Harnessing Solar Power
Power Purchase Agreements and Enhanced Use Leases are two useful tools that can be utilized to finance a solar energy project—but their true benefit is realized over the long term.
By Tyler Fauerbach, M.SAME
With the U.S. military dealing with across-the-board budget cuts and the expiration of short-term government funding, all branches of the service are looking for ways to reduce costs. However, in the rush to hedge and stabilize energy price volatility, requests for proposals (RFP) may not be structured in a way to capture the most ideal responses from the market, particularly for large-scale military projects.
Third-party ownership of the solar system, like with Power Purchase Agreements (PPA) and Enhanced Use Leases (EUL), are both useful tools to finance a project up front. Some of the distinct advantages over direct ownership of the system include being able to access federal tax incentives, such as the 30 percent Federal Solar Investment Tax Credit and the Modified Accelerated Cost-Recovery System. But there are many factors that contribute to a good, renewable project. These include location, subsidies available in each state, and what the capital markets look like at the time.
Making Wise Investments
Many project developers in the solar market have limited resources when it comes to evaluating projects. Developers are quick key in on project proposals that promise the greatest chances of success—and that means raising capital.
To complete third-party renewable project financing, the three types of capital required are sponsor equity, tax equity and senior debt. All of these have very specific return hurdles, and returns are dependent upon the amount of cash the project produces over the terms of the PPA or EUL. There are also many inexperienced developers out in the market who may indicate they can execute at a lower rate. But once these developers engage the capital providers, they realize the true costs of these transactions are often very different.
The military, traditionally, has expected developers to bid at a kWh-rate below the current rate. In most markets, this is below what it takes to achieve the return hurdles of all three capital providers. Because of this, top-tier developers will give it a pass, and focus their efforts on transactions they know they can get done. That means the military will get lower bids from lower quality providers, a dangerous proposition for two reasons: 1) the project will be delayed and potentially renegotiated due to the pricing not meeting the return requirements of the capital markets; or 2) if it does get completed, it will be by cutting corners to reduce the upfront costs. This is not acceptable for any project that would power any component of our nation’s defense.
A government procurement officer’s job is already challenging, even without the nuances of more innovative projects like solar energy. Solar energy systems require technical and financial information that many may not be intimately familiar with.
The military and their procurement officers need to evaluate each opportunity as if they were an experienced project finance banker, or even a developer, so they can force rank the optimum projects and financing structure. It is recommended to have staff with expertise in financial analysis, to advise on best practices to ensure that the bids that do come in propose systems that are both economically viable and maximize the military’s return on investment.
Understanding Project Advantages
The first step for a project is similar to that famous rule of real estate – location, location, location. The military needs to pick geographic markets where they have unusually high market power rates, or where there are significant state-level incentives for renewable energy.
In 2010, Hawaii’s rates were more than double the national average—27.8 cents/kWh on average versus 11.5 cents/kWh for the rest of the nation, according to Electric Choice. But in September 2012 alone, Hawaii’s average was 37.07 cents/kWh, more than triple the national average at 12.3 cents/kWh, according to the U.S. Energy Information Administration.
“We all know Hawaii has plenty of sun, but the state also has the nation’s highest power rates, and the state’s economy is dependent and held hostage to fuel costs,” according to Alex Tiller, Chief Executive Officer of Sunetric. “With all those factors, we believe the 50th state has great potential to lead in the U.S. solar market.”
Since 2004, Sunetric has worked on several innovative projects in Hawaii, working with military clients who have limited capital and have bases in remote, geographically diverse areas. Sunetric is the largest solar integrator for the state’s military bases. With 11 military bases covering about 20 percent of Oahu’s land mass, Hawaii currently allows up to 35 percent of tax credits for PV systems. Other potential markets include California and Arizona. These markets could price out close to or below current power market prices, and still meet the capital markets return hurdles. Additionally, developers need as much relevant geographical information as possible. Site characteristics can include building plans, and electrical and structural analyses of the site.
Even though California is one of those idyllic markets, the City of San Jose had some struggles with their RFP. When the city government issued RFPs for a 1-MW system at the municipal airport, officials received bids three times what the city paid for electricity from the utility.
Respondents then offered feedback, citing overly restrictive elements in the RFPs, like restrictions of site access, bonding requirements, mutual indemnification clauses and making payments contingent on annual appropriations that did not reflect the market’s realities. Based on the feedback, the city administration was able to create a template to obtain more than two dozen PPAs for other properties.
Good solar projects will not get ideal responses from the market, due to inadequate RFP structures, and that has happened to some recent RFPs to come out of the military. Any developer can come equipped with claims to offer a PPA with a certain cost/kWh. But will that number clear the market? The developer needs to have a strong connection and understanding of the capital markets; otherwise it would be a costly waste of time to the military.
The military also needs to accept that these third-party financing instruments are not a means to reduce power costs in the short term. There are three distinct and important attributes. First, they act as a hedge against rising, volatile power costs. Second, they fix a portion of the base or area’s power cost, which helps to clarify the budget and appropriations process. And third, they provide base-level energy security.
What the Future Holds
According to a January 2013 report from Pike Research, the U.S. military will grow from 80-MW in 2013 to more than 3,200-MW by 2025. That is a four-fold increase in 12 years, with spending reaching almost $1.8 billion.
“The military is one of the biggest consumers of electricity,” Tiller said. “Military solar projects aren’t only for stabilizing power costs and creating reliable, local sources of energy. They’re also a fine example of our federal tax dollars at work, with government encouraging innovation, job creation and technology development in the private sector.”
Renewable energy is a major catalyst of not just sustainability, but energy independence—and the U.S. Department of Defense is a major driver of this push. The challenge is to ensure that projects produce what they promise, and that investments are maximized.