SEIA and kWh Analytics Release the Best Practices for Solar Risk Management

Originally posted on SEIA’s latest news.

WASHINGTON, D.C. – In an effort to simplify the complex world of tax equity and debt investment, the Solar Energy Industries Association (SEIA) and kWh Analytics released today the industry guide on the Best Practices for Solar Risk Management.

Informed by some of the largest financial institutions investing in U.S. solar assets, SEIA’s Solar Energy Finance Advisory Council (SEFAC), and the U.S. Department of Energy’s Orange Button program, this guide is designed to help financiers of solar projects and portfolios successfully navigate their solar investments from start to finish.

“Our goal is to facilitate new sources of investment capital for solar projects across America by communicating and leveraging the standards and practices the industry has already developed to measure and manage risk,” said Mike Mendelsohn, SEIA’s senior director of project finance and capital markets. “This guide will serve as a valuable tool to both experienced investors looking to grow their businesses, as well as newer investors unsure of how to review the relevant risk factors.”

Featuring a risk management checklist, the analysis outlines current industry standards and benchmarks, alongside the solar industry’s robust compliance infrastructure.

“From our experience serving multiple investors, we have a privileged vantage point to help our industry codify best practices and ensure healthy industry growth,” said Jason Kaminsky, COO of kWh Analytics. “We are pleased to have been invited by SEIA to co-author the industry guide that enables investors, large and small, to manage the unique risks posed by the solar asset class.”

SEIA will routinely update the document as needed as part of its ongoing industry coordination efforts to streamline project development, open new sectors for solar deployment, and open new sources of low-cost capital.

To download the complete guide, go to https://www.seia.org/research-resources/best-practices-solar-risk-management.

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About SEIA®:

Celebrating its 43rd anniversary in 2017, the Solar Energy Industries Association® is the national trade association of the U.S. solar energy industry, which now employs more than 260,000 Americans. Through advocacy and education, SEIA® is building a strong solar industry to power America. SEIA works with its 1,000 member companies to build jobs and diversity, champion the use of cost-competitive solar in America, remove market barriers and educate the public on the benefits of solar energy. Visit SEIA online at www.seia.org.

About kWh Analytics:

kWh Analytics is the market leader in solar risk management. Founded in 2012, kWh Analytics has built the industry’s largest repository of solar asset performance data, with over 100,000 operating systems, representing between 10-20% of the U.S. market.

Customers such as Google (the world’s largest non-utility investor in renewable energy) and PNC Bank (America’s 5th largest bank) rely on software and insurance solutions from kWh Analytics to enhance their investment returns. kWh Analytics is backed by private venture capital and the US Department of Energy.

Media Contacts:

Alex Hobson, SEIA Senior Communications Manager, ahobson@seia.org (202) 556-2886
Sarah Matsui, kWh Analytics Senior Communications Manager, contact@kwhanalytics.com (415) 891-9601

Paul Young SPI Poster

Addressing Solar’s Growing Pains with Data Standards & Analytics

Originally posted on pv magazine USA. Written by Data Engineer Paul Young.

It is hard to fathom just how much solar has been installed in the last few years—over 1.3 million systems added 36GW of capacity to the grid.  As the industry catches up to this rapid growth, it is important to take stock of some of the challenges that lie ahead.  While solar has been around for over forty years, 90% of solar systems are less than five years old.  Only a handful of industry players have experience managing, monitoring, and maintaining large distributed fleets, and fewer still have done so with fleets of any significant vintage.

At kWh Analytics, we have aggregated the solar asset performance data of nearly 20% of the U.S. market, allowing us to study the challenges that these organizations face as they grow and mature.

Challenge No. 1: Scaling data management practices.

Processes that worked while managing hundreds of systems start to break down when managing thousands of systems.  Building out databases and servers, handling multiple monitoring systems, and setting up robust quality control processes and pipelines require good planning and timely execution.  Fast growth can wreak havoc on these processes, as teams will often find themselves continuously struggling to scale up their data management tools in order to keep up with the company’s growth.  In the software engineering world, we refer to this problem as ‘technical debt.’

While there are no precise definitions of technical debt, here is the general concept: A debt is created when engineering teams sacrifice quality for speed.  This concept originated in the software engineering world, but it is very applicable to data management and warehousing projects.  While some technical debt is normal, if teams let it build up too much, it can create problems.  Quality control issues, software bugs, and long execution times are all symptoms of excessive technical debt.  Good software teams will plan regular cycles of code refactoring and maintenance in order to ‘pay’ down their debt, but this is difficult in a fast-growing environment.  As new solar systems come online and more data sources get added to the pipeline, data teams find themselves overwhelmed. Carving out the time to step back and properly build out the necessary infrastructure becomes increasingly difficult, if not impossible.

