Part II: The Crucial Fourth Piece of Energy Management

This is the second part to my previous post about integrating the crucial fourth piece of energy management, solar distributed generation (DG), into your energy management strategy costs and the complexities of the value streams generated by solar DG. In this post, I will expand on the various ownership models of solar DG.

Solar DG can be treated like other value-generating assets in your portfolio, which require deciding whether to buy or lease and whether to manage or outsource operation of the system. That decision requires comparing financial returns and determining procurement and hedging strategies for fuels and production inputs.

Here’s a guide to the five main types of ownership strategies currently available:

1. Onsite Net-Metered With a Power Purchase Agreement (PPA)

This is one of the most common models and what most people think of when they hear “commercial solar.” This model is popular because it is the no money down, low-risk workhorse of the industry. Energy users with sufficient land, roof or parking lot areas, and energy consumption enable a solar developer to install a solution at their facility and in turn agree to buy the energy produced by the solution for a long time, typically 20-25 years.

In turn, the developer brings in a financier to purchase the system (either its own company or an arms-length owner) that earns the revenue stream from the energy-using customer. The owner takes on most of the risk associated with production and operations while the customer’s risk is limited to the requirement to buy the power. That requirement is important because the power exported to the grid and credited to the customer through net metering cannot exceed the customer’s energy usage. Thus, the customer is essentially committing to maintaining an energy consumption level that is at least as much as the annual production of the system.

Pros: In addition to facilitating going solar without a cash investment and minimizing risk, the key benefit of this structure is that the financial owner brings a tax appetite to the table, meaning that the owner has income against which to apply the 30% investment tax credit (ITC) and depreciation benefits afforded by the system. Net metering enables energy users to become energy producers at their retail cost of power and, in some cases, to switch to a more advantageous (i.e., expensive) rate.

Cons: A big slice of the economic pie created by the solution goes to the financial owner, just like any asset financing. Additionally, the long-term agreement to purchase power requires a clear picture of the facility’s future use and energy consumption. Sometimes PPAs are negotiated with a purchase option after the owner has reaped the tax benefits, which can allay some of this risk.

Often there are no alternatives within any one state or utility, but this structure requires the greatest alignment of physical suitability of the site, availability of the allocated space for a long time and energy consumption matched with production.

2. Onsite Net-Metered and Customer-Owned

Similar to the previous option—in terms of facility requirements and net metering benefits—owning the system and financing it through a vehicle rather than a PPA provides additional flexibility. For purposes of this discussion, the financing can be internal or external and provided by the customer or solar developer. Financing options are similar to any other capital purchase and include cash, lease, loan, grant, and bond financing.

Pros: For entities with reasonable cost of capital, most financial key performance indicators (KPIs) will be more attractive using other sources of financing compared to a PPA. This enables consideration of solar with less long-term visibility into the site’s operations than with a PPA. Additionally, companies can often benefit directly from the tax incentives and treatment provided by solar rather than sharing them with financial owners in a PPA scenario.

Cons: Any of these financing options deplete, to some extent, the source of capital employed, whether it’s the actual cash balance or borrowing capacity. Even within organizations with healthy balance sheets and good credit, moving a deal to finance solar through the organization can be difficult. Also, the system owner takes on a broader portfolio of risks. Much of the risk can be offset by guarantees and warrantees from the developer and sub-system vendors, but more diligence is required to negotiate these than in a PPA scenario.

3. Virtual Net-Metered—PPA or Customer-Owned

Known as Virtual or Remote Net Metering (RNM), this ownership model can be PPA or customer-owned. Available in Massachusetts and New York, this model is very different from onsite solar. It is different enough that I will devote the next post to this topic and provide just a brief overview here.

RNM greatly expands the addressable market for commercial-scale solar by decoupling the feasibility and attractiveness of the site for solar from the ability and appetite of the commercial, industrial, or institutional energy user to benefit from net metering credits. In this model, the solar solution is built on a suitable site that can be greenfield, brownfield, or developed and a meter is installed for a new account at that location.

