YieldCos, A Modern Solar Shakespearean Play

Act V is still to come.

Originally posted on pv magazine. Re-posted in May 17, 2017 SolarWakeup.

Now even NRG may be looking to sell NRG Yield, a top five YieldCo. With NRG under pressure to cut costs, this news stokes growing concerns about the future of YieldCos. Last month solar industry analysts had a field day when First Solar announced it would explore a sale of its stake in 8point3 (CAFD), declaring YieldCos a “losing proposition,” “dividend trap,” and “dead structure.”

This open punditry reminded me of The Tempest, which I last read in middle school. The Tempest was my first introduction to Freytag’s Pyramid, a ‘data visualization’ of the classic Shakespearean narrative. Across comedies, tragedies, and historical plays, Freytag’s Pyramid identifies the structural similarity of plots and maps them into five acts: Exposition, Rise, Climax, Fall, and Dénouement.

The YieldCo story follows an identical plot line. With leading YieldCos 8point3, TerraForm Power, NRG Yield, and NextEra Energy Partners down over the past few years, many industry watchers seem to be (understandably) caught up in Act IV of the YieldCo story and have not yet considered Act V. First, here are my cliff notes on Acts I-IV:

Act I, Exposition: The year is 2012. Enter our protagonist, YieldCo, a young, independent power producing (IPP) company created to own and operate solar assets in order to generate a predictable cash flow. By separating the development activities (a risky activity) from the long-term asset ownership (a more stable risk) into two different companies, YieldCos democratized investor access to solar assets.

Act II, Rise: As hoped, YieldCos fulfill their initial promises and provide their investors reliable dividend checks. Sensing an opportunity, a YieldCo begins to promise both steady dividends and rapid growth. Thus begins a virtuous cycle: Investors expect YieldCo dividends to grow rapidly, causing investors to bid up the YieldCo stock price, which enables the YieldCo to buy more dividend-generating assets with its valuable stock, which then increases the expected dividend growth, and so on. Through 2013 and 2014, at least 15 YieldCos go public.

Act III, Climax: At their peak, market valuations of leading U.S. YieldCos include TerraForm Power at $5.5B, NextEra Energy Partners at $4.4B, NRG Yield at $4.1B, Abengoa Yield at $3.9B, TerraForm Global at $2.6B, Pattern Energy at $2B, and 8Point3 at $1.3B. By mid-2015, YieldCos are valued at $20B+, a princely sum worth much more than all publicly-listed solar panel manufacturers worldwide.

But stock prices of these sustainable energy companies had been bid to a point of unsustainability. Theories diverge on the exact cause, but no one disputes that during “the Summer Shock of 2015,” the self-reinforcing cycle of high growth and high yield collapses.

This brings us to what many believe is the end of the YieldCo story.

Act IV, Fall: The cycle changes from virtuous to vicious. Within months, share prices fall by as much as 60%, producing widespread investor concern over the function, transparency, and durability of YieldCos.

NASDAQ YieldCos Stock Chart

Market valuation of the seven listed U.S. yieldcos from mid-2015 to mid-2017. Source: NASDAQ stock charts

Two years later, the stocks still haven’t recovered. Just a few weeks ago, First Solar and Abengoa explored selling their respective YieldCo stakes in 8Point3 Energy Partners and Atlantica Yield. Amidst the headlines predicting doom, many industry observers are understandably mistaking this act as the end of the play.

But, as Freytag observed of plays, so too, can we observe of industries: this financial vehicle may be new to solar, but YieldCos are not a new financial vehicle. And neither is this story arc.

Act V, Dénouement: Traditionally, conflicts are resolved in the fifth act: the protagonist either dies or matures, having learned a few life-changing lessons.

YieldCos, as a structure, have not died—the decline of growth-focused YieldCos does not diminish the YieldCos’ original value proposition of separating risky development activities from less-risky, long-term asset ownership. Instead, we are witnessing the maturation of the YieldCo model, and along with it, the maturation of capital deployment into solar.

In the heyday of the growth-focused YieldCo, many investors believed that the YieldCo structure was the single ‘natural owner’ of all renewable assets, and all forms of investment risk. The YieldCo from Act II owned all risks of the operating asset, including the risk of offtaker default, O&M risk, weather risk, etc. Driven by their aggressive growth expectations, YieldCos even assumed a level of development risk, pushing past any cautious objections. These YieldCos were true generalists.