Challenge No. 2: Finding cost-effective ways to diagnose O&M issues across large fleets.

This challenge will become more pronounced over the next few years. The vast majority of installed capacity is relatively new, so there is limited data available on how well current modeling techniques predict the performance of aging fleets.  Revenue models usually account for module degradation, defaults, and O&M costs.  But residential O&M presents unique challenges due to the distributed nature of the systems.  Smaller O&M issues (I like to call them micro O&M), like moderate soiling and gradual increases in shading, can be hard to detect because the signal-to-noise ratio can be too small.  And even if we could reliably detect these micro O&M issues, sending maintenance crews out to fix these problems would be cost prohibitive.  But spread across a large fleet, these micro O&M issues could add up to real revenue loss.

Data analytics can be a valuable tool to assist fleet managers in distributed O&M efforts by allowing them to remotely diagnose problems and prioritize their O&M efforts in order to maximize ROI.  Analytics allow us to accurately identify underperforming PV systems and to diagnose the specific problems associated with those systems.

However, in order to implement these tools, you need good data.  And one of the lessons that we have learned at kWh Analytics is that data availability and data quality varies greatly across the industry. Data rarely lives in a single silo.  Equipment manufacturers, installers, monitoring companies, developers, and financial institutions are all generating, sharing, and consuming data.  This has resulted in a byzantine landscape of nomenclature, data quality, and data formats.

Where do we go from here?

As solar scales, data standards and analytics become more important than ever before. Making smart investments in data infrastructure can pay dividends on many fronts:

On an organizational level, investing in data enables teams to better prepare for growth and allows for smoother scaling of operations.  And as the organization grows, data becomes increasingly useful for business intelligence and analytics driving further efficiencies.

On an industry level, creating unified data standards can help the solar industry reduce market inefficiencies and lower costs for consumers. To move our industry forward, Orange Button, a program of the U.S. Department of Energy SunShot Initiative, has organized the creation and adoption of industry-led open data standards.  As a part of Orange Button, kWh Analytics is creating a new data translation tool that will ease the solar industry’s transition to a unified solar dataset by translating original data formats to consistent data standards. This technology is currently being developed with lessons learned from the development of our HelioStats platform, which is capable of synthesizing thousands of data points on project payment and performance. Leading solar companies now implementing Orange Button include Wells Fargo, Sunnova, and Sunrun.

If you would like get involved with the Orange Button initiative, visit the Orange Button website or come meet with Orange Button participants at SPI.

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#Solar100’s Varun Sivaram: The Hamilton of the Solar Industry

Originally posted on pv magazine USA.

As the second interview in the #Solar100 Thought Leaders series, Richard Matsui, Founder of kWh Analytics, speaks with Varun Sivaram, the Philip D. Reed Fellow for Science and Technology at the Council on Foreign Relations and a professor at Georgetown University.

Even before his meteoric jump within weeks, starting at #40 and peaking at #3 on the #Solar100, we knew we wanted to catch up with Varun Sivaram.

Varun reminds us of the solar industry’s very own early Alexander Hamilton. Bold claim, we know. But hear us out:

  • Both are polymaths. Hamilton studied math, medicine, and law at King’s College (now Columbia University). Varun studied international relations in college, and finished a PhD in condensed matter physics in two years on a Rhodes Scholarship to Oxford University.
  • Both started careers as advisors: Hamilton held his first important public office as a colonel on George Washington’s staff when he was only twenty years old. Within the first decade of his career, Varun’s managed to hold a position as a Georgetown professor, as a senior advisor to the Mayor of Los Angeles and the Governor of New York, and as a McKinsey consultant advising C-level executives.
  • Both have big ideas and are compellingly articulate about those big ideas: Hamilton for the American Revolution, and Varun for the ‘Solar Revolution.’
  • Both are prolific writers. Hamilton is credited with most of the Federalist Papers. Varun publishes regular op-eds on clean energy, and he also has a forthcoming book with MIT University Press.
  • Both are not afraid of going against the grain, and maybe even enjoy it. Hamilton was based in New York, the hub of loyalists, and still regularly and loudly challenged conventional thinking. Varun was recently cited in a NYT article titled, “Fisticuffs Over the Route to a Clean-Energy Future.”
  • Both are influential spokespeople for their groups. Hamilton became the leading spokesperson for the Federalist Party. It is not difficult to imagine that Varun will represent a set of thoughts and people in the future of the solar industry.

