US solar market snapshot
Two solar chief financial officers, one solar company co-CEO and one managing director from a private equity fund that is investing heavily in solar talked at the annual Solar Energy Industries Association finance conference in New York in late February about current issues in the US solar market.
The panelists are Pete Keel, CFO of Longroad Energy, Benoit Allehaut, managing director for clean energy infrastructure at Capital Dynamics, Dan Dobbs, CFO of Standard Solar, and Laura Stern, co-CEO of Nautilus Solar. The moderator is Keith Martin with Norton Rose Fulbright in Washington.
MARTIN: How is coronavirus affecting your companies?
KEEL: Our investors are in New Zealand, and we have a board meeting scheduled there in 10 days. We are having second thoughts about whether we ought to make that trip.
MARTIN: It is not that you might catch the virus there. It is that you might be quarantined on the way back?
MR: KEEL: That is my fear.
ALLEHAUT: And you are afraid of being quarantined in New Zealand? [Laughter]
KEEL: I am afraid of what my wife and children will say if I am quarantined there. And then of course, supply chain is a concern. We do not have any issues that are acute, but it is certainly something that we are monitoring.
MARTIN: Have you received any force majeure notices from suppliers?
KEEL: We have.
MARTIN: Wind, solar? Are the suppliers Chinese?
MR: KEEL: I probably should not identify them. We do not have any solar panels coming from Chinese suppliers. We think it is more of a -– what’s the term — CYA type of notice. Our understanding is that we will still be okay.
MARTIN: How have you responded?
KEEL: We acknowledged the notice, but we are trying to understand what is going on and thinking through how the project will be affected if there is a delay.
MARTIN: To be clear, these are non-Chinese suppliers who have sent force majeure notices?
KEEL: Non-Chinese suppliers, yes, but their concern has to do with a Chinese supply chain.
MR: MARTIN: Benoit Allehaut, how has your company been affected by coronavirus?
ALLEHAUT: I just signed a letter responding to a force majeure notice. It is pretty small over the total portfolio, but we are seeing some supply chain issues.
MARTIN: Is the force majeure notice from a non-Chinese supplier?
ALLEHAUT: No, a Chinese supplier.
MARTIN: How did you respond?
ALLEHAUT: Same as Pete Keel.
MARTIN: You just acknowledged receipt?
ALLEHAUT: And reserved our rights.
MARTIN: Dan Dobbs?
DOBBS: We have not received a force majeure notice yet. However, we have received word that some equipment for an energy storage project will be delayed coming out of China. There has not been a formal notice yet, but we anticipate one shortly.
MARTIN: Laura Stern?
STERN: We have not been affected by it in terms of our equipment supplies. We safe harbored virtually all of our panels and inverters and had orders in a long time ago for the 2020 pipeline. Nothing that has been safe harbored is affected by any shipment delays.
MARTIN: Pete Keel, this is expected to be a crushing year in terms of new capacity additions. Are you seeing shortages of equipment, human resources or anything else at this point?
MR: KEEL: Wind projects that want to qualify for tax credits at the full rate must be completed by the end of this year. The equivalent deadline for solar is the end of 2023. The one place where supply is tight is EPC contractors. EPC prices are flat to up.
MARTIN: That is to erect wind turbines? What about solar?
MR: KEEL: It is solar EPC contractors where we are seeing upward pressure on pricing.
MARTIN: Benoit Allehaut, shortages?
ALLEHAUT: I will echo what Pete said again. We are seeing some tightness in the EPC market. The United States has a labor shortage, and that is a real problem. Our approach to answer this is scale. We are bundling gigawatts of projects to get better pricing from contractors.
MARTIN: Dan Dobbs?
DOBBS: We are not seeing any constraints at the moment.
MARTIN: Laura Stern?
STERN: We are not either.
MARTIN: Moving to another timely topic, the Dow was down 345 points at 1:25 this afternoon on top of drops of about 1,000 points over the last two days. Axios reported on Friday that many companies are behaving as if we are already in a recession in the sense that they are cutting back and conserving cash. Do you agree?
MR: KEEL: We have not seen any effect from falling
MARTIN: The exact quote is, “Companies are behaving like it is a recession. They are being unusually frugal, holding back on issuing new debt and pumping their balance sheets with cash.”