The “Summer Shock” left a vacuum of capital that sparked a Cambrian explosion of new, specialized sources of capital that are the true ‘natural owners’ of specific risks. Power traders, the intellectual descendants of Enron, are rapidly developing hedges that ‘own’ the risk of fluctuating wholesale power prices. Energy management firms like Altenex are developing new contract structures that enable large, investment-grade corporates to ‘own’ the credit risk. At kWh Analytics, we partnered with insurers that rely on our vast data repository of solar asset performance (fast approaching 200,000 operating solar projects) to create an insurance product that ‘owns’ solar production risk. This specialization allows each capital type to play to its unique strengths.

Similarly, we think YieldCos will specialize. YieldCos are modeled after REITs. Today, it is rare for a REIT to be a generalist. There are REITs that specialize in owning strip malls in the Midwest, and others that specialize in owning A-grade office buildings on the coasts. It doesn’t take much imagination to envision a YieldCo that will specialize in distributed solar while another specializes in utility-scale. And no YieldCo should take on development risk again. Put another way, YieldCos are to REITs as West Side Story is to Romeo and Juliet. Different names, same story.

This specialization is ultimately good for the industry. While the fall of growth-focused YieldCos left many investors shaken, managed and financed correctly, YieldCos still have the potential to provide investors with steady yields, project developers with access to capital, and consumers with cheaper solar.



Solar Refinancing: When Asset Management Steals the Show

Originally posted on Renewable Energy World.

We all know that asset management is in many respects the under-loved function within a solar company. Solar asset management involves the ongoing management of financial, commercial, and administrative tasks necessary to ensure the optimal financial performance of a solar PV plant or portfolio of plants. From an executive-level perspective, it’s easier to invest in developing a new solar project, buy an early-stage project, or invest in a project finance team to try to get better financing terms (as these functions are understood to drive value) than it is to invest in asset management.

In most businesses, revenue is the clearest driver of profitability. So, it’s an easy decision for executives to invest in their sales activities. Similarly, in solar, acquisitions and project finance are commonly prioritized, whereas asset management is oftentimes an afterthought.

However, there is at least one point (often multiple points) in every asset’s 25- to 30-year life when asset management steps into the limelight: the refinancing of a solar project.

What is refinancing? Refinancing is when you take an existing, operating asset and then get a new loan from your bank—ideally with better terms, since the project has been de-risked.

Taking a step back to understand financing: Banks have appetite for solar investments, but loans are carefully structured to avoid even the smallest risk of default. Consequently, banks size deals to the asset’s downside and assign conservative terms on loans. This conservatism results in an inefficient pricing of risk—banks apply about a 25 percent haircut for commercial and utility-scale solar projects, and a nearly 35 percent haircut for residential portfolios — known as debt service coverage ratios).

Today, the single-biggest cost of a solar project is actually an invisible one: the cost of capital. In this context, refinancing is particularly valuable because it presents an opportunity to reduce that single-biggest cost. What magnitude of savings can be gained from refinancing? According to Ahana Renewable’s Director of Asset Management Philip Williams, “savings could be up to a couple percentage points better than the original terms,” which translates to tens of millions of dollars of value on a large portfolio.

While the total installed price of solar has continued to decline, non-module costs now comprise the majority of the total installed price of solar. Since 2010, reductions in inverter and racking costs represent a smaller share, roughly 20 percent, of the decline in total non-module costs. The sizeable remainder can thus be attributed largely to declines in various soft costs. Credit: Lawrence Berkeley National Laboratory.

Asset management is critical for refinancing. Williams noted, “when refinancing solar assets, a lender is about to shine a light on every dark corner of your portfolio. So, from the very start, you actually need to think years ahead, to consider what software systems you need, what first-class preventative maintenance you want your O&M to perform, how this information will flow into your existing data infrastructure, etc.”

It’s true: To justify better terms, you need to prove to the bank why this is a better asset. You need to have strong documentation of your warrantees, the energy production data must be centrally managed, you have to make sure you have good O&M records of how you’ve taken care of this plant, and so forth. Assets can only be refinanced if they are proven to be higher-quality assets than they were last assessed several years ago.

Furthermore, new opportunities have recently emerged for assets with good asset management. For example, my company offers an insurance product that guarantees up to 95 percent of a project’s estimated energy production, which reduces the “haircut” that a lender would normally assign. But if an asset is falling apart, no lender or insurance carrier will be willing to touch it.




Opinion: Silicon Valley InsurTech

By Matthew Neill, originally posted on Insurance Insider.

The sun-kissed avenues of Northern California which house the technologists who have come to run the world are thousands of miles away from London.