While Varun is early in his career, having only finished his Oxford PhD from 2011-2013, he is undeniably scrappy and hungry, and he is already establishing himself as a thought leader in our industry.

A Happenstance Beginning

Richard Matsui: Your educational background is in International Relations and Condensed Matter Physics. What drew you to working specifically in solar?

Varun Sivaram: You know, it was initially a little bit of happenstance. Right out of high school I got a job working for Nanosolar, a CIGS company that went on to raise half a billion dollars. Nanosolar was the first company I had ever worked for, and it was infectiously optimistic. I learned everything I knew about solar power from Nanosolar—which was a very skewed way to learn about solar. I learned that today’s solar panels are obsolete, that the future will look flexible and lightweight, that silicon will be replaced by necessarily superior materials, and that the Silicon Valley model of disruption is going to work great for this entire industry. It turned out many of those things would be wrong, at least for the next decade. But I stuck with solar.

At Stanford, I studied Physics because I was interested in solar, as well as International Relations because I had always been interested in policy. And at Oxford, I applied to study under a scientist, Henry Snaith, who just so happened to be on the cusp of discovering perovskite photovoltaics, a technology that has rocketed to over 22 percent efficiency in just five years. I was so lucky—it felt like the most exciting place to be in all of academia. And I was the only person in the lab who had startup experience. It was an interesting perspective, having been at Nanosolar, and while I was doing my PhD I was watching Nanosolar explode.

And it hit me that even though everybody in academia thinks that perovskite’s going to be the next big thing, it probably is not going to work in this environment, because there are various external factors that make it really hard for innovative solar companies to go to market. And I thought, “You know, even though I’m likely in the best position possible from a science perspective, I need to go out and solve this problem another way,” and that’s why I eventually made my way into policy.

Controversial Bylines & Technology Lock-In

RM: Speaking of policy, of the thought pieces you’ve written for local papers, journals, or CFR, which, if any, do you think have been the most controversial?

VS: I think there are two pieces in particular that have been controversial. The first piece is a report I co-authored through the MIT Energy Initiative called, “Venture Capital and Cleantech: The Wrong Model of Clean Energy Innovation.” The Greentech Media guys just skewered us for that one because they basically asked, “How can this be true? We see cleantech is having all kinds of successes—look at all these software companies.” And we should have been more careful in choosing the title. Our title should have specified hard Cleantech—materials, chemicals and processes—those are the wrong kinds of companies for VCs to invest in.

The other controversial piece was an article I wrote for Issues in Science and Technology titled, “Unlocking Clean Energy.” It’s about technology lock-in, and here’s the situation: There are first generation clean technologies—silicon for solar PV, compact fluorescent lights for efficient lighting, light water reactors for nuclear, and corn ethanol for biofuels. And many of these first generation technologies make it really hard for the next generation to take their place. When that happens, I argue we get stuck in what’s called technology lock-in.

Some fields have managed to beat technology lock-in. For example, LEDs have beaten CFLs, and so efficient lighting is not a victim of technology lock-in. But other fields—nuclear is the best known example—have gotten stuck in technology lock-in because people were not forward-looking enough to invest in innovation. And as a result, nuclear’s share of world electricity peaked in the 1990s and has declined ever since.

I fear that we in solar are approaching technology lock-in. I also suspect that technology lock-in could take hold for lithium ion batteries. These incumbent technologies are getting so entrenched, and their costs are declining as a function of scale, that new technologies just won’t be able to break in.

The conclusion is that it is really difficult to get around lock-in. Some public policies can worsen the situation by entrenching the incumbent, such as the renewable fuels standard or indiscriminate tax credits. But other public policies on support for R&D and public procurement of emerging technologies can also help; for example, by procuring emerging flexible PV technologies for use in battlefield, the military could encourage technological succession.

That’s the article. People hate it, obviously, because it basically takes everybody to task. It says existing policies are often ineffective at countering lock-in, and that today’s solar industry—though it’s come a remarkably long way—is in need of disruption and technological change.

Why Write a Book?

RM: You’re the author of the forthcoming book, Taming the Sun. The back story for you personally is fascinating, and I’m curious— why did you write a book and what  are you looking to add to the discourse?

VS: I wrote the book because I feel like I’ve been very fortunate to see solar from different perspectives: from science, from startups, from the McKinsey experience of analyzing utilities, and from making and assessing public policy at the state, national, and international levels.

Each of these different perspectives has an incomplete view of what solar will need. The scientists think that obviously the next theoretically superior material is going to win. The business people understand the business constraints best and so are understandably biased toward minimizing risk. For example, I’ve heard utility executives caution that, “Changing the grid’s clean energy make-up is like switching out the engine of a 747 in flight, so why would you go and add technology risk?”