The solution consumes a small amount of energy (for lighting, inverters, security) but mostly “spins backwards,” earning net metering credits, typically at a small—expensive—commercial rate. Those credits are applied to the customer’s bill for the location or locations in the same load zone where the power is consumed. The customer typically pays for the power generated by the solar system through a PPA that is priced at a lower rate than the credits it generates. The difference between those two rates is the customer’s benefit, not the difference between the PPA and the customer’s cost of power from the utility or supplier.

Pros: There are numerous benefits to this structure with the common attribute of flexibility. Site considerations for the customer are eliminated and the credits are a benefit applied to the bill and are not impacted by the customer’s cost of power. Typically, credits can also be reassigned if site usage changes.

Cons: RNM is a complex structure. If explaining net metering and building consensus for solar in an organization is difficult, RNM requires significant education, even for experienced and sophisticated energy managers. Also, while not impacted by the customer’s cost of power, the magnitude of the benefit—as defined by the difference between the value of the credits and the PPA rate—varies with the tariff at the site. The benefits are substantial, but getting comfortable with their variability requires effort and sophistication. Also, the nature of the contracts are such that customers hitch their wagons to projects that are not fully developed and, if not brought to successful completion, may miss out on the expected benefits. Finally, the case for RNM is so compelling that various caps and allocations have created scarcity in these markets.

4. Onsite Independent Power Producer (IPP)

This is a compelling way for real estate owners to drive additional value from their holdings and is possible in a few different scenarios.

The most familiar scenario is in utility zones with feed-in tariffs (FIT), where the utility commits to purchase power under specific terms over a 20-25 year term. In one scenario, the real estate owner leases the space (land, roof, or parking lot) for the solar system to the developer and earns a regular payment without dealing with the complexities of contracting for the power or owning a system and interaction between the system and onsite load. Alternately, the real estate owner may choose to own the system as a way to increase its asset base and earn a return.

Another way to achieve similar benefit is in states that allow virtual or remote net metering. In this scenario, rather than selling the power to a utility, it is sold to energy users who benefit from the net metering credits generated by the system.

Pros: These models facilitate onsite solar without many of the barriers related to owner/tenant relationships and concerns about future energy usage. They also provide a compelling opportunity for real estate owners to generate more revenue from their holdings while elevating their standing in the community and among tenants.

Cons: If the space for solar is leased and the real estate owner does not invest in the system, the payments can be modest compared to the effort required to evaluate the opportunity, contract and work with the developer through engineering and construction of the system.

5. Net-Metered with Power Sold to Tenants

In this scenario, the real estate owner purchases the solar system with cash. Instead of paying the utility for power, the tenants pay the property owner, who supplies power at a discount to what the utility charges.

Pros: The property owner can take advantage of the 30% ITC and there isn’t any sales tax applied, providing an attractive return on capital and increasing the asset base of the property. The owner can also offer lower electricity rates to his tenants and highlight the property’s sustainability features, earning higher lease rates and attracting top tier tenants.

Cons: The owner must deploy submetering technology and manage the billing to tenants (or simplify billing on a $/square foot basis). The owner must also have a high degree of confidence that occupancy rates and tenant usage will consume all of the energy produced by the system in order to earn the full projected return.

Keys to Your DG Project

Work with partners that can educate you on the process and considerations along the way. In addition, engage with vendors that have a focus on flexibility when it comes to design, financing, and technology procurement, as this means that they will be able to execute across a broad range of scenarios.

Having the right team as you head into developing a DG project will determine how quickly and smoothly it will get done. An integral role on your team is a leader from the business and finance side of the operation, as solar DG can be treated like other value-generating assets in your portfolio.

Start now. The market and regulatory environments are very fluid—new policies are implemented and market conditions shift quickly. In most cases, these changes can have a big effect on the economics of your project. There are various federal and state programs that are approaching a decline.

The 30% ITC will be reduced to 10% starting in 2017. In addition to affecting the economics of a solar DG system, this also means there will be a rush to complete projects before the decline, straining the solar industry’s resources.

Net metering programs in California are also facing a decline. Depending on the utility area, net metering caps are expected to be met in the next year or so or the program will come to an end—whichever comes first. There will be second net metering program; however, the value of the credit isn’t expected to be as high as in the current program.

Engage with a solar developer sooner rather than later to make sure you’re taking advantage of the various programs in place to support solar deployment.

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