And at first glance it appears that the cultures of its (re)insurance world is several multiples of that distance apart from the traditional strongholds of London, Europe and the US East Coast.

But with the rise of InsurTech in the last two years, Silicon Valley has become the epicentre of the biggest figurative earthquake to rock the industry for some time.

While other parts of financial services industry have been fundamentally changed by technology, (re)insurance has remained relatively unchanged, particularly in London.

Brokers still shuffle to and from Lloyd’s laden with stacks of papers, underwriters come to their box and approve policies with a stamp, and the pubs remain encouragingly full at lunchtime in spite of those who would see it otherwise.

But the winds of change have blown over the Atlantic now, and London is sitting up and taking notice.

The question is – what is going on in Silicon Valley that is going to make it to the other side of the pond?

From all my conversations with venture capitalists, start-ups and investors on the West Coast, one theme continued to rear its head: seriously technically savvy people with no prior experience of insurance are paying attention to the issues in the industry.

And they think they can do a better job than the incumbents.

There are many reasons why they claim to be able to do this: No legacy technology noose around their necks, the capability to change tack quickly and innovate as and when issues appear – offering the same product for a much lower expense level.

But the one thing that stood out above all was their ability to gather enormous clumps of data on specialist industries and, through technological alchemy, transform it into (re)insurance gold.

Take kWh Analytics as an example. Before entering the (re)insurance world, the start-up was a benchmarking tool for the global solar energy industry, aggregating data on the price and quality of solar panels all over the world for the use of investors.

Now it has shifted into insurance, using that data to not only underwrite more effectively, but to give its Lloyd’s backers access to a market they were previously unable to enter on the terms they want.

For the moment, these companies want partnership. They have no desire to take on the regulatory and capital requirements demanded of full balance sheet carriers.

But as these businesses begin to increase scale and gain momentum, there is a distinct possibility they will decide to strike out on their own.

Big data is no longer a buzzword – it is a daily reality that the industry must get to grips with.

kWh Analytics & NREL Collaboration Wins Award at 2017 PV Reliability Workshop

“Rate of Degradation Tools: Open-Source Degradation Analysis Toolbox,” a joint collaboration between kWh Analytics and NREL, was recognized as one of the Top 3 posters in its session at the 2017 PV Reliability Workshop. To download full poster, click on the image below.

Open invitations for people who are interested in using or contributing to this software are available in this public repository: https://github.com/kwhanalytics/rdtools.

Coverage of this poster can be found on Solar Power World.



My 2017 Solar Resolution — Inspiring Dialogue with Key Solar Influencers

Originally posted on Renewable Energy World.

A funny thing happened recently: We wrote an article suggesting that a lower cost of capital, driven by increased debt in project finance transactions, would help to mitigate some of the new risk the solar industry faces in 2017. We didn’t anticipate that this would be a particularly controversial viewpoint. After all, paying a lower cost of capital is like paying off old credit card debt. Who could disagree with that?

So we were surprised at some of the pushback. People from various functional backgrounds in solar argued that their area of expertise was the aspect of the market most in need of cost reductions. Marketers pushed for lower customer acquisition costs, operations managers pushed for more efficient fleet ops, and so on. None of these are wrong. Any opportunity to reduce solar’s costs should be explored. Our company is focused on the finance side of solar and so naturally, our view veers toward the costs associated with project finance.

The lower cost of capital argument reminds me a bit of the importance of sleep in our everyday lives. What do I mean by that?

Sleep impacts every aspect of our lives. Consistent, good sleep makes us more alert during the day. We are more productive in our jobs. It improves our memory, makes us more creative, and even helps us lose weight. In essence, sleep is a multiplier. We do not directly include it in our measurements of productivity, creativity, or health. But it is always there, impacting all of us in innumerable ways nevertheless.

Solar’s high cost of capital is similar. It will never be a specific line item in the installed cost per watt of a solar project. But it is always there, in the background, impacting every aspect of the solar value chain — from equipment to labor to marketing, and at every size — from utility-scale down to residential. For instance, consider a small installer in Vermont that uses a third-party financing service to offer a lease or PPA. That lease or PPA is more expensive because of the financing service’s higher cost of capital. Financing costs are hidden but significant.

Here’s a way to reduce this cost: Credit enhancements, such as insurance on the production of a solar asset, are increasingly available to project financiers today. These enhancements can improve the net present value of solar project finance transactions by 5-15 percent. Assuming an installed cost of $3/watt for a residential system, that’s as much as 15 to 45 cents of added value. With equipment prices plunging, this additional value is akin to completely eliminating the cost of a module.