These different perspectives mean that everybody comes to solar with their own siloed views. And there are also a lot of unbalanced headlines that pose an additional challenge for folks interested in learning about the field. Some argue that we already have all the tools we need for a 100 percent renewable energy future; others slam subsidies for solar as wasteful handouts. Folks don’t have a single one-stop place to go to get an even-handed story. That’s what I was trying to create. The book aims to present an authoritative, even-handed view of solar’s coming of age, including both the terrific progress that’s been made and the innovation that’s still needed to harness the full potential of solar energy: creative financing, revolutionary technologies, and flexible energy systems.

Solar’s Biggest Challenges

RM: On the topic of what needs to change, what do you think are the top three challenges coming up for the solar industry?

VS: When I think about the rise of solar over the next few decades, without three kinds of innovation—financial, technological, and systemic—solar could hit a wall. That would be catastrophic, because we need solar to anchor the transition to a nearly completely decarbonized power sector. Fundamentally, solar’s rise could stall because the cost of solar power, although it’s declining, could get undercut by its sharply falling value.

The three kinds of innovation collectively work together to ensure that solar’s value stays above its cost, so that it stays economically competitive:

First, financial innovation is needed to massively increase capital flows into the sector, continue solar’s near-term growth, and continue to drive down costs as the industry gains experience with producing and deploying solar PV. I know I’m preaching to the choir here, but the world’s biggest investors have overlooked solar so far, and for solar to continue its growth will require trillions of dollars in capital that existing sources are not going to be able to supply.

The industry faces the challenge of attracting institutional investors with appetites for long-dated, yield-oriented investment opportunities—solar lines up with this perfectly, but they just need a way to invest in it. In the developing world, however, oftentimes solar’s great advantages are overshadowed by country-specific challenges: political risk, currency risk, offtaker risk, credit risk, etc. Policymakers need to improve the investment environment to make solar’s inherently low risk and stable cash flows shine for large investors.

In summary, I think that solar needs financial innovation to help the industry access public capital markets, for example through securitization and maybe even the next generation of YieldCos. Data will be crucial to drive down the cost of capital, and firms such as kWh Analytics can enable investors to prudently invest in solar.

Second, technological innovation is also needed to bring down the cost of solar even faster. Let me use a figure from my upcoming book to explain why [figure appears below]:

Panel 1, on the left, plots the global average cost and value of the next unit of electricity from solar panels as the total installed solar capacity increases. Thanks to financial innovation, more and more solar panels get produced and installed, and the red curve shows costs declining steadily as a result (both axes are logarithmic).

But the blue curve shows how much a marginal kWh is actually worth, and that figure declines steeply as more solar power comes online in each region of the world. That effect, known as value deflation, occurs because solar starts to oversupply the grid in the middle of the day. We’ve already seen value deflation in a place like Chile. We had a bunch of solar on merchant contracts and then suddenly solar, in the middle of the day, started to get a price of zero dollars per megawatt-hour. And this is a problem that afflicts solar more than, say, a natural gas generator, because natural gas is dispatchable, whereas all the solar kilowatt-hours come at the same time. So, supply and demand tell you that with an oversupply of solar kilowatt-hours, you’ll have a mismatch in low prices with demand. A lot of people say, “Hey, solar won’t have this problem because it’s contracted on long term PPAs.” Those PPAs are basically masking the fundamental issue, which is value deflation. It doesn’t matter how you’ve done the contracting; if solar’s economic value is falling, you’ve got a problem.

Pretty soon, when solar produces 10 or 20 percent of the total electricity (kWhs) on the system, the value plunges below the cost. But with technological innovation, you can delay that point. Panel 2 shows the red curve falling more steeply, as new PV technologies, such as perovskites, enable dirt-cheap solar that falls in cost way faster than waiting for silicon PV to ride down the experience curve. New materials enable these cost reductions not just because they use cheap materials, but because they can be highly efficient, slashing balance-of-system costs. Still, I said that technological innovation only delays the point where solar value dips below cost. To prevent that from happening, we’ll need a third kind of innovation.

Third, systemic innovation is needed to prevent solar’s value from dropping so quickly, enabling it to remain above solar’s cost and making solar economically attractive. Systemic innovation entails reimagining energy systems, starting with the power system. A power system that can better match up solar supply with customer demand will mitigate value deflation by using every marginal kilowatt-hour of solar more effectively when demand is high. So in Panel 3, you can see that by adding systemic innovation, the blue curve becomes less steep—i.e., the value of solar drops less rapidly as more solar is installed. As a result, the blue curve always stays above the red curve, driving ever more solar deployment.

