Earlier this month I handed a $10 bill to a clerk at the local theater. I didn’t think about it at the time, but a portion of that bill probably didn’t go directly into the coffers of a movie production company or the theater. Instead, it’s likely that some of my money was thrown together with money from tens of thousands of other ticket purchases, bundled up into a virtual package by a banker, combined with cash flows from other payments, and traded on a financial market.
My movie ticket was part of a security, a pool of assets (like car loans, credit card receivables, student loans, and home mortgages) that generate a steady stream of revenue over time. It’s strange to think that movie tickets are considered steady streams of revenue, but it makes some sense: the syndication of a sure-fire hit like Avatar has got to have some pretty reliable cash flows, right?
As an advocate for distributed renewable energy and a bit of a finance geek, I can’t help but look at this definition of a security and draw a connection to photovoltaic solar projects. At its core, a solar system is a piece of equipment that generates a steady, relatively predictable stream of electricity over a 20- to 30-year period, with a dollar value attached to each electron produced. So why can’t we simply bundle up electricity purchases from PV systems and “securitize” them like we do with movie ticket sales?
It turns out there are a number of reasons, mostly related to investor risk and a lack of data on rooftop solar. RMI’s solar team is currently working with industry to address these various risks and help distributed solar PV developers access currently inaccessible financial markets.
Why are we at RMI and the solar industry are so interested in things like securitization of solar systems? Travis Bradford of the Prometheus Institute recently answered this question in a single sentence (I paraphrase): If capital for PV projects came from open financial markets, we could cut distributed PV solar’s cost to the end user in half.
Now, that’s a seriously bold claim and explaining it is a bit complicated, but bear with me.
Earlier this month, my colleague Dan Seif wrote about how tax equity-based financing is the norm for most PV projects in the U.S. Even though tax equity is currently supporting healthy growth in the PV industry, it’s not a good long-term solution.
In contrast to tax equity, financial mechanisms such as mutual funds, corporate bonds, municipal bonds, stocks, and pension funds generally coincide with much lower costs of capital and allow individuals to buy into them (not just sophisticated institutional or corporate investors, as is the case with tax equity). Furthermore, most documentation and processes related to these mechanisms have been largely standardized. A good example of this is the market for residential mortgages: borrowing costs are low (4-7 percent interest), variation between mortgages is minimal, and they’ve been traded for decades on public exchanges as a part of large asset-backed securities.
As an advocate for distributed generation, RMI wants solar PV developers to have access to tools like securities and commercial PACE bonds because doing so can drastically reduce costs to the end user. Customers pay for electricity by the kilowatt-hour, so industry types usually express electricity costs as the levelized cost of energy (LCOE) in $/kWh. To illustrate the power of these financial mechanisms, I’ve sketched out two cases for a small commercial rooftop PV system in San Diego using the National Renewable Energy Laboratory’s PVWatts tool. (For all you wonks out there, please email me for specific assumptions—too many to list here!)
- The left bar is based on a PV system constructed in June 2011 in San Diego. This project relied on the investment tax credit, a 30 percent credit that forms the basis of tax equity deals.
- The right bar is a hypothetical PV project using the same technology as the tax equity project. However, it’s simulated as a part of a security, so three major financial changes took place:
 The investment tax credit was not utilized.
 The debt-to-equity ratio has changed, meaning the loan used to build the system looks more like a residential mortgage.
 The cost of capital is much cheaper.
Why is the tax equity deal more expensive than the securitized deal? It’s primarily about the cost of capital (mostly interest rates). For the tax equity project, these costs were over 19 percent. For the securitized project, that same cost of capital was just under 10 percent.
In the example above, we assumed that a tax equity investor would seek returns of 30 percent. Some might claim that most tax equity investors look for much lower returns. But supplemental evidence from Bloomberg New Energy Finance says otherwise: some tax equity investors have realized returns as high as 48 percent! In contrast, things like pension funds and mutual funds are more comfortable with single-digit returns from investing in bundles of stable assets like PV systems, so the interest charged to developers is much lower.
Now, this hypothetical deal doesn’t quite generate electricity at half the price of the tax equity deal as the quote above suggested it could. But if rooftop solar PV project developers were able to access open financial exchanges, costs of capital would continue to decline, the industry would mature at a faster rate, and PV costs could come down even further.
To summarize, recall the movie ticket scenario from earlier and replace a single movie ticket sale with the single PV system. Now, combine that PV system with hundreds of other systems of varying sizes located throughout the country and you can start to imagine what a PV-backed security could look like. Assuming someone aggregated all of these systems into a single package (like the hypothetical banker did with movie tickets and other cash flows), they could then be sold on a public exchange. Furthermore, such a security could be included in a mutual fund for any individual to buy into as hundreds of thousands of people currently do with other asset-backed securities.
This hypothetical deal can undercut the cost of electricity from a tax equity project—at today’s PV costs—without any support from the 30 percent investment tax credit. Given all the hoopla about renewables being dependent on subsidies to survive, that’s pretty compelling. The challenge now is to help codify rooftop PV systems as investment-quality assets in order for projects like this to become reality.