility to purchase unsubscribed electricity. For example, if the developer cannot find enough subscribers to take output  from the whole project, then the utility will pay for the unsubscribed amount.

The amount the utility would pay in event of undersubscription is not as much as a subscribing customer would pay, but it is a helpful backup. The utility usually pays a rate set in the program guidelines equal to its avoided cost.

In the subscription model, subscriptions are transferable. If a subscriber moves within the utility’s service territory, it can keep its subscription. If a subscriber moves outside the service territory, it can transfer its subscription. Developers maintain waiting lists, so new customers can join in place of customers who have moved.

Why the Growth?

Community solar projects are growing as an asset class because customers, developers and utilities all benefit from them.

Utilities benefit from community solar because they can recover their fixed costs, while promoting growth of renewable energy to meet state mandates. Community solar does not necessarily contribute to any utility death spiral by picking off utility customers and leaving utilities with stranded costs to maintain the grid without the customer base to support it. The customers remain with the utility, and the utility usually is able to continue recovering its costs in the fixed portion of a customer’s bill.

Utilities can still charge customers fixed fees to recover the costs of transmission and distribution infrastructure. Compared to net metering, where a customer with solar can reduce the fixed-cost portion of its bill to zero, this arrangement is less scary to utilities. Rather than crediting customers the retail rate of electricity, as with solar net metering, the utility credits them at a lower rate, which is often decoupled from fixed charges the utility might otherwise not recover. Customers are typically allowed to offset 100% to 120% of their electricity demand.

Utilities are also the accountants in the community solar model. They bill customers and calculate the offset to each customer’s electricity charge from the customer’s portion of the community solar project. Some developers, like Clean Energy Collective, offer proprietary software to facilitate this accounting.

Customers also benefit. Community solar projects are often compared to community gardens. They allow people who do not own their buildings or have a roof on which to put solar panels to subscribe to, or own, part of a community array.

Only about 20% of residential utility customers can host solar projects. The remaining 80% may be renters, own apartments or own homes with unsuitable roofs. Community solar programs are designed to reach this 80% and often try to reach low-income customers in particular.

Customers also do not have to worry about the complications that come from having solar panels on their roofs. Community solar avoids questions about roof repair, system maintenance and what happens if a customer sells his or her house.

If a customer moves, the customer can usually transfer the subscription to another customer that the developer finds (or that may be on the developer’s waiting list). If the customer moves within the utility’s service territory, he or she can keep the subscription.

Community solar is also good for developers. Projects are often in the one-megawatt range, but can be larger, depending on the program. This can give developers economies of scale, relative to residential solar. As First Solar’s recent investment in Clean Energy Collective showed, panels that are most economic at larger scales can reach a market that includes residential, commercial and industrial customers.

Customer acquisition costs may also be lower. The pitch to customers of community solar is possible savings and environmental benefits without the on-site construction or maintenance required for rooftop solar.

Risks

There is interest from lenders, tax equity investors and even yield cos in financing and acquiring community solar projects, but the market is still feeling its way on risks.

Third-party ownership is a threshold requirement for domestic renewable energy projects seeking tax equity investment. In order to receive tax benefits from a project, a tax equity investor must own the project. There are three main forms of tax equity structures in use in the solar market. They may be hard to use in community solar projects using the purchase model where the customer owns the panels. Any tax equity investment would have to use a pooled structure like a master sale-leaseback with multiple customers as separate lessees.

The purchase model is usually more favorable from a securities law perspective.

Community solar projects risk running afoul of state and federal securities laws if the sale of interests or subscriptions is considered a securities offering. Factors that bear on classification as a security include availability to the general public, the number of subscriptions offered and the characteristic of the subscriptions in the subscription agreement. Programs and projects where panels are sold to customers should have less risk of violating securities laws than those where a customer subscribes to an uncertain output. In the former case, the benefits to the customer rely less on the developer’s future efforts.

If a subscription in a community solar project is a security, then the developer would either have to register the offering or find an exemption from registration. State legislators and market participants are still working through the securities law issues. In the meantime, agreements between developers and customers should be drafted to avoid potential securities law risk by, for example, excluding words like “share” and “investment” and by emphasizing the sale of electricity and the developer’s administrative role rather than an active decision-making role that could affect the project’s viability.

Cash flow to developers of community solar projects comes from customer payments. In the subscription model, developers may also have separate agreements with utilities to sell renewable energy credits or “RECs.”

Customers are typically a mix of companies, municipalities and individuals. This mixture presents a more complicated risk analysis to credit committees than in single-offtaker projects. The market will eventually get used to it, but the first projects take more time for credit committees to evaluate.

Some community solar programs require that a certain percentage (e.g., 5% in Colorado) of the participants in each project be low-income residential utility customers. This requirement introduces a new type of customer to the risk analysis. Investors are used to residential projects whose hosts have FICO scores above 650 or 700.

The low-income component in some community solar programs complicates tax equity financing. A developer in a subscription arrangement can improve the creditworthiness of a community solar project by trying to have low-income customers prepay, instead of making monthly payments over 20 years.

Having the utility provide backup payments for unsubscribed amounts also is a form of credit enhancement. Credit committees can take comfort in knowing that if subscribers default, there is still a base level of revenue from the utility.

Part of what makes community solar appealing to customers is that if they move, they can either take their subscriptions with them or transfer them to other customers. Developers often have waiting lists for community solar projects, so they can transfer a customer’s interest to a new customer with little delay. Requiring a customer to provide notice of an intention to transfer (e.g., 180 days) helps reduce risk.

There is more risk of an interruption in revenue in a project with a few large subscribers or panel owners than one with many small customers. It may be harder to replace a large customer, even with 180 days’ notice.

Municipal customers require non-appropriation provisions in their long-term power purchase agreements, including community solar subscription agreements. Non-appropriation provisions allow a municipal customer to terminate its contract if the municipality fails to appropriate enough money to pay for the electricity. Although non-appropriation risk is hard to avoid with municipal customers, provisions can be added to reduce risk. For example, the municipality might agree not to sign a new power contract with a third party for a set time after a non-appropriation event. Another common provision is a requirement that the municipality use best efforts to re-appropriate funds after a non-appropriation event occurs.

Utilities often want to own and operate community solar projects directly. Recently, Xcel Energy, a leading utility in community solar efforts in Colorado and Minnesota, asked the Colorado Public Utilities Commission for permission to own its own community solar projects. The commission denied the request preliminarily. Similar attempts by other utilities are inevitable.