Distributed Solar: Unalloyed Growth Story?
Solar companies broke open the US rooftop market by offering customers the option to lease or buy electricity from solar systems that the companies put on roofs but continue to own. Customers like the model because they do not have to pay the full cost of systems up front. Will the model catch fire in other countries? What are projected growth rates in the US distributed solar market? Are the developers making money? Is there much potential beyond the handful of existing states in which developers are already operating?
Three CEOs of distributed solar companies and two tax equity investors talked about the rooftop solar market at the Chadbourne global energy and finance conference in June. The panelists are Danny Kennedy, founder and director of Sungevity, Lyndon Rive, CEO of SolarCity, Vikas Desai, CEO of EchoFirst, Richard Moore, division head for strategy at Washington Gas, and Edward Levin, director of renewable energy with Rabobank. The moderator is Todd Alexander with Chadbourne in New York.
MR. ALEXANDER: The mood at this conference is one of mild pessimism about the renewable energy sector in the United States, particularly for wind. However, I do not think we will hear the same pessimism from the distributed solar people. The US solar market grew at an 85% rate year over year to the end of the first quarter this year. Panel prices are continuing to fall. Panels now cost less than $1 per watt before installation. The United States is now the fourth largest market in the world for photovoltaic solar behind Germany, Italy and China. Many people believe the opportunities in wind and other renewables are becoming more limited. Tax equity investors are becoming more comfortable with residential solar installations as an asset class. Tax equity investors used to be able to charge a premium to distributed solar companies. We will talk about whether that is still the case and where people think rates are headed. We will also talk about some small headwinds in the market: for example, tariffs that the US just slapped on Chinese solar cells. We will also touch upon the plummeting SREC — or solar renewable energy credit — prices in the northeast.
Lyndon Rive, your company has been on a rapid trajectory. What do you foresee for the distributed solar market in the next 12 to 24 months?
MR. RIVE: Rather than focus on SolarCity, let me talk about what I think the industry as a whole can achieve. The industry has had two years of rapid growth. Customer demand remains strong and should be enough to sustain that growth for the next few years.
The declining cost of technology combined with the rising cost of retail electricity is opening rooftops for solar in more and more states. The different solar leasing companies are all offering roughly the same value proposition. We typically price around 10% to 15% below your retail rate so when you have a scenario where a consumer has a choice of paying 10% to 15% more for dirty power or 10% to 15% less for clean power, what do you want to do? People prefer to pay less and do something good for the environment at the same time.
MR. ALEXANDER: Danny Kennedy, one appealing thing about the distributed solar market is you are competing against retail electricity prices, unlike utility-scale solar developers who compete in a wholesale market. What do you foresee for the distributed solar market in the next 12 to 24 months? Does rooftop solar make more sense than utility-scale solar?
MR. KENNEDY: Like Lyndon, we are very bullish. We expect nearly to double our customer base this year and to double again next year. We are presenting customers with a lower cost way of getting solar electricity. As to your question about residential versus utility-scale, obviously we will be the first place where solar electricity reaches grid parity because we are competing against a retail rate for electricity. There are many potential markets around the world. There is a natural market for solar because solar is becoming the lowest cost provider of electricity.
MR. ALEXANDER: How much does the typical homeowner save on his electricity bills by installing rooftop solar?
MR. KENNEDY: The savings vary by utility service territory. The pricing formula Lyndon described for the solar leasing industry is right. We are all trying to offer customers 10% to 15% savings, at least over the lifetime of the lease.
MR. ALEXANDER: Vikas Desai, your company has a different approach. Tell us what it is.
MR. DESAI: EchoFirst is a product company. We combine rooftop solar panels for generating electricity with a solar hot water heater. We have remote metering and monitoring of the system. We have more than 50 patents all around integrating base technologies that have existed for years and in many cases for decades. We are positive and energized about where solar is going. There has been a lot of recent innovation. Companies like SolarCity are leading on financing strategies. An army of installers has come into the game. States like California now have more than 2,000 installers that install solar. You also see a lot of signs of the market maturing so that at every kitchen table there are on average three to five bids.
MR. ALEXANDER: What kind of value proposition are you offering? How much cheaper is it buying electricity and hot water from you than from the local utility?