As we have pointed out, replacing expensive equity with cheap debt changes solar’s equation for the better, for everyone in the industry. Because money is fungible, it ultimately doesn’t matter where cost is driven out of the price of an installed watt. Simply put: a dollar saved from lower acquisition costs is the same as a dollar saved from lower capital costs.

This is an important conversation for the industry to have, and it is particularly useful for solar professionals to get out of their silos and hear the views from other functional areas. I know this is an area where I can improve. I’ve been in solar for 10 years, yet I have blind spots that are obvious to an installer, a marketer, a technologist, or a policy maker.

So this is one of my professional resolutions for 2017—to get out of my solar finance comfort zone and learn more about other aspects of our industry. To make this easier, our team assembled a ‘Top 100’ list of Thought Leaders and is making the list publicly accessible at this link. By updating this list weekly, we hope to inspire dialogue across our industry. I look forward to learning more from all of you!

The Danger of Solar’s ‘Hot-Hand Fallacy’

This article was originally posted at Greentech Media.

It’s late in the fourth quarter. The Golden State Warriors, pride of the Bay Area, are down by two. Draymond Green rebounds the ball and passes to three-point savant Steph Curry — arguably the greatest shooter on the planet. What could go wrong?

The shot hits the front iron, falling to the floor as time expires. The Warriors lose.

It’s a classic example of the “hot-hand fallacy,” which is the tendency to believe that past achievements increase the probability of success in future attempts. I worry that a potential hot-hand fallacy is taking shape among the solar intelligentsia: a misguided belief that the industry’s achievements in recent years point to unabated growth in the future regardless of actions by Donald Trump, Republicans in Congress, or even changing market dynamics.

That’s not to say that solar’s success in recent years was random — it took a lot of hard work and innovation. Nor does it necessarily mean that solar’s winning streak won’t continue. But assumptions being made today about future growth are based on historical trends that may no longer have predictive value. It is a trap of hubris that is dangerous for the solar industry.

For solar in the U.S., there are poorly understood risks everywhere. Obvious among them is the policy risk to the tax equity market, either through a reduction in the pool of available tax equity via lower corporate tax rates or simply an outright repeal of the solar Investment Tax Credit (ITC). Even staff changes at the Treasury Department have the potential to adversely impact the ITC’s value to asset owners.

There are macro-level issues beyond tax policy that could have even greater impact on solar. Though they may seem unlikely to come to fruition, if 2016 taught us anything, it is that seemingly improbable events can and do occur. For instance, what would be the impact on solar if Trump imposes a 45 percent tariff on Chinese imports, as he has proposed? Probably unlikely, but possible. The ramifications for not only solar, but the entire economy, are difficult to fathom.

 The most likely exogenous policy outcome may be the one that could have the biggest impact on solar: continued increases in the federal funds rate by the Federal Open Market Committee. The market is pricing in multiple Fed rate increases for 2017, possibly pushing rates above 1 percent for the first time since October 2008. It is not coincidental that this was the same month that Congress extended the ITC for eight years.

It is easy to overlook the degree to which low interest rates have been a boon for project developers. The ITC gets most of the credit for solar’s incredible growth. But if the ITC has been the primary mechanism by which equity flowed into project finance transactions, zero-bound interest rates facilitated the accompanying debt at cost-effective terms.

Indeed, virtually all of the solar installed in the United States was done so under a 30 percent uncapped ITC and near-zero percent interest rates. The impact of higher rates on solar’s growth trajectory are not exactly clear, but one thing is certain: Project developers will face higher-cost borrowing as lenders look to maintain their margin above the risk-free rate.

fed fund rate

Counterintuitively, the best way to respond to higher-priced debt is to find ways to deploy more of it in solar project finance transactions. That is because debt is invariably less expensive than equity, and loans typically only account for roughly 35 percent of solar project capital costs. Applying more debt would squeeze out higher-priced equity, resulting in a lower blended cost of capital.

In fact, our modeling shows that increasing debt in project finance transactions to cover half of capital costs could increase equity yields by 150 basis points.

However, the challenge of convincing banks to increase the size of loans reveals an inherent shortcoming of debt — it is a fundamentally blunt financial instrument. Lenders have appetite for solar investments, but loans are carefully structured to avoid even the smallest risk of default. Consequently, lenders size deals to the asset’s downside and assign overly conservative terms on loans. This results in ineffective pricing of risk. What financial tools are available to break this conservative lending paradigm and enable banks to extend more debt?

