Each month we see dozens of solar projects; most of them will never get financed. Quite simply, the economics do not support the deal. For promising projects, we perform a detailed viability analyses but in most cases this is not necessary; it does not take much to spot an un-financeable solar project. Why then do they keep coming?
The lack of knowledge regarding a project’s financial viability is not only widespread in the solar community, but it is costing the industry terrific amounts of time and lost opportunities as projects are pursued (sometimes for months) before a check on project economics points out their unsuitability.
Whether EPC firms (aka installers or integrators) are focused on PPA/third party financing or customer owned projects, economic viability is a key driver in getting these projects built. For EPCs looking to match their clients with a third party financing partner, the consequences are quite serious. Not only do project pipelines get clogged up with bad deals, but relationships with financiers quickly sour with the presentation of clearly unviable deals. This inevitably results in loss of credibility among the financing community. For customer financed and owned projects, turnkey pricing must remain competitive in order to offer customers viable lease payments and/or suitable power savings.
By their nature, EPC firms excel in assessing the technical viability of a solar project. The question of whether a rooftop installation is technically viable is of course, substantially different from whether it can be done at a price which is simultaneously attractive to the off-taker and provides a sufficient return to the financier.
DG Energy Partners is focused on securing financing for commercial scale (200kW-20MW) distributed generation solar project opportunities. This involves vetting projects for financial viability, and educating our clients on the components that make up a financially viable project. We have found over time that the old adage rings true in solar – an educated customer is our best customer. In this spirit, the following are the six key factors to look for in assessing a project’s financial viability.
1. Solar Radiation: As Arizona residents will attest, there is substantial differential in solar radiation levels depending on which region of the country a project is located. Production levels can vary up to nearly 30% from a low radiation region to a high radiation region. This is not to say that solar cannot be built in the northeast (New Jersey, Massachusetts and now Connecticut put paid to this theory), simply that good sun gives a project an immediate advantage and they may not require the same level of local incentives to ensure viability.
2. PPA Price/FIT: In recent years, PPA prices have been overshadowed by Solar Renewable Energy Credits (SREC) prices, with financing parties entering into shamefully low off-taker contracts to secure customer commitment. This is no longer the case. Revenues from energy sales (either via a feed in tariff or PPA price) play a critical role in project economics. Look to the prevailing retail rate for an avoided cost against which to benchmark.
3. SREC/Incentives: Incentives, state specific rebates and SRECs used as a mechanism to implement Renewable Portfolio Standards remain critical to a project’s viability. However, SRECs remain an illiquid market, long term contracts rarely exceed three years in length, high price volatility and lack of understanding exists among market participants.
4. Turnkey Cost: Panel and component costs have been steadily declining over the past few years as have EPC margins and Balance of System (BOS) costs. Turnkey cost is the project component that is most often subject to misaligned expectations between PPA providers and EPC firms. This is especially the case when the PPA provider itself has access to competitive pricing for hardware and BOS.
5. Operating Expenses: O&M expenses are found in the $10 -$15/kW range. Higher than this will raise questions. The scope of this work varies slightly among the sponsor equity/developer community, but most include system monitoring, quarterly site visits and maintaining clean panels. An additional $10 – $15/kW cost is included for other expenses including insurance and accounting.
6. Risk Factors/Value Components: With each deal that crosses our desk, we work through a checklist of potential issues. These include off-taker type and credit, site/roof condition, project documentation, geography, interconnection pricing, and the permitting process. Each can mean additional cost and risk sufficient to derail a project.
Many will notice that we make no mention of tax advantaged financing structures. Starting in October, the real impact of tax equity financing will begin to be felt and we expect many pending deals that have failed to meet safe harbor rules to be restructured as ITC transactions. Nonetheless, while effective tax equity structuring can improve returns on a good project, it will not make a poor project viable. It is important for a project to have an underlying financial viability regardless of its structure.
Incorporating financial viability analysis early in the origination process is critical to an EPCs success. To help with this evaluation DGEP has created online tools including the Solar Project Pricing Index and the Price Your Project tool. This month, we launched the Solar Finance Bootcamp for firms that wish to internalize the skills, knowledge and tools necessary to evaluate solar project opportunities.
Each month, the solar industry is becoming more competitive; being able to quickly identify financially viable projects and walking away from others will be the most important determinant of an EPC firm’s ongoing success. A large pipeline alone is not a guarantee of success; EPCs need to consider not only what can be built, but what can be financed.
Mike DellaGala is a director at DG Energy Partners in New York City. Jonathan McClelland is DG Energy’s chief of operations and strategy, and a member of the Breaking Energy editorial advisory board.