MR. DESAI: Our value proposition is similar to what the other companies are offering. Our customers typically end up saving 10% to 15% off their utility bills.
MR. ALEXANDER: Rick Moore, how does distributed solar compare to the other opportunities you have as an investor?
MR. MOORE: We think about distributed generation as less of a technology play and more of something that is central to the goals of our company. We want to be a company that is focused on generating clean and efficient energy. This is part of our DNA. We see distributed solar as a tremendous opportunity. We have an investment in American Solar Direct, which is a residential rooftop company in southern California, and we are also doing commercial solar thermal nationwide with Skyline Innovations, a company based in Washington, DC.
The reason why distributed generation is so interesting is the value proposition to the customer. We think customers are looking for protection against fluctuating energy prices. They are looking to be green. They are looking to lower their energy costs. They are looking for reliability. Distributed solar offers all of these things. We like this market because it is a market where customers have reasons to seek out solar companies and the products they offer.
Cost of Capital
MR. ALEXANDER: Ed Levin, transaction costs have to be an issue when trying to finance lots of small solar systems. Don’t they push up the cost of capital to these companies?
MR. LEVIN: There is no doubt it was a problem five years ago, and it remains an issue in this market. The only way I have seen the model work is for solar rooftop companies to batch together large numbers of systems and to have standard contracts with customers.
MR. ALEXANDER: Are there many tax equity investors interested in financing solar residential installations?
MR. LEVIN: More and more tax equity investors are showing an interest in the sector. It was not an easy sell with credit people and management when I did my first financing for SolarCity five years ago. The sector now has the scale to attract people who are interested in making large tax equity investments or loans.
MR. ALEXANDER: Where are tax equity rates today? Are they going down? Will the drying up of the wind market bring rates down further? Are investors getting more comfortable with the asset class?
MR. LEVIN: Anybody in the prediction business is asking for trouble. All I can say is the industry will have to adapt to a new environment in six months. It seems clear that the Treasury cash grant is, unfortunately, a thing of the past. Frankly we have been living on the grant for the last two years. The industry is in a better position than wind because the investment credit for solar runs through 2016. It is not good for solar to see the wind industry suffer the way it is suffering now. Anybody who has been to the global windpower conventions the last few years has seen attendance shrink significantly from year to year. That is not good for solar.
MR. ALEXANDER: Lyndon Rive, SolarCity has been a market leader in raising capital for rooftop solar. You have pioneered various forms of master financing facilities to try to lower transaction costs. How are you finding financing sources and particularly tax equity as Treasury cash grants recede as a source of capital?
MR. RIVE: Since our initial transaction with Ed, we have closed on another 22 master tax equity facilities. The potential pool of investors has been expanding. What is particularly exciting is we are starting to see corporations show an interest; tax equity is no longer being supplied solely by banks. There is a learning curve for new entrants. The financing structures can seem complicated. However, once investors get up the learning curve, they almost always make repeat investments. The return for the risk profile is pretty good.
MR. ALEXANDER: What kind of returns are we talking about?
MR. RIVE: The returns can range from 6.5% at the low end for debt to 10% to 12% at the upper end for tax equity. We are trying to reduce our overall cost of capital by combining back-levered debt with tax equity.
MR. ALEXANDER: Do you think we will see a decline in tax equity yields given the success of the solar industry, growing familiarity with the asset class and a low customer default rate?
MR. RIVE: Tax equity yields are not a reflection of the risk profile of the asset class; they are function of supply and demand for tax equity. As long as there is more demand than supply, the rates will remain high. As the supply of tax equity increases, the cost of tax equity will fall. The maturing of the asset class will not lead necessarily to lower tax equity rates. However, it does get reflected in lower debt rates. Debt rates are a better reflection of the market’s view of asset risk.
MR. ALEXANDER: Danny Kennedy, how has Sungevity overcome the challenges of trying to finance small projects? Where do you see the tax equity market headed?
MR. KENNEDY: It has been an ongoing and interesting challenge, but things are improving. As Lyndon said, tax equity yields are more about supply and demand than the riskiness of the asset class. I am optimistic that things will improve in the US as more corporations start making tax equity investments. Rooftop PV is becoming more financeable around the world. We just started a joint venture in Australia where we see a lot of interest from lenders. Retail electricity prices are high in Australia, providing an entrée for residential solar companies.
