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Mar 28, 2013

Safety in Numbers: Just How Risky Are Crowdsourced Investments in Renewables?

 

After my last blog post on solar crowdfunding, a colleague suggested my enthusiasm for business models like those of Mosaic in the U.S. and Energyshare in the U.K. was somewhat misplaced. Doesn’t crowdfunding, that colleague asked, take advantage of inexperienced investors by exposing them to an asset class they don’t understand? Doesn’t dressing up crowdfunded renewable energy in a slick website with a strong social message misrepresent the underlying risks of the actual assets and/or the risks posed by inexperienced fund managers?

This skeptical view on crowdfunding is shared by many: legal wonks are quick to point out that crowdfunding could result in a slew of lawsuits due to the relaxed financial reporting requirements established by the JOBS Act; some financial regulators worry that crowdfunding will become a tool for financial fraud and abuse (think penny stocks).

These are valid points, but I’d argue that debt-based crowdfunding (as offered by companies such as Mosaic) is a fairly low-risk investment that avoids many of the pitfalls associated with higher risk, equity-based crowdfunding—which is what most crowdfunding skeptics focus on. To better understand these dynamics, let’s consider the various risks associated with turning photons into electrons, starting with the sun and ending with the end user of solar electricity. Such risks for debt-based crowdfunding of renewables fall into three primary buckets:

The Sun

Mosaic Yep GroupThe risk
Critics of solar PV point to the technology’s diurnal generation pattern, the influence of weather and cloud cover, tree growth, evolving local zoning laws, and other variables that impact solar’s reliability for electricity generation. And of course, if the panels aren’t producing electricity, the end user isn’t paying for that electricity, which means Mosaic isn’t getting paid, and neither are its investors.

The reality
The sun is going to keep shining for at least a few billion more years. It’s effectively an unlimited resource, especially compared to Earth’s finite fossil fuel reserves. Meanwhile, the abundance of solar resources in a given location is fairly predictable using historical weather data, and this kind of predictive capability should only get better, as evidenced in a new effort by the National Center for Atmospheric Research. Combine such improved solar forecasting with ever-better grid integration strategies and you have a predictably reliable energy source.

The Hardware

The risk
The panels and supporting equipment that turn sunlight into usable electricity can fail over the 20–30 year lifetime of a solar system. Further, solar manufacturing firms continue to declare bankruptcy on an almost weekly basis as the solar industry matures and consolidates. So if and when equipment fails, sometimes replacement components can be difficult or impossible to find.

The reality
PV systems generally have low failure rates (although exceptions exist, especially for individual components of the larger system) and O&M clauses—including warranties—usually cover module, electrical, and inverter failures. Never the less, these are real concerns, as evidenced by an inverter company’s latest bankruptcy filing and a scramble by solar developers to find replacement inverters for systems they currently have operating in the field. However, the due diligence process meant to mitigate these risks through quality project and product selection is currently one of the most emphasized (and expensive) steps in securing financing for a commercial solar PV deal. As an example, Mosaic has taken a positive step to both streamline this process and protect investors even further by partnering with Distributed Sun, RMI, and other organizations in an industry-wide standardized credit evaluation initiative called truSolar.

The End User

The risk
If an end user stops paying for electricity from a solar system, payments back to the crowdfunder could stop. In addition, the first round of notes on crowdfunded solar systems in the U.S. are good for about ten years. What if the intermediary company (like Mosaic) went bankrupt after four? How could the investment be recouped?

The reality
First, most crowdfunded projects to date in the U.S. are on the roofs of municipal buildings, schools, and nonprofit organizations. These kinds of buildings make up a majority of the energy services company (ESCO) market that’s largely financed with performance-based contracting, so I suspect that these customer classes don’t usually default on their electricity payments. However, I actually haven’t been able to find a solid dataset or paper on the topic, let alone for other kinds of commercial buildings. So I’ll tap the crowd here: anyone seen a paper on commercial electricity bill default rates? If so, email me! The most cited default rate statistics are from companies like SolarCity and SunRun, who claim default rates of less than 0.5% of their customer base, but these are mostly residential installs.

Second, regarding intermediary insolvency: companies like Mosaic can enter into backup servicing and successor agreements that should keep payments on track to crowdfunders even if the intermediary company were to fail. Giant residential installer SolarCity also recently entered into one such agreement to protect their investors. Also, operations and maintenance reserves are usually paid upfront into an escrow account so the services are performed regardless of whether the controlling company is still in existence.