ALLEHAUT: How this industry operates is not particularly correlated with the stock market. What I am more interested in is the 10-year treasury is at a 60-year low. The low cost of money is extraordinarily beneficial to the industry.
MARTIN: Dan Dobbs?
DOBBS: No impact on how we are running our business.
MARTIN: Laura Stern?
STERN: No impact.
Solar + Storage
MARTIN: Next topic. What percentage of solar projects today are being bid with batteries?
ALLEHAUT: We have five projects under construction that are solar plus storage. It is more and more rare to have solar without storage in the western United States. We are moving to renewable energy 2.0. 1.0 was unit contingent, and 2.0 is better dispatch.
MARTIN: Does anyone have a percentage for me? 50%? 60%? Benoit, you say it is more common to pair solar with storage in the west than in the east.
ALLEHAUT: Storage does not really make sense when you get to the northeast. The economics do not support it, but in California they do.
MARTIN: Any percentages?
ALLEHAUT: Maybe one in 10.
MARTIN: That’s nationwide?
MARTIN: What part of the country are you focused on? A group of wind CEOs told us a few weeks ago that 50% of the proposed new projects that they are bidding today for power contracts include storage.
ALLEHAUT: That is surprising.
MARTIN: When you do add a battery, how much does it increase the electricity price?
STERN: It can’t because our offtakers will not pay more for storage. If it will increase the power price, it is not viable unless there is an adder or some kind of local incentive.
MARTIN: Does everyone agree?
ALLEHAUT: It is an extremely complicated question. Some people say storage is inexpensive, but the size of the battery is nothing versus the size of the project. We bought the Eland project from 8minute Solar Energy. The price is public. It is a 700-megawatt dc solar project, with a 1,200-megawatt-hour battery. The battery flattens the output curve tremendously and allows us to offer an extremely competitive price for the Los Angeles Department of Water and Power.
MARTIN: Xcel held an auction a couple of years ago. Many solar projects bid with batteries and the price was $7 a megawatt hour higher for electricity from a solar-plus-storage project than from a plain solar project. Yet, Laura Stern, you are saying that adding a battery does not increase the price for electricity in the distributed market and, Benoit Allehaut, if I understand correctly what you said, the battery helps to smooth electricity deliveries in the utility-scale market without increasing the price.
ALLEHAUT: The way to look at it is from the perspective of the customer. Not every block has the same price. If you look at the price of power at 12 p.m. in California, it is close to zero. If you are able to move that block to 7 p.m., the price is $70. The reality from a customer perspective is you will pay based on the profile of the dispatch.
MARTIN: The battery gives the supplier more tools to shift the time of day during which it is offering the electricity. It can earn more revenue from doing so.
How much does the cost of a project increase if you add a battery? Maybe that is also too simple a question?
KEEL: That is complicated. Again, we could see batteries in the $100 million range for a $300 million solar project.
MARTIN: So it can add 25% to the project cost.
How much would you expect the revenue to increase as a consequence of having a battery?
KEEL: The additional capital cost has to be recovered, right? Benoit and I were talking earlier about what adding a battery does to the cost of capital. I think that is an interesting question. Is the capital more or less expensive for the battery versus a solar project without a battery?
MARTIN: What is the answer? That’s not the question I asked but having posed it . . . [Laughter]
KEEL: We are sellers. I am just as curious what the answer is.
ALLEHAUT: I think that batteries are becoming mainstream quickly. I remember investors in straight solar projects were worried in the early days about panel performance and they got comfortable quickly. Battery technology is evolving rapidly. I could go geek on everybody and talk about liquid cooled batteries. These are really, really sturdy systems for the simple reason that they piggyback on the retooling of the auto industry supply chain . . . .
MARTIN: Before going geek on us, how much does the revenue increase when a battery is added to a solar project? By what percentage?
ALLEHAUT: The problem with that question is you need more factors. What is the size of the storage versus solar or wind and in which market? If you take California, utilities like the resource adequacy component of the battery. You need a couple of associates with really good quantitative degrees to do the calculation.
MARTIN: Is there a range?
ALLEHAUT: You’re not going to quote me on that. [Laughter]
MARTIN: This session is being recorded. [Laughter] Dan Dobbs, anything to add?
DOBBS: To Laura’s point earlier, a simple answer is it increases the revenue of the project commensurate with the increase in costs because the project basically has to pencil to zero.