MR. ALEXANDER: Rick Moore, you just heard what they said about tax equity investors. Do you feel appreciated? (Laughter.)
MR. MOORE: I was hoping to hear from the panel that tax equity yields would go through the roof in the next six months, so I am disappointed. (Laughter.) We are one of the “corporations” to which Lyndon and Danny were referring. We are continuing to see very interesting opportunities come our way, and we remain active. We have been investing in this sector for two years and have built some capabilities that foster our ability to remain active. I think the challenges associated with developing these capabilities remain barriers to new entrants in the market. For example, the complex accounting approaches and various investment structures require time and effort to understand. There are competing technologies that require constant assessment and a large number of developers with differing capabilities. Washington Gas is now trying to look at ways to leverage the capabilities that we have developed, perhaps by aggregating capital with some other peer tax equity investors. That is one way to increase the supply of tax equity.
MR. ALEXANDER: When will this sector reach grid parity? How close is it to competing with other sources of electricity?
MR. RIVE: The answer varies by state. We are installing systems in dozens of communities in places like Nevada, Florida and Utah — nontraditional solar markets. We have to push the boundaries.
MR. ALEXANDER: Will we still be talking about tax equity in 2016?
MR. RIVE: Yes. The investment tax credit for solar drops from 30% to 10% after 2016, so there will remain a need to barter tax subsidies for capital in the tax equity market. However, securitization structures will become more critical after 2016 as solar companies package portfolios of solar residential leases, have them rated, and then borrow against the future rents. The key to continued cost reduction is volume. As the incentives decrease, the margins are getting tighter because the incentives are decreasing faster than the cost of technology is decreasing. The only way you can profit is by pushing more volume through your fixed sales infrastructure.
MR. ALEXANDER: Does this mean that rooftop solar might only have a long-term future in the southwestern United States?
MR. RIVE: Without any incentives, you would have to sell electricity for 17¢ or 18¢ a kilowatt hour. US Energy Information Administration forecasts for 2017 suggest that these numbers would work for about 20% of the US population.
MR. ALEXANDER: Rick Moore, what’s the future for this sector? Do you foresee a wave of consolidation?
MR. MOORE: We are indifferent as investors as to whether there are many companies or a few companies. As a 160-plus-year owner and operator of energy assets, for us, the ability to own a working asset is more important than how that asset arrived on our books. It does not matter if the assets come from a single supplier or 20 suppliers. We see a future under either scenario.
MR. ALEXANDER: Vikas Desai, do the solar rooftop companies need to consolidate to reach the type of volume to which Lyndon Rive referred?
MR. DESAI: We are a long way from a mature sector. A lot of the action is happening upstream where there is severe overcapacity among manufacturers of solar panels. Compared to more mature industries like HVAC or windows or other home improvement categories, solar is at mile marker one. I think we are far from consolidation. Many new business models will still emerge.
Opportunities Outside the US
MR. ALEXANDER: Danny Kennedy, what opportunities are there for investors, panel suppliers and developers in markets outside the US? Will the same lease model that has led to a boom in solar rooftop installations in the US take hold in other countries?
MR. KENNEDY: There is a lot of opportunity. There is opportunity wherever the price of electricity for residential customers is high. This includes Australia where my family pays 22¢ a kilowatt hour in the suburbs of Sydney for electricity, and the price is expected to go up 16¢ on July 1 and another 16¢ again next year. Brazil is one of the fastest growing economies in the world. Brazilians are paying 23¢ a kilowatt hour for residential electricity.
MR. ALEXANDER: Vikas Desai, do you have your hands full in the United States? Are you looking overseas as well?
MR. DESAI: We are looking overseas. There are many, many exciting markets. There are several potential markets in Europe. We are also looking at places like Japan, Australia and Latin America, though we do not intend to go there in the immediate future. Markets like Turkey will become very interesting. There is a focus on certain markets in the Middle East as well.
MR. ALEXANDER: Lyndon Rive, what about SolarCity?
MR. RIVE: The market is insanely huge and sometimes the biggest challenge is to remain focused on what we are doing here because it is exciting to move into new markets. However, I have to finish this job before I can do that job. The market expansion is essentially going to be infinite in our lifetimes with distributed solar. Countries are starting to realize the benefit of this. For now, we are focused solely on the US.