The most obvious answer is external credit enhancements, such as surety bonds or new insurance products. External credit enhancements typically involve transferring risk to a third-party offtaker with a balance sheet capable of absorbing said risk. As a nascent market with a limited track record to assess risk, these enhancements were previously cost-prohibitive or altogether unavailable for solar project financiers.

But the solar market has reached a level of maturity and sophistication that finally unlocks these instruments and can help open the door to new sources of capital. As project performance data continues to become more widely available through new risk management platforms and big-data analytics, the ability to accurately quantify risk engenders confidence in the financial markets that solar is a safe investment.

The global insurance market is a particularly prime venue for solar financiers to increase their creditworthiness. As a means to effectively price risk, insurance is a more preferable source of capital compared with debt. The key differentiator is the willingness of insurance firms to take some losses, which is why insurers are historically best positioned to accurately price low-probability risks. Solar’s variability risk is much more efficiently priced in hedging products than in loans.

To be sure, insurers have significant market challenges of their own. While a zero-bound interest rate environment helped facilitate solar’s growth, it has hindered the ability of insurance firms to meet target yields through investment of their cash balances. This dearth of investment opportunities has led to intense competition for customers in new risk categories, squeezing profits across the board. The insurance industry is hungry for new premium revenues, and solar assets represent a potentially massive market — the solar asset class today is valued at half a trillion dollars. Insuring the production of these assets would limit the bank’s exposure to repayment risk, thereby allowing lenders to safely increase debt levels in project capital stacks.

Not every industry can be a metaphorical Steph Curry. Solar, like many other sectors of the economy, seems to be underestimating the market risk that our new political reality presents. It would be a mistake to believe and act as if solar is above the fray. Taking action now can prepare solar firms for the market uncertainty ahead.

For solar to truly become unassailable, the industry will need to tap into larger and more cost-effective sources of capital. Exploring new opportunities for credit enhancements is one way to help ensure that project finance transactions receive debt terms consistent with the actual risk presented by solar assets. These new financial tools for de-risking projects are the best way to ensure solar’s “hot hand” continues.

New Product: Solar Revenue Puts

This article was originally published in Chadbourne & Parke’s October 2016 “Project Finance Newsire”

By Richard Matsui, Jason Kaminsky and Jared Blanton, with kWh Analytics in San Francisco


The solar market needs a revenue put like what is now used to finance merchant gas-fired power plants, except it would cover output rather than price risk.

Such a put would lead to higher advance rates for solar project debt and possibly also tax equity.

The insurance market is the natural venue in which to place this product.


While the multi-year extension of the federal investment tax credit has reduced market risk, solar companies nevertheless continue facing challenges in financing projects and securing cost-effective project debt.

The deterioration of the yield co model and the liquidation of industry giant SunEdison point to a need for a “back-to-basics” approach to securing capital. With these recent crises fresh in investors’ memories, corporate debt is increasingly difficult to raise. Firms are now focused on raising capital against the cash flows of their existing assets, highlighted recently by the $305 million sale of future cash flows SolarCity completed for a 230-megawatt portfolio of residential, commercial and industrial PV projects.

New financial instruments, such as energy hedges, that facilitate increased capital flows would be highly welcomed in this industry context. But new financial instruments require a new depth of understanding about solar risks.

At its most basic level, cash flows in the electricity generation business are a function of two factors: the price of electricity multiplied by the quantity of electricity. This basic equation applies across all electricity sectors. With gas-fired generators, the quantity of electricity produced is controlled by the plant operator. The unknown part of the equation — the risky part — is volatile prices for electricity sold on the wholesale markets.

For solar, the problem is reversed. With zero marginal cost to produce a unit of energy, there is no price risk with a photovoltaic system. Well-structured PPAs ensure that the electricity delivered will be sold at an agreed-upon price to an offtaker with a strong balance sheet such as utilities, big-box retailers, or residential customers with high credit scores. The unknown variable in the equation is the amount of energy produced. In other words, uncertainty in solar production is the real risk.

Uncertainty chiefly comes from two sources: weather and system quality. Cloud cover and other weather patterns are major contributors to inter-annual weather variability, in addition to inclement weather events such as snow and hurricanes. In addition to weather risk, the quality of the photovoltaic system itself is variable due to the choices between hundreds of module manufacturers, dozens of inverter brands, thousands of different contractors, and varying O&M programs. All of these variables create millions of permutations that add uncertainty to the expected energy output of a project.

