Clean Energy Finance 101

on June 10, 2014 at 2:00 PM

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As innovative energy products and services come to market, so do new mechanisms to fund them. And existing funding options become more popular. This has resulted in a boom of finance jargon, especially regarding energy efficiency and renewable generation. Though many of the finance terms used in clean energy finance are similar to those used in traditional finance, it’s easy to get lost. We hope this glossary will help those in clean energy navigate the new and growing world of clean energy finance.

Asset Class: A grouping of similar types of investments that behave similarly in the marketplace and are subject to the same laws and regulations. Broad examples of asset classes include:

  1. Equities (also known as stocks) – assets that represent ownership of part of a company.
  2. Bonds – assets that guarantee a fixed payment stream.

Bonds are often further categorized based on structure or source of the payments. Examples of these subclasses include municipal, corporate and mortgage bonds.

Credit Enhancement:  A feature that increases the creditworthiness of an individual or corporate borrower. They are intended to reduce the risk that the investors will not be repaid. One simple type of credit enhancement is a loan loss reserve, which accepts the losses for a portion of the defaults in an asset pool. Other types of credit enhancements include payment mechanisms such as On-Bill Repayment and PACE (see explanations below).

Energy Services Agreement (ESA): In an ESA, energy efficiency is treated as a service rather than a product. In this type of agreement, a project developer evaluates a building and executes energy efficiency upgrades. The customer pays for this energy service over time at an agreed upon rate. One way to structure the contract is to have the customer pay per unit of energy saved, which means they only pay for the actual savings and do not bear the risk of an underperforming project.

Green Bank: Green banks are generally defined as public or quasi-public financial institutions that use public funds to attract private investment to clean energy projects. Green bank activities can include offering financing guarantees, creating new financial products, and helping alleviate market barriers and inefficiencies. Green banks in Connecticut, New York and Hawaii have hired staff with extensive experience in both the private and public sectors. Each of these banks has the authority and capability to work closely with private sector entities to design effective clean energy financing solutions.

Green Bonds: A type of bond that is issued to pay for climate/environmental projects. These are often issued by large institutions, such as World Bank, Bank of America, and Toyota, that invest in both environmental and non-environmental projects. However the proceeds from the green bonds are invested exclusively in green projects.

MACRS: The Modified Accelerated Cost Recovery System (MACRS) is the primary tax depreciation system used by the IRS. Depreciation is an income tax deduction that taxpayers can use to recover the cost of certain types of property over time.  MACRS specifies different cost recovery periods for different types of properties, usually based on the expected useful life of that property. However, MACRS allows for a relatively short five-year cost recovery period for solar photovoltaic assets despite the fact that solar systems often have a useful life of 25 years or more. This accelerated recovery period increases the attractiveness of solar investment.

On-Bill Finance (OBF): OBF allows utility customers to borrow money from their utility at little to no interest to pay for certain energy efficiency measures. The loan is repaid over time through the utility bill.

On-Bill Repayment (OBR): OBR is a program that helps utility customers secure private financing for energy efficiency and renewable generation by allowing them to repay the private financing institution through their utility bill. Placing the repayment on the utility bill provides lenders and other investors with greater assurance that they will be repaid, therefore enhancing the credit of participating customers. This results in a greater number of customers being eligible for financing as well as better overall financing terms for qualifying customers.

Open Source OBR: An OBR program that allows multiple lenders and other investors to compete for customers and allows a wide variety of financing products, such as loans, leases, Power Purchase Agreements and Energy Services Agreements, to be eligible through the program.

Property Assessed Clean Energy (PACE): PACE allows building/home owners to repay loans for energy efficiency and/or renewable generation through their property tax bill. Placing the loan repayment on the property tax bill reduces the risk of default because property taxes are almost always successfully collected. This reduced risk of default provides a credit enhancement for participating building/home owners, and therefore allows more building/home owners to get access to financing at attractive rates.

PACE 2.0: PACE 2.0 is a new version of PACE that is emerging in Connecticut, California and some other states. Like the original PACE, PACE 2.0 allows for clean energy investments to be repaid through the property tax bill. But PACE 2.0 goes a step further by allowing payments for solar leases and for solar power purchase agreements to also be repaid through the property tax bill.

Renewable Electricity Production Tax Credit (PTC): The Renewable Electricity Production Tax Credit (PTC) is a per-kilowatt-hour tax credit for electricity generated from qualified renewable resources including, but not limited to, wind, geothermal, and closed-loop biomass. It incentivizes renewable energy in a market dominated by fossil fuels. This tax credit is generally only available for the first ten years of production. The PTC is not typically used for solar generation.

Secondary Market: The market(s) where securities and other assets can be purchased from somebody other than the initial issuer of the asset. For example, when a bank sells the mortgages that it originated as mortgage-backed securities, they are selling into a secondary market. Secondary markets are particularly important to clean energy finance because the payment obligations that are created through clean energy finance mechanisms like PACE and OBR (see definitions above) can be turned into an asset and sold on secondary markets. The ability to sell these assets on the secondary market is very attractive to investors and helps drive down the cost of capital for clean energy projects.

Securitization: The process of combining financial assets into a pool and then selling portions of that combined pool on the secondary market to institutional investors, such as pension funds. The resulting asset (i.e. mortgage-backed securities) generally requires a credit rating from a rating agency assessing the risk associated with it. By allowing the original investor in a project to sell the resulting asset on the secondary market, securitization increases initial lenders’ willingness to provide low-cost capital. This is particularly true if the resulting securities receive a high credit rating because the asset will be worth more on the secondary market.

Solar Investment Tax Credit (ITC): The Solar Investment Tax Credit (ITC) is a 30 percent tax credit for the cost of solar systems installed on residential and commercial properties.

Solar Lease: A contractual agreement under which an individual or business allows solar panels owned by a third party to be installed on their property, and leases those panels for a fixed period of time. Lease periods typically fall within 10 to 20 years. Third-party ownership structures, such as solar leases and Solar Power Purchase Agreements, allow investors to take full advantage of the tax benefits of solar (see Tax Equity Investment).

Solar Power Purchase Agreement (PPA): A contractual agreement under which an individual or business allows solar panels owned by a third party to be installed on their property, and agrees to purchase the power produced from the solar installation at an agreed upon rate over a fixed period of time. Third party ownership structures, such as Solar Leases and Power Purchase Agreements, allow investors and consumers to take full advantage of the tax benefits of solar (see Tax Equity Investment).

Tax Equity Investment (Third Party Ownership): Investment in solar development by a third party private investor who utilize federal tax benefits to offset taxes they would otherwise owe. In such an arrangement, a third party investor owns the solar panels and collects the tax benefits while leasing out the panels, or selling the power through a Solar Power Purchase Agreement. The two primary tax benefits for solar investment are the Solar Investment Tax Credit (ITC) and the MACRS. In practice, tax equity investments are generally attractive for profitable financial companies and for a few wealthy individuals with extensive real estate holdings.

Yield Co: A yield co is a publicly traded company that is created for the purpose of owning assets that produce cash flow. Some yield cos specifically focus on renewable energy assets. The income from these assets is then generally distributed to the shareholders as dividends. While yield cos are structured as a normal taxpaying corporations, yield cos that own renewable resources can use the tax benefits associated with clean energy investment to avoid paying taxes.

By Rachel Neil 

Originally Published on June 5, 2014 

The Energy Exchange Blog is a forum where EDF‘s energy experts discuss how to accelerate the transition to a clean, low-carbon energy economy. Follow them on Twitter here: @EDFEnergyEX.