MARTIN: Next topic. This is an industry that depends heavily on favorable public policy to function. What happens if Trump is re-elected? What difference will it make, if any?
ALLEHAUT: I have been in the renewable industry for a long enough time to have seen how it fares under both Republican and Democratic administrations. My favorite statistics are the percentages of wind and solar projects in Republican Congressional districts. The reality is that the center of the country, where there is land and our projects are located, is generally red, not blue. The Senate, which is under Republican control currently, has a staunch supporter of renewable energy in Senator Grassley from Iowa. He chairs the Senate tax-writing committee. It is fine to focus on the executive branch, but the legislature is really behind the industry.
MARTIN: You think the industry is in pretty good shape no matter who sits in the White House. Are there other views?
STERN: In the community solar and distributed solar markets, we are much more affected by state and local policies than we are by federal policies. While the investment tax credit and lots of other federal policies are incredibly important, our day-to-day activities and our market growth potential lies at the state and local level.
MARTIN: Next question. The solar industry came within a hair’s breadth of extending the 30% investment tax credit at the end of last year. How important is it to get that extension?
ALLEHAUT: I think at this point in the renewable energy market, tax credits are a perverse incentive. When we see wind projects selling electricity for prices per megawatt hour in the single digits or low teens, it is frankly ridiculous. The value of the commodity offered is higher than what the market is paying. What will happen when the tax incentives disappear is the price will adjust to the unsubsidized level. The tax incentives are simply passed on to the customer in the form of a lower power price.
MARTIN: You think the market will adjust to whatever the reality is, but you are competing with other sources of supply. Does that make a difference?
ALLEHAUT: Fundamentally you are looking at unsubsidized solar or wind versus gas, and in most markets, the reality is that renewable energy generation is able to compete effectively today without the subsidy.
MARTIN: Are there other views about the tax credit extension?
MR: KEEL: We would always rather be more competitive than less competitive. From that standpoint, it is very important not to lose ground. We have seen this story before. The tax credits have lapsed periodically in the past, and then there is a painful period when new capacity additions plummet while power buyers wait to see whether they can get a better price if the tax credits come back. Uncertainty is not good for business. There is still plenty of runway with the phase-out schedules and four-year window today, but it may not feel as good a year from now.
MARTIN: Any other views on the tax credit extension?
STERN: I would like to think that it is a bridge to a more long-term, sustainable carbon policy.
Dealing With Tariffs
MARTIN: Next topic. How are you dealing with unpredictable import tariffs?
ALLEHAUT: I will echo what Pete just said. The unpredictability is destabilizing. We are big buyers of First Solar panels, but the reality is there are not enough First Solar panels and not enough US-made panels in general to supply the market. The tariff on solar panels adds to cost. It squeezes margins. We all have to plan three or four years in advance of deployment. Unpredictable tariffs are the area that worries me the most because they are a tax that will not have been taken into account when we committed to a price at which we are prepared to supply electricity.
MARTIN: First Solar panels are exempted from the US import tariff. What special measures are any of you taking to deal with unpredictable tariffs?
ALLEHAUT: We buy early.
STERN: I also think that the tariffs have put a lot of pressure on the availability and pricing of bi-facial panels.
MARTIN: The exemption from tariffs on bi-facial panels is almost certain to go away within 60 days. What happens then?
STERN: Never say never. [Laughter]
MARTIN: Anyone else have any special measures that he or she takes?
KEEL: For us it was to buy First Solar panels, so we developed a relationship with First Solar. We are one of its largest customers. We are very concerned about tariffs for the reason that Benoit said. That is what we have done about them.
Minimum Offer Price
MARTIN: Next question. The Federal Energy Regulatory Commission has endorsed a minimum offer price for renewable and nuclear power projects bidding to supply capacity in PJM and the New York ISO. How big a deal is this and, if it is a big deal, why?
KEEL: It is a huge deal and a big problem. Solar projects in PJM count either on renewable energy credits – RECs — or a capacity price. Most solar developers were counting on capacity until these rules came out. FERC has really upset the Virginia market in particular. Hopefully, the problem will get fixed.
DOBBS: It has had less of an impact on C&I solar projects because they are competing against retail electricity suppliers. However, it has a serious effect on co-located solar and storage projects. I think that we will suppress the development of co-located storage because there we would be looking through demand-response registration or other means to participate in the wholesale market.