This volatility, without widely available data to quantify it, is the reason lenders assign conservative coverage ratios for solar projects. Independent engineers provide lenders with projected energy output, but these are only opinions — estimates that are not guaranteed.

Volatility in cash flows is not a new problem. Other asset classes have faced similar financing challenges and have overcome them through independent, industry-wide databases of historical performance. There is an opportunity to combine data with strong balance sheets to create new financial products that transfer risk away from the solar projects and into the hands of well-capitalized specialists like insurance companies; it is not dissimilar to what happened with revenue puts for combined-cycle gas-fired power projects.

Natural Gas Hedges

An instructive example can be found in the experience of gas-fired generators. These generators smoothed out the volatility in the delta between electricity revenue and the cost of inputs through hedges called revenue puts.

An essential primer on the revenue put was covered in the article on page 38 of the November 2015 Project Finance NewsWire by Chadbourne attorneys Robert Eberhardt and Monika Szymanski. As described by the authors, a revenue put operates as insurance against volatile wholesale power prices for power project owners. A revenue put establishes a floor — a minimum revenue amount — for a merchant gas-fired generator. If the revenue from electricity delivered does not meet that floor in a given period of time (typically a year), then the hedge provider pays the difference.

The revenue put became prevalent in the immediate aftermath of electricity market deregulation in the late 1990s when merchant-based projects were being proposed and the price of natural gas subsequently increased. Revenue puts have become an essential component of most project finance deals involving combined-cycle gas-fired power assets.

Applying a similar hedge to solar, wrapping not the price of electricity but rather the expected power production of a project, would substantially lower the cost of capital by allowing lenders to increase project leverage.

Because this concept is not new, a project developer today can go to any number of financial institutions and negotiate a production hedge. But because that hedge provider does not possess a strong understanding of solar production risk, it will require prohibitively expensive premiums, if it agrees to take on the risk at all. What is needed in combination with a balance-sheet provider is quality industry-wide performance data that allows for actuarial analysis and deep understanding of the risk.

Increasing Leverage

The liquidity challenges facing the solar industry create fresh urgency for equity investors to raise greater amounts of cheaper debt. The uncertain outlook for corporate credit has forced developers to be more creative in securing project finance.

The challenge is to change the status quo of conservative underwriting to allow for more debt to be safely placed within a project finance transaction. For developers, leveraging project deals frees up equity that can be more optimally deployed toward other business objectives. The more leverage they can stack on project deals, the better.

Coverage ratios in today’s market are typically in the 1.3x to 1.4x range, providing debt for roughly 75% of the projected cash flow of a project. These coverage ratios fall in this range because that is what lenders are comfortable providing given their understanding of the risk presented by solar projects or portfolios of projects. At their core, coverage ratios address perceived volatility in cash flows.

Solar assets today have lower advance rates than aircraft leases, student and auto loans, mortgages, and even credit cards.

Part of the perceived risk is the long-term nature of solar assets. The most comparable of these asset classes might be mortgages: it is a long-term cash flow secured by an asset. Mortgage-backed securities, incidentally, have advance rates of 99%, largely because there is an independent third party with a vast depository of historical performance data on US mortgages that allows for data-driven predictive risk modeling.

The prevailing approach to underwriting loans in solar forces developers to commit pricey sponsor equity to fill the remaining project capital requirements. A floor on energy production, backed by a strong balance sheet provided by the global insurance market, would transfer production risk away from the project finance transaction and result in lower coverage ratios and increased project leverage.

The global insurance market has been used before to secure capital in the solar market. Lenders have reduced exposure to investment tax credit recapture with an insurance product specifically tailored to this market. Recapture insurance unlocked new value in solar project finance by enabling securitizations. Similarly, a production floor would increase leverage and lower equity contributions, reducing the overall cost of capital for solar projects.

The solar industry has seen that strong balance sheets can lead to better terms on debt. Transactions have been completed where diverse corporate balance sheets can wrap solar production risk to achieve a lower cost of capital. The challenge today is how to price the risk effectively for a disinterested third party in a way that creates value for both project sponsor and lender. Traditionally in the insurance market, historical data and actuarial analysis provide the means to correctly price risk.

Insurance Market

A credible production guarantee that captures the drivers of volatility — including weather, equipment performance, O&M practices, etc. — is an effective means of risk transfer that makes the cash-flow profile of solar projects much more predictable.

As has been demonstrated by recapture insurance, having specialty insurers in solar project finance can add value to these structured transactions. For solar, attracting this kind of balance sheet, likely in the form of the global reinsurance market, requires a missing ingredient: data. In order for a provider to feel confident that it understands the risk being transferred to its balance sheet, it needs an actuarial analysis informed by historical, industry-wide production data.