Systemic innovation encompasses modernizing the electricity grid, to make it bigger and also smarter. Connecting a diverse range of resources—from load-following nuclear plants to concentrated solar power plants with thermal storage to batteries to demand-side management tools—also helps to accommodate a high penetration of volatile solar PV on the grid. Another example of systemic innovation will be via sectoral linkage. For example, if you link the transportation sector by intelligently charging electric vehicles whenever there’s a surfeit of solar energy on the grid, or the heat sector by using electric heat pumps to track solar output, or even the water sector by modulating the operation of desalination plants, you’re basically making new ways to store intermittent solar power. This sectoral linkage reduces value deflation, because we will have many more valuable uses of solar power, no matter when it’s generated. And by keeping solar’s cost below its value, it can break through the ceiling that its penetration would otherwise hit.

RM: I hear you. My favorite iteration of that idea is that at some point, someone is going to realize that solar’s so cheap that you should hook up a Bitcoin mining machine to a solar panel. That could be a great way to make money from solar. Some day.

VS: Wait, hang on, that’s so interesting—Bitcoin is acting as a battery.

RM: Right. The same way that you’re describing desalination, it’s the idea of storing the value of energy not as energy but as something else that’s valuable.

VS: I love that idea. Has anybody written anything on this?

RM: No, it was my idea, but you should feel free to take it. You had already come up with the broad idea, I just said that specific iteration of it.

Data & Resource Based Financing

RM: As a data company, we think about data a lot. Are there areas for which you think data is uniquely positioned to cause systemic change?

VS: There’s a paper out from David Sandalow and colleagues from Columbia University called, “Financing Solar and Wind Power: Insights from Oil and Gas.” It’s interesting. They basically pick three different financing options from the oil and gas industry and ask, “Could we use this for solar and wind?” Data would help enable these options.

For example, in resource based financing, oil and gas companies get to basically take out loans in advance based on the value of the proven reserves, and they also get financing based on promising a cut of every barrel of oil they sell.

You can imagine a solar company could do the same with good data. Right now, banks think solar is too uncertain, and as a result it is hard for solar to get debt. A solar company with a parcel of land, plus good data on how much their projects produce in this particular area, plus an analytic model on how much money it will make—it would be a game changer if investors would look at that land that’s prime for solar development and value it for its solar potential, the same way that investors look at land with oil under it, and value the land for its oil reserves.

Call to Action

RM: It’s August 2017, and in the past few months, Trump announced that he’s pulling the U.S. out of the Paris Climate Agreement, some leading solar companies, such as Sungevity, have declared bankruptcy—my perception is that people in the industry are feeling quite down right now, even though our numbers on solar deployment and cost have actually never looked better. What would be your call to action or your parting thought for the people and the policy makers in the solar industry?

VS: I am infuriated with the Trump administration’s policy because first, I think the Paris Agreement is important for political and diplomatic reasons. And second, I think funding energy innovation through Trump’s budget proposal and supporting it through initiatives like Mission Innovation are really important, but he’s stepping away from both. He wants to slash energy innovation funding by half and cut support within the Department of Energy. I think that’s terrible.

Also, I think that profit compression in the solar industry, which we’re seeing both upstream and downstream, is an inevitable byproduct of a lack of innovation. If you’re making commodity profits and everybody’s trying to do the same, obviously you’ll have profit compression. The lack of innovation is what’s causing this compression. Given a commodity with no differentiation, no one makes any money. The fact that the value of solar is falling faster than the cost of solar—value deflation—is a critical problem for our industry’s future.

What is my call to action? Innovation funding in this country has stagnated for two decades. We certainly can’t afford for it to fall now. We instead need to strengthen it. We are not paying enough attention to this problem. Innovation is important both because it brings down the cost of solar to outrun value deflation, and also because it makes some producers more competitive than others, thereby enabling there to be profits in the industry. Innovation enables American companies to make money, as long as we’re the ones investing in innovation.

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"Small businesses can be agents of change, and entrepreneurs are the classic ‘won’t take no for an answer’ activists, really. They just use business tools rather than community organizing."

#Solar100’s Danny Kennedy: The Most Interesting Man in Solar

Originally posted on pv magazine USA.

As the first interview in the #Solar100 Thought Leaders series, kWh Analytics Founder Richard Matsui speaks with Sungevity co-Founder and Managing Director of the California Clean Energy Fund Danny Kennedy.

It seems fitting for our inaugural monthly #Solar100 interview to be with activist turned entrepreneur turned fund director, but ever the solar advocate, Danny Kennedy.

