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Jun 22, 2011

Financial Innovation in the Solar Sector


Google’s recent $280 million investment in solar developer SolarCity is a win-win-win scenario.

About 10,000 homeowners get cheaper, cleaner energy, Google gets a hefty tax write-off (to the tune of  $80 million dollars), and the emerging preferred financing mechanism for solar installs—the power purchase agreement (PPA) —gains yet another stamp of approval from one of the clean energy sector’s most important investors.

PPAs allow for a solar developer (like SolarCity) to sell the solar-generated electricity from their own installation(s) to a building owner through a long-term 15–25 year contract. This model has helped to make solar affordable and attractive to millions of risk-averse customers, and overcomes several barriers to PV adoption: customers avoid a significant up-front investment, the burden of operation and maintenance falls to the developer, and electricity prices are locked in at a pre-determined rate.

While Google’s investment aims to boost residential installations, PPAs and other third-party financing mechanisms are also helping to transform the domestic commercial PV market.

However, the rapid growth enabled by PPAs has a flip side: solar developers are expanding so quickly that they can’t find enough investment dollars to keep up with demand.

Attracting Investment

Over the past several years, solar developers have used two main financing mechanisms to attract investment in PV solar systems:

  • A solar developer enters into a special partnership with an investor (jargon: “Special Allocation Partnership” or “Flip” structures). The investor provides 99% of a project’s up-front capital. The investor reaps the tax benefits, but most of the cash made from actually selling energy goes into the coffers of the solar developer.
  • Under an “operating lease”, a developer leases an entire system from an investor and sells produced electricity to their customers. The developer is responsible for operating and maintaining the system while the investor receives tax benefits and provides capital for the solar system.

Both of these mechanisms have helped the solar industry to mature. However, they come with limitations.

Going Bigger

Under these two investment schemes, investors typically provide equity and capital at the “project level.”

But, if solar developers had access to portfolio-level debt financing from major institutional investors like big banks and investment funds, the industry could grow even faster. Luckily, innovation is brewing to attract such large-scale investment.

On the residential front, SunRun wants to bundle thousands of their PPAs and sell them to investors. Bundling or securitizing assets like PPAs so they can be bought or sold as bonds could potentially mobilize a great deal of capital (so long as the practice is coupled with better oversight to prevent disasters like the subprime lending crisis).

At RMI, we’re working with partners in government and industry to identify and develop other innovative financing approaches. One idea: aggregate demand.

Within the commercial solar world, 1–5 megawatt projects are a more attractive investment over smaller, disaggregated installs like those found on medium-sized big-box commercial retail stores. With a shortage of rooftops that can handle larger-scale projects, a significant opportunity exists to create portfolios comprised of hundreds of medium to large commercial installs that, when taken as a whole, reach the 10 or 100 megawatt size.

Such portfolios may incur higher transaction costs due to legal requirements and administrative challenges. But diversified projects like these (projects with inherently lower risk given the spread in project size and location) could attract huge financiers, eventually making Google’s investment in SunCity look like a small-time deal.

Given the solar industry’s momentum and growing hunger for capital, continued financial innovation will be necessary for the industry to compete for the billions of investment dollars out there waiting to find a home.

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