The benefits of such a financial transaction are clear for both asset owners and project lenders.

For lenders, the reduction in volatility takes away the need for conservatism in loan structuring. Having a credible third-party backstop would enable lenders to reduce their risk and extend more capital in each deal.

For asset owners, the benefit of increased leverage means a lower proportion of project capital from sponsor equity and subsequently a lower cost of capital. For the solar industry more broadly, simplified underwriting analysis would attract more investors into the space, potentially reducing the cost of capital even further as more lenders enter the market.

We have observed that as other asset-based markets have matured, they have been able to secure more debt because the variability of those assets was accurately quantified by robust data analysis. Solar is still seen as highly uncertain, thus the high cost of capital today. Simplifying the investment thesis by allocating risk to entities that understand it best is a necessary step in solar’s progression toward a more established asset class.

Fed Rate Increase: Tilting scale back to fossils? Maybe not.

Bloomberg New Energy Finance chief editor Angus McCrone had a sobering piece last week on the potential impact on renewable energy financial investments in the event of an increase in interest rates by central banks. And with news this morning that jobless claims hit a near 40-year low, the probability of a rate hike seems substantially higher than it did even yesterday.  Higher interest rates from central banks, especially the Fed, would necessarily lead to higher cost debt for solar and other renewable project financings. It is a stark reminder how market and political uncertainties, well beyond the scope of solar’s ability to influence them, can have serious implications for investors and asset owners alike.

McCrone demonstrates the point with an assumed 2% increase in the all-in cost of debt:

Let’s look at the impact higher interest rates would make, compared to the H1 2016 LCOE estimates. If all-in costs of debt were to rise by 200 basis points, this would raise the LCOE of a U.S. solar project by $7, to $94 per megawatt-hour, assuming it was financed pre-construction with a debt-equity ratio of 70:30 and a 20-year loan… And by the way, if you think a 200-basis-point rise in debt costs sounds extreme, and therefore very unlikely, I would point out that this would only return all-in borrowing costs in northern Europe to where they were in 2012.

These estimated increases in LCOE, of 9 percent or so, would not kill renewable energy stone dead –far from it. But they would tilt the balance back towards coal and gas (and biomass), where the upfront capex is a smaller fraction of lifetime costs and where operating-stage expenses, notably the purchase of the fossil fuel feedstock, are a far bigger part.

I don’t have any particular insight on whether or not a 200 basis point increase in the near future is a real possibility.  But given uncertainties in the market — particularly uncertainty surrounding the November U.S. presidential election — combined with an improving economic outlook, it doesn’t seem at all out of line.

What if there is an opportunity to shield against a 200 basis point increase?  In a rising interest rate environment, all investors (both debt and equity) will try to maintain their rate premium above the risk-free rate, and therefore all forms of capital get more expensive. The scenario above assumes that a 70:30 Debt-to-Equity (D/E) ratio is a fixed assumption — but what if we could raise the D/E ratio to something closer to 85:15 or even 90:10?   Although the cost of debt is higher, it would be offsetting substantially more expensive equity.  Increasingly leveraged projects, even under increased interest rates for lenders, would still be preferable.

By our calculations, the LCOE of a project can actually be reduced — even with more expensive debt — simply by challenging the leverage assumption.

But how do we get lenders to lever up projects?  The common view is that low advance rates are “just the way it is.” Lenders have appetite for solar risk, but they size to their downside and consequently assign very conservative coverage ratios for debt.

This is a challenge we’ve been working on at kWh Analytics. You may have heard last month that we raised a $5 million Series A. That part of the news got a lot of the headlines and we were obviously very excited about it. But also part of that announcement was the launch of a new production guarantee that we are now offering solar asset owner and lenders.

There are guarantees and warranties available to the average solar finance professional, usually offered by the EPC firm or the equipment manufacturers. What makes ours different, and more competitive than current offerings, is that it combines the industry’s most comprehensive database of historic project performance (that’s the kWh Analytics part) with the A-rated balance sheets of the global reinsurance market.  We contribute a hefty dose of actuarial analysis to underpin the underwriting to enable a lender to wrap all of the disparate risks of a solar project into a single energy output figure.

Our re-insurance partners are so confident in the actuarial analysis that our data allows, that they are able to competitively guarantee up to 95% of the output of a solar project or portfolio of projects. For a lender evaluating how to think about the risk of a solar project, the equation is now much simpler.  By transferring most of the production risk of projects to the global reinsurance market, lenders can confidently deploy more debt than the current 70:30 ratio up to as high as 95% and still be confident that their investment will be secure.