MARTIN: What percentage of revenue could be adversely affected? How much are capacity payments as a percentage of total revenue?
DOBBS: Hard to say. I am not sure because we have not taken capacity payments yet on the solar side since we are retail suppliers.
ALLEHAUT: It has not been large. The bigger picture is regulatory intervention. Is this the first domino that will be followed by other dominos? Why intervene in a functioning market? We know why the administration wants to do so, but coal plants are still retiring left and right. The intervention is not changing anything when it comes to coal. I just read this morning about a state that is thinking about leaving PJM. That is the law of unintended consequences.
MARTIN: Four states are reportedly thinking about dropping out of ISOs in response to the minimum-offer-price rule.
MARTIN: Next question to you, Benoit. Himanshu Saxena, CEO of Starwood Energy, said a couple of times last year that he was thinking of having t-shirts printed that say, “Who needs profits when you have solar?” You manage an investment fund. You have a choice of investing in anything you want. You are putting a lot of money into solar. Do you agree with what Himanshu wants on his t-shirt and, if so, why are you putting so much money into solar?
ALLEHAUT: I think what he said was fantastic because it calls attention to an important point. In the typical solar project with a 15-year contract to sell electricity, the tax equity gets paid back first, then the back-levered debt, and then the cash equity, in that order. By the end of the 15-year PPA, the cash equity has gotten maybe 30% of its money back. In reality, the cash equity is a merchant investor.
We have refused to play that market. If you look across our portfolio, all of our projects have contracted returns during the PPA term. That is important for us because we are fiduciary investors. We represent teachers’ retirement funds, and we do not want to gamble on merchant curves. It is important to realize that, when people originate projects, if all the value is based on a hypothetical merchant curve, it creates a lot of risk for the cash investor.
MARTIN: You seem to agree with Michael Polsky. He said at the New York REFF conference a couple years ago that unless you get your capital back by the end of the contracted term, you are not going to get it back.
ALLEHAUT: I completely agree with that. The reality is that nobody knows with any degree of certainty what power prices will be after the PPA term. From our perspective, the risk is not only not getting your money back, but also not earning a return on your money.
MARTIN: Pete Keel, you develop both wind and solar. How do the developer returns compare between the two?
KEEL: During the development period, you tend to get higher internal rates of return in solar than in wind because it takes less capital to develop a solar project than a wind project, although that is changing. That said, developers focus less on the IRR than on the multiple of invested capital they will earn. Solar capital is not out for very long. On the other hand, solar margins are very tight. You might try to create a project at a 10% return, but exit at 8% or 9%. There is less margin for error on the solar side than there is with wind.
MARTIN: At what discount rates are solar assets trading currently?
KEEL: There are two variables: discount rate and assumption about residual value. One bidder might bid a 6% discount rate, but with no residual value. Another person might bid 9%, but assume a 20-year PPA and assign value to another 15-year merchant tail. Where most people appear to be in the current market is to assume a 35-year useful life, and then they flex the back end.
MARTIN: What does it mean to flex the back end?
KEEL: They look at sensitivities. What is the project worth if the merchant electricity prices are the Ventyx forecast plus 10%? What about the Ventyx forecast minus 10%? What is the return for the contracted period without relying on any merchant revenue? It all goes into the mix.
STERN: The yields are often close to the expectations of any individual company’s investment committee, by definition. There are probably 10 variables that go into the bid model. It is not just residual value, but also O&M pricing, insurance costs, property tax increases, degradation — all of these factors play into the yield.
MARTIN: Where do you go for your out-year electricity price forecast? Do you take an average of different merchant price curves? Do you inflate current prices by 2%? What do you do?
ALLEHAUT: Since we are mostly looking at retail rates, we typically assume retail rates plus somewhere between 1% to 2% per year.
MARTIN: A lot of people say that in auctions, the winning bidder is the one who mispriced the risk or had too optimistic an out-year electricity price forecast. Given that winning an auction should not be cause for celebration, why would anybody participate in one? [Laughter]
ALLEHAUT: What is interesting is that this industry has become about scale. We work very closely with Tom Buttgenbach at 8minute Solar Energy. The ability of 8minute to source and build projects and optimize the cost side is second to none. The company will create value through its ability to deliver. If you are able to bundle multiple projects, you will get a better EPC price and realize other economies of scale. The key to creating value in this market is to create a large portfolio. If you do everything small, it is a tough market.