Kennedy believes the different roles are not at odds, noting, “Entrepreneurs are the classic ‘won’t take no for an answer’ activists, really. They just use business tools rather than community organizing.”

Though the tools may change across roles, Kennedy’s means and ends—his theory of change and his ultimate vision—are decidedly centered on people. He believes people will drive the necessary changes towards clean energy, and that changes towards clean energy are necessary to protect Earth and its people.

It is striking how easily Kennedy uses a broad “we” and “us” in the place of “solar”; or how quickly he can name examples of off-the-radar startups and activist campaigns that are contributing to the revolution for clean energy; or outside of this interview, how often we hear Kennedy’s name cited among solar groups just getting their start.

Kennedy speaks like an activist, builds community buy-in like a grassroots organizer, can leverage financial tools like a capitalist, and at kWh Analytics, we think he’s the most interesting man in solar.

Solar’s Biggest Challenges

Richard Matsui: In Rooftop Revolution, you identified the challenge of building a movement for solar amidst the many marketing campaigns started by solar’s opponents—that it is expensive, inefficient, subsidy-driven, that it can’t be scaled, that it takes away jobs, etc. As you look at the landscape five years later, what are the top 3 challenges you see in solar now?

Danny Kennedy: There’s an irony in how things have progressed since 2012 when I wrote that book—then, we were “too small to be significant” for everyone—from Bill Gates to Donald Trump. And now, we’re becoming “too dominant.” It’s a complete turnaround that we’re now being depicted as a problem in the grid because we produce too much free electricity. I find it stunning that regardless of how many anti-solar marketing myths are refuted or how much progress is made, certain people will create excuses in attempts to stop solar.

I would say the three biggest obstacles are:

1) Fossil fuel interests trying to protect themselves. The only way coal survives is a political choice for it to survive. There is no economic or social rationale otherwise. But we’ve seen that political choice being made by governments from America to Australia: subsidies being crafted, policies being set up to literally overturn the outcome. Fossil fuel interests will obfuscate, make up crap, and create crazy stories to defend coal and gas. That’s the number one obstacle: political power of the vested interests.

2) Sustaining popular commitment to the cause against fatigue. We cannot relent. We have been driving fast to get from one to three to maybe ten percent of the electricity supply in some states, and we’ve done really well. But we’re still a fraction of the supply and have to continue doubling. That demands consumers and citizens and activists all carry on building the market—movements make markets as much as businesses do, and we cannot forget that.

3) Technical. I think getting to 50% renewables is relatively easy; getting from 50% to 100% will present some new technological challenges. And so as solar grows towards dominance in the grid, there will be some new technical challenges, which are not insurmountable, but which will still need to be addressed.

RM: When we have this conversation in five years’ time, what do you think will be solar’s top three challenges then?

DK: A lot does depend on what happens in the next four years. Politics can get uglier still. People ask me what can slow down the inevitable rise of renewables, and I think war could do that. The world could fall apart like a pig in a blender, go back to its corners, do what it knows and not be advanced, adventurous, or push the boundaries of technology and good things. And I think war is very possible. That’s the big one that risks all the progress we’ve made. Other than that, in 2022 the main obstacle and question will be: How fast can we make the change to solar?

RM: Can you talk about an off-the-radar startup that’s tackling one of these big issues?

DK: When it comes to building the buy-in and commitment of a community to solar, my favorite right now is called Solar Ear. They are working to make hearing aids available to the hundreds of millions of humans who can’t get them because batteries are expensive and hard to get into remote and emerging markets. Solar Ear’s solution: a solar-powered hearing aid, which effectively recharges the battery rather than disposes of it, making it more advanced than the current crop of hearing aid technologies, as well as much more affordable and available. And their business model is really cool—it’s driven by deaf people doing this work in these countries for deaf people.

And I love it because it doesn’t sound like a direct response to any of the obstacles I just listed, but the political will and cultural commitment to the transition we were talking about has to happen most in emerging markets. The billion plus people under 30 in Asia and Africa that are looking at the world and wondering what their future is need to be engaged by this to carry it forward. That’s where electrification is going to happen. America’s an interesting, small portion of the movement in terms of the Gigawatt capacity that will be built in America, so building movements worldwide and empowering people literally and figuratively with solar products is really important. In terms of demonstrating how solar can have a really meaningful impact in peoples’ lives, that’s one company that touches me.

Activism, Entrepreneurialism, & Building the Movement for Solar

RM: As a leader in solar, you have a particularly unique background as an activist in Greenpeace. In your 2013 TEDxSydney talk, you mentioned the profit motive as a driver for change, and this line made me chuckle: “Capitalists are coming for your rooftops. It means the solution will come.” I think it’s fair to say that you are now a capitalist, although perhaps a conscious capitalist. What sparked that change for you?