A quick note: I’m greatly generalizing the risks associated with crowdfunding by cramming everything into these three high-level risk buckets (for more detail on additional risk categories, check out GTM’s piece on truSolar). But if I had to make a judgment call right now based on the above criteria, I’d say that investing in crowdfunded commercial solar systems is a pretty low-risk investment.

Of course there’s risk, but how much?

SVdPanelsEven after making such large generalizations and walking through the issues with my colleague, it became clear that I was actually answering the wrong question in the first place. Of course there’s risk involved in crowdfunded investments, just like there is when you buy stock in a company or invest in a Silicon Valley startup. Instead of asking if there’s risk associated with crowdfunding, we should be asking how much? In other words, does the yield on crowdfunded investments compensate investors for any additional risk they’re taking on?

An excellent blog at ImpactIQ seems to think so. If the risk-free, ten-year Treasury rate that any investor can make money on is currently just under 2 percent, that means that the first round of crowdfunded solar notes, issued with yields of 4.5 percent, imply a 2.5 percent premium over the risk-free rate. For some, this 2.5 percent premium, in tandem with the somewhat intangible “social returns” (such as reduced electricity payments for low-income tenants and support of low-carbon energy) that crowdfunders get for investing in solar systems on schools and nonprofit buildings is an adequate rate to compensate investors for the added crowdfunding risk.

Personally, I’m all for including things like social returns in risk calculations and supporting impact investing. But at RMI, we’re also focused on helping to make investments in solar energy a solid decision based on standard financial criteria through our balance of system and innovative solar business models work. And when the S&P 500, a widely used indicator of corporate stock performance that millions of people trade in every day, exhibits wild swings of –38% in 2008 and +23% in 2009, making a 4.5 percent steady return from investing in a simple, stationary piece of electrical equipment on a roof seems like a pretty easy decision to me.

Full disclosure: The author invested in a zero-interest Mosaic project prior to the company’s offering of projects with interest. 

Recommended Reading 

Images courtesy of Mosaic.

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Showing 1-2 of 2 comments

April 9, 2013

Hardware risk - at least here in Colorado - is not to be discounted; a single lightning strike can take out a commercial-scale array. Well-structured O&M agreements will include insurance to cover catastrophic failure, but the loss coverage may not be 100% and is unlikely to cover loss of revenue from interrupted generation.

But the real risk lies with the system Owners who are being cashed-out by Mosaic's Investors, ie. crowd-funders. These Owners are tax-equity investors (typically recruited through large investment operations like Morgan Stanley's MS Solar Solutions fund) who form the LLC that actually owns the solar array, executes the PPA with the local utility, and generates a revenue stream. A portion of that stream flows to crowd-funders, who are earning around 4.5% (net pretax) - while tax equity investors are generating around 10% IRR. That's in ADDITION to a significant return of their capital through the federal ITC, PTC, and accelerated depreciation - and through the cash supplied by crowd-funders.

Mosaic and whatever entity is actually hosting the panel site - usually a school or other non-profit who has no use for the tax benefits - are basically irrelevant in the risk equation. Certainly Mosaic makes no guarantees whatsoever about the reliability of the investment. It is the system Owners whom crowd-funders must trust to make payments on an entirely unsecured loan and maintain an adequate O&M escrow account.

This group of Owners is entirely opaque - in fact, anonymous - to crowd-funding Investors, who rely on Mosaic's word that proper due diligence has been applied to vet the ownership group. Likewise, the details of the Owner's O&M arrangements are not visible to crowd-funders. And once the chief tax benefits have been reaped in the first 5 years of operation, ownership of the array is likely to be flipped to a new set of owners who want to "participate" but don't insist on the double-digit returns that the original tax-equity investors signed up for.

The crowd-funding model as it applies to renewable energy investments has an appealingly democratic and pluralistic veneer - but like most large-scale investment vehicles the benefits flow mainly to the large-scale investors.


April 11, 2013

Also, risks re "The Sun":

Business models that predict the rate of return on investments in solar energy are not using predictive techniques like the NCAR tools cited in this article, which in any case are specifically focussed on short-term supply/demand management, not long-term output forecasts.

Instead, nearly every residential and commercial scale project uses the insolation model built into NREL's PVWatts tool (http://www.nrel.gov/rredc/pvwatts/grid.html) to predict the generation capacity of a given sited photovoltaic array; that model in turn is built on a historical insolation database detailing a "typical meteorological year" over the period from 1961-1990.

This model does NOT incorporate any predictions of insolation changes due to global warming, which through changes to cloud cover patterns might well have a significant effect (positive or negative) on the output of a given solar array. This uncertainty represents another risk to overall returns from solar energy investments.

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