This would, assuming central banks do raise rates as posited by McCrone, mean that project developers are still paying a higher price for debt than under current conditions. But equity contributions would still be substantially more expensive. By replacing the equity contribution with more debt, the net result would still be positive for project financiers. And solar will remain more competitive than coal and gas.


Adding Value to Secondary Market Solar Transactions: A Case Study

The degradation rate of a solar project is a major assumption in developing the financial projections for a project. kWh Analytics was hired to perform an analytical study of a 200 MW+ portfolio to determine what levels of degradation can be identified by using actual, field performance data. To test the degradation rates, kWh utilized a research methodology developed by the National Renewable Energy Lab (NREL), and applied a modified technique to the subject portfolio, leveraging established principles into market-based applications. Download the link to read more about the details of the case study.

kWh featured speakers at Intersolar North America

This week the kWh Analytics team attended the Intersolar North America Conference, the world’s leading exhibition series for the solar industry and its partners. Along with other industry professionals, Richard Matsui (CEO) and Jason Kaminsky (VP of Partnerships) were honored to be speakers at multiple conference sessions, covering topics such as the bankability of solar and the “billion dollar opportunity” in solar asset management.

In this post, we wanted to share our thoughts on how data can both enable bankability and also be the foundation of a huge opportunity, by looking at how data has helped shape other industries. Although we have seen data be a key enabler in almost all major asset classes — everything from commercial mortgages to student loans and aircrafts — we focus in this post on two very different but high-growth segments of the market: residential mortgages and credit derivatives.

Data accumulation and percolation are fundamental to the success of any asset class. If we consider the mortgage market in the 1980’s, we see a data-leveraging opportunity that emerged then that is similar to the one we have today with solar. Like solar, mortgages were considered an esoteric investment class when they first came onto the scene, which created an opportunity for the company CoreLogic (then called LoanPerformance) to fill in the gaps in information and provide intelligence to investors. Their solution was focused on two key elements: trends in housing values and trends in financial performance of the mortgage contracts. Their gradual construction and distribution of an extensive database on the mortgage industry became one of the catalysts to growth in the mortgage debt market. Today, CoreLogic has data on more than 99% of the mortgages in the US and is a publicly traded company with $1.4 billion in annual revenue. As for the mortgage market? It is now a trusted industry with more than $14 trillion in debt outstanding.

Similarly, in the early 2000’s the credit derivatives market was small but promising. Credit derivatives are essentially insurance products for corporate credit in which a lender can transfer the default risk of a loan to a third party. This product was poised to become a big player in the financial ecosystem, however, its potential for growth was inhibited by the lack of independent data and transparency at the time. Founded in 2003, the company Markit took advantage of this position. The major inhibitor to growth in the early days was the inability to answer a very simple question: how do you price this new product? Markit’s first product, a pricing database to provide transparency into the pricing of transactions in the market, helped bring new investors into the segment. Secondly, they undertook the systematization of unique ID’s for credit derivatives in order to improve reference data on trades. With this project underway and an industry database established, the natural progression was the addition of key complementary databases. These were products and services that fit the market and helped either bring in more capital or improve transaction efficiency. Because of the development of these databases, the market for credit derivatives grew ten-fold in 3 years. Markit went public in 2014, and just recently merged with IHS to form what is now a $13 billion company.

So what do these stories say about the solar market? At kWh Analytics, we believe that the establishment of industry-wide databases can induce tremendous growth in the solar market, just as it has done for the mortgage and credit derivative markets. Currently, growth in the industry is hindered by the high cost of capital and the lack of information needed to improve investment decision making. While our current focus is on risk management for investors – the unique solar pain point that we can address – we understand the power that the data can bring to improve underwriting decisions and improve market efficiency. Similar to CoreLogic, we focus on analyzing and understanding both the physical asset and the performance of the financial contracts. Solar is unique in that there is risk carried in electrical performance, as well as payment performance. This makes it even more important to use data to help investors get a clearer picture into operational and financial risk, so that they can gain more confidence in the solar market. And with an industry database, complementary products and services that will either improve liquidity or improve transaction efficiency are sure to follow.

The potential for growth in the solar market is great, and the opportunity for data to improve liquidity and reduce the cost of capital is immense. As with the mortgage and credit derivative market, establishing an industry-wide database will transform the market and help investors and key stakeholders realize the bankability of this asset.