DK: First, a lot of Greenpeace’s successes over the years and strategies are capitalist. I don’t think the two are mutually exclusive. To give an example, I ran a lot of forestry campaigns trying to save forests in places like Papua New Guinea. It’s often the case that you can use market forces to make change as an activist, such as forcing good wood procurement practices as a way of protecting ancient forests. That’s been the strategy for the climate and clean energy case for a long time, as in adding cost to carbon. Small businesses can be agents of change, and entrepreneurs are the classic ‘won’t take no for an answer’ activists, really. They just use business tools rather than community organizing.

Second, that doesn’t mean that I’m not also a socialist. My personal thinking is that capitalism has its uses, but it’s pretty simplistic to just stick with one or other of the -isms. We have to find the blend that makes sense for the 21st century. Capitalism has had its use in unleashing the energy innovation that we’ve seen in the last decade, but there was also chronic market failure before it—capitalism had failed for most of the 20th century in creating any innovation. That’s the hundred years prior to the California Solar Initiative, which was kind of a socialist model, and certainly up to Germany’s Energiewiende, wherein the market was somewhat constrained by strong industrial policy. Prior to those the energy industry had been failed by monopoly capitalism. For me, market force is a means to an ends—market force works, but that doesn’t mean it excuses us from the bigger conversation of what capital is for and what market force should lead to. I believe in a guided market, at the very least.

RM: I like that point you’re making—this idea that market forces are very capable of doing certain tasks, but maybe not great at all tasks. The forestry example is new to me, but I think you were working with Jeremy Leggett on the divestment movement to put financial pressure on institutions to do more. Is there another big campaign that you’re working on?

DK: I think the focus on stranded assets is really important. There is a phenomenal amount of money that is being wasted by the fossil fuel and nuclear industry as they enter their dying days, with examples like Adani’s Carmichael coal mine in Australia or the gas pipelines from Texas to Mexico. In Australia, $1 billion tax dollars are being used to subsidize a coal mine that should not be opened in in a region that represents 2% of allowable carbon pollution left for the atmosphere. It’s just wrong. In Mexico, they’re spending billions this year on natural gas pipelines from Texas, which is going to lock them into debt payments on those pipes whether or not the gas price stays low, whether or not they decide to make the transition to wind and solar, which is much cheaper than gas already in Mexico’s reverse auctions, to electrify vehicles, etc.

The stranded assets campaign is really about avoiding “locking in” communities to uncompetitive infrastructure. Remember when Shell went up to the Arctic from Portland? The drilling rig was blockaded by canoeists and people like those I used to work with for a while, but the rig got out. And then they failed to find anything worth developing, which was predictable. It forced Shell to report a write-down of $7b dollars within about six months. The Arctic exploration effort of the oil majors generally has led to tens of billions of dollars of write-downs by those companies. There’s no accountability and instead there’s still support from government. There’s a huge contrast between the waste of money on the dirty side of the ledger versus the amounts we’re profitably deploying on the clean side of the ledger. There’s a capital market campaign I would love to run against the stranding of further assets in light of climate change. And maybe I will.

RM: Given that you’ve gone from activist to solar entrepreneur to clean energy investor, how are you liking this new role, and how is it different?

DK: It’s different in that I get to play with a lot of entrepreneurs instead of just a couple companies, like Sungevity, Mosaic, and others that I helped get going. The job is working more on the system than in the system, in the entrepreneurial ecosystem itself. It’s a different layer of responsibility. I really like our work, both because managing other peoples’ money effectively is important and challenging, but also because it’s about open-sourcing a lot of the lessons we’ve picked up over the last decade in California. The solar coaster, as we call it, has been tumultuous—plenty of lessons for future entrepreneurs that we hope to make transparent and share with the world. California’s like the lab for the world—we actually should get to 100% renewable energy by 2030 if we can. The main focus now for me is not California, as important as it is—it’s on continuing this work in Africa and Asia, otherwise we don’t turn the carbon dial.

RM: Fascinating. Given that you’re looking at this ecosystem more holistically now, are there gaps you perceive in the ecosystem that others can help supplement?

