Solar structured transactions within a capital markets securitization approach can help increase the penetration of solar. In this article we will explore ideas for solar securitization in more detail.
Renewable energy generation and distributed solar generation in particular has made considerable progress over the last few years. Firm like Solar City on the residential side and Tioga Energy on the commercial side have helped move distributed solar forward. While there has been considerable progress, the current estimates are that only about 30k solar leases have been implemented on the residential side and a much lower amount for commercial PPA. The potential is vast, with 44 million rooftops in the United States. While there are differences in the residential and commercial markets the potential for securitization exists in both markets. Though in this article we focus on the commercial sector in more detail then the residential, the core issues are similar in both markets.
Solar project finance basics
Depending on the project finance structure employed a solar transaction consists of numerous parties, including a developer, tax-equity investor, a strategic investor, EPC (Engineering Procurement Contract) firm, O&M (Operations and Maintenance) firm and financial and legal firms. The dominate model on the residential side has been the solar lease model and on the commercial end a PPA (Power Purchase Agreement). A long-term agreement for sale of electricity is put in place with an off-taker counterparty and a SPV structure is created with a tax-motivated investor. Numerous variations of the financing structures exist which are beyond the scope of the article. Investors provide long-term financing and receive tax-benefits, environmental benefits if any, cash flows from operations (payments in a lease or PPA structures) and potentially residual interest in the assets.
Solar PPA background
A solar PPA is an agreement between a developer/investor of solar energy and a customer/off-taker to purchase the solar power at an agreed upon price in a long-term contract. The developer/investor installs, maintains and retains ownership of the solar facility on a customer facility – be it a rooftop or other property. The customer pays only for the power generated by the facility and not for the cost of the equipment and installation costs. On-going operation and maintenance is also the responsibility of the developer / investor. A solar PPA agreement reduces the risk and cost for the customer by eliminating out of pocket capital expenditure. The agreement also locks in energy costs for 15 to 25 years, thereby reducing energy cost volatility for the off-taker.
The basics of a solar PPA cover:
The above outlines some of the key issues, though not by any means comprehensive, covering a solar PPA. Standardized PPA contracts for the solar and renewable energy sources will reduce costs for investors / developers and off-takers and allow for more efficient analysis by the rating agencies and capital market investors. Capital Markets stake holders – investors, deal arrangers and rating agencies prefer to have standard well defined structures that can be replicated and can be assessed using standardized risk assessment metrics. Standardization allows for economies of cost and allows for the development of standard models which can be used to develop a rating and risk criteria by all stakeholders.
Investment thesis
The drivers supporting the growth of renewable energy are a combination of factors, including global climate change, higher energy prices, and resource security. Society is faced with numerous challenges as more countries are developing rapidly and competing for the same scarce natural resources. Global concern about climate change is a limiting factor for growing carbon based fuels as countries adopt tighter environmental laws and regulations. Additionally most industry observers feel that we’ve reached peak oil within the last ten years and would be hard pressed to increase production. Shale gas production is an interesting development, but is also challenged by concerns about environmental impact. Higher energy costs continue to dominate and concerns about economic and national security factors necessitate the development of clean local and distributed renewable resources. Renewable energy structures can be a viable new asset class employing securitization methodology for the development of solar, wind, and other energy sectors on a cost efficient basis.
Developing a new market
Developing any new market is challenging and involves collaboration with numerous stakeholders. There is a need for document standardization; development of systems and analytics, education and development of the investor base. Rating agencies have to develop rating methodologies and legal and tax accounting guidelines need to be established. Does the sector have sufficient history of performance data? Are there qualified servicers and credit-worthy issuers? Can securitization structures be cost-effective for the issuer and investor? These and other key issues need to be addressed and standards developed. Other central issues around Dodd-Frank and regulatory policy and its impact are a key source of concern for the sector as it is for the broader securitization sector.
Challenges
New markets have always presented fundamental issues that need to be addressed by all stakeholders. From a lenders perspective the key drivers center on cost of capital, capital relief for off-balance sheet financing and cost effectiveness of accessing the capital markets. Investors similarly have to determine if the asset class is attractive and there is a long term opportunity with sufficient liquidity, well structured credit support and most importantly liquidity for trading and asset / liability management.
Securitization basics
Benefits of securitization
The capital markets can provide large efficient long-term and liquid sources of capital for renewable energy projects. Structured markets can offer more flexible structures then the traditional project finance markers by offering longer tenors, fixed or indexed rates with third party credit enhancement and flexible covenants. Innovative strategies can be employed to develop “green” and sustainable financing structures allowing the various attributes of renewable energy to be monetized. Capital Markets can support larger public transactions incorporating a portfolio approach for diversification as well increased liquidit.
Rational of securitization
Securitization allows the development of resilient markets that can harness dependable technology and offer investors transparency, liquidity, an attractive yield without active management from the investors. Scalable deals can be developed that allow the utilization of all cash, tax and environmental inventive available through various regulatory schemes. Investors can earn a healthy return on their investments with low variability based on a long-term observation of natural resources.
Credit process
Any analysis of a solar transaction would include a review of the cash-flow waterfall, regulatory policy, portfolio correlation, diversity and historic loss profiles. The rating process and the investment evaluation process would include quantitative modeling using scenario and stochastic analysis on robust models designed to stress test the structures.
Securitization of renewable energy assets and specifically solar assets would provide a new asset class for investors that incorporate the key benefits of securitization - including portfolio diversification, credit enhancement, liquidity, time and risk-tranched securities, bankruptcy remote SPV with a delinking of credit risk and originator risk and a social dividend to society. Issuers would benefit from a more efficient use of the balance sheet, lower cost of capital then traditional project finance, and a wider investor base. Models and analytics can provide access to robust models for analysis, thereby increasing the number of investors who can participate in transactions.
Liquidity is a key need of investors and deal arrangers so that a robust market for a new asset class can be developed. A liquid, transparent and standardized process for solar PPA securitization (and solar leases) will benefit all stakeholders by providing transparency, broader appeal to investors, lower cost and wider access to capital, resulting in broader adoption of solar energy by consumers and commercial customers.
[Editor’s Note: This article is adapted from various articles and presentations by Mr. Joshi that were originally published in AOL Energy, Power Sparks, Total Securitization and Renewable Energy Magazine and/or presented at various conferences. John Joshi is a managing director at CapitalFusion Partners LLC, an advisory firm focused on renewable energy and infrastructure projects. Mr. Joshi can be reached at: jjoshi@capitalfusionpartners.com.]