STERN: There is an incredible velocity of project turnover. Winning an auction is really just creating an option value on flipping a project. How many entities that won auctions still own and operate their own assets? It is a very low percentage.
MARTIN: Next topic. Bankers are say that debt is pricing today at 125 to 137.5 basis points over LIBOR. Has anybody actually seen these rates?
ALLEHAUT: Yes, and I expect that we will do better.
MARTIN: You expect rates to decline further.
ALLEHAUT: I would caution you about use of the word LIBOR, as it is going away.
MARTIN: Anybody else on debt rates?
STERN: I would say no. I would add another 50 basis points.
DOBBS: I agree at our end of the scale.
KEEL: I think the spreads are accurate for the utility-scale market.
MARTIN: ERCOT says that there are 100,000 megawatts of renewables in the pipeline. What does that say for development opportunities in ERCOT?
KEEL: ERCOT has a 75,000-megawatt peak load, so I would say it is a good place to be looking at storage.
ALLEHAUT: One of the lessons learned about renewable energy projects is that the lower the barrier to entry, the more likely you will see a degradation in the final value of your asset. ERCOT is probably the easiest market to get in. A lot of developers are active in that market. The universe of owners is probably smaller and a very discerning group.
MARTIN: Dan Dobbs, Laura Stern, you work on commercial and industrial projects. C&I has always been the next big thing, but it has been challenging because the transaction costs are so high. Each individual power contract is individually negotiated, making diligence expensive. Has it turned a corner, and if so, what has changed?
DOBBS: It remains challenging. We look for portfolios of projects with multiple sites where you can refuse sites after doing the diligence. We are not necessarily committed to doing every building in the portfolio.
STERN: We work almost exclusively in community solar. Such projects have many of the physical characteristics of a utility-scale plant, which makes the due diligence similar to larger projects. The nature of the community solar offtake agreement moves the credit underwriting focus to the entities that are ensuring that the output remains fully subscribed. This reduces the need to review each customer’s offtake agreement and credit profile. That would make the transaction costs prohibitive.
MARTIN: People often say that community solar is power supply at close to retail rates. How true is that?
STERN: Fairly accurate. The electricity is sold at a discount to retail rates. The price is often indexed to retail rates.
MARTIN: A 15% discount?
DOBBS: Ten to 15%. I think one of the things that makes it a more sustainable business model than rooftop solar is the local utility usually keeps the customers and continues billing them for the electricity.
ALLEHAUT: Community solar has consolidated on the capital side, so Blackstone, for example, has a platform. Blackrock has a platform. We have a platform with Sol Systems. Goldman Sachs has one. These arrangements consolidate on the capital side by allowing portfolios of community solar, C&I and residential rooftop in single financings.
Trends and Challenges
MARTIN: I have two general questions remaining. Let’s work across the panel. What are the one or two biggest trends this year in the solar market, starting with Pete Keel?
KEEL: The first is an uptick in community solar activity. The second is growing interest in solar coupled with storage.
ALLEHAUT: More structured offtakes. I think that . . .
MARTIN: What is a structured offtake?
ALLEHAUT: A fixed-volume or full-requirements contract. Another trend is the industry is developing a better understanding of the promise of bi-facial panels.
DOBBS: I agree. We see a lot more community solar growth.
MARTIN: That is despite the fact that only a handful of states have really good community solar programs at this point. [Pause] Dan is nodding yes.
STERN: I agree about community solar, and all of us have to work to open up more states and markets.
MARTIN: Starting with Laura Stern and working back to Pete Keel, what is the greatest challenge this year for your company?
STERN: Tariffs remain a huge challenge for us. Another challenge will be to see how the tax equity market adjusts to the lower investment tax credit for projects that were not safe harbored before December 2019.
DOBBS: Our biggest challenge is the investment tax credit stepping down and managing the use of equipment we purchased in 2019 to start construction of projects by making sure it is properly deployed in individual projects.
ALLEHAUT: Return on human capital.
MARTIN: What does that mean?
ALLEHAUT: That means that we are all really busy, so how do you squeeze more productivity out of the team?
KEEL: Execution. We are trying to push 1,000 megawatts to financial closing this year. We will need good execution across that portfolio.
MARTIN: That’s a challenge every year.
MR. KEEL: Ideally, yes. [Laughter]