DK: Oh, god yeah. There’s this wrong belief that now that clean energy’s got some poster children that have been successful and have made it public and disrupted some categories like private vehicles that it’s inevitable that we will succeed in time. But that’s not true at all. We’re talking about a trillion dollar value creation story annually for the next 20 years. We need hundreds and thousands of highly successful companies, from entrepreneurs working in niche segments to entrepreneurs working on broad electrification. 100% renewable energy is not going to be done by a couple businesses out of California that expand their models to Africa. It’s going to be carried forward by African entrepreneurs. The future of the energy demand in the massive new urban realities in Asia—these mega-cities in India, China, Indonesia, and elsewhere—how will their needs be met in a uniquely local and specific way? Leveraging learnings and technologies from afar no doubt, but the distributed nature of renewable energy suggests that it’s going to be accomplished through a combination of ideas, and those are going to come not just from people in Palo Alto. We need to find and fund many more entrepreneurs.

There are big human capital gaps, as well as massive financial capital gaps. Emerging markets get no joy, even though that’s where the work is. Early stage gets very little investment these days, as you know, because investors prefer to do project finance now that they’ve kind of got their heads around wind and solar farms. We still need to do a lot more in different segments, whether that be community solar in America or off-grid in developing countries. Or diesel displacement, which can be very lucrative and great investments, but for other reasons people don’t want to make them, like presumptions or prejudices they have about those markets. There are also major policy gaps, which is why I’ve joined the board of Power For All, a campaign to bring distributed renewables to the 25 countries in the world with the least electricity by 2025.

Lessons Learned & Advice for Entrepreneurs

RM: What advice would you give to an entrepreneur? Given that you witnessed and helped drive the founding of the first generation of solar startups, at least in the states, what is the one thing that you take from that experience that you think is broadly applicable to other founders?

DK: The one thing? Oh, I’ve got lots of lessons. If just one, I would say pick your investors carefully so you can control your own destiny. That’s one of many, if I had to choose just one for other founders. Another is plan for the long haul. Beware this is going to go all kinds of crazy…

RM:  Has your time in CalCEF working more broadly on the clean energy ecosystem, instead of just residential solar, lent additional perspective on the solar industry? For instance, at kWh we look at CoreLogic and say, “Ah, that’s how mortgages are financed, therefore solar must eventually look more like this, and this is how we should think about the data infrastructure for our industry.”

DK: Yes, because so much of solar is about the financing of solar—which now involves a lot of your data and statistical insights—I think the microfinance experience is very relevant to the solar industry as it goes forward, again, in the emerging markets. It sounds obvious, but it has not happened yet.

RM: That’s surprising. What’s the gap there? I would assume if you’re doing microfinance, I would assume you could make the argument very easily for why solar-powered light allows someone in the BOP (“Bottom Of Pyramid”) to be more productive in the evening, which would enable loan repayment.

DK: I just don’t think we’ve gotten there yet. We’re talking about hundreds of millions of people who lack basic services like electric lighting. So, those entrepreneurs that are there are still using the most expensive type of money there is—equity, like we did for early establishment of US residential solar—to do solar as a service. Mainstream microfinance reaches hundreds of millions of people today, which required a system of controls to be built at the village-level. I think solar will follow this path, to create a de-centralized market of electricity of the future.

Call to Action

RM: Everything I’ve ever read or heard you say points to an underlying theme of people as entrepreneurs, as agents of change. You identified entrepreneurs as activists and talk of social movements that are leading the solar revolution. This hopeful picture stands in stark contrast to the brutal “solar coaster” we live on. I think the people in our industry are actually feeling quite depressed right now, even though our numbers on deployment and costs have never been better. What would you want to say to the people working in solar?

DK: I think you’re right on. Solar has been so wildly successful on important measures like $/kWh—but this is not the same as profitability. I would say my recommendation is people should take care of one another. And particularly, to bring up leaders to step into our shoes, follow in our footsteps. This is a long haul. And I think you’re right—at Sungevity, we were one of the vanguards to modernize solar, rode the wave as it crested. Kind of like Netscape for the internet. [Laughter] It was a necessary precedent to Google Chrome, Mozilla’s Firefox, and all sorts of newer and better ways of doing it. And those people doing that work needed to be supported by the people before them. Leadership development, mentoring, investing in young upstarts. And diversifying that leadership. Because if our movement is not inclusive of women and minorities locally and internationally, and if we just become tech bros, we don’t go global and we don’t achieve the climate justice that we’re meant to be about.

 

YieldCos Playbill

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.

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Richard Matsui (CEO & Founder of kWh Analytics) and Philip Williams (Director of Operations at Ahana Renewables) at “Financial Optimization of Operational Assets - Refinancing” Panel, Solar Asset Management North America Conference. March 29, 2017.

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.

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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.

shinn_pvrw_2017

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steph curry

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.

Chadbourne_Logo

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

Summary

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.

Challenge

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.

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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.