Originally posted on pv magazine USA. Richard Matsui, Founder of kWh Analytics, speaks with Ed Feo, President of Coronal Energy.
Hank Aaron and Ed Feo have had homerun successes in baseball and solar development, respectively.
While they are known for their out-of-the-park hits, it is perhaps their lesser-known ‘plate discipline’—knowing when to swing and when to pass—that makes both Hank and Ed exceptional in their respective fields.
Described by fellow #Solar100 leader Keith Martin as “invariably impressive,” Ed combines a lawyer’s attention to detailed process with a solar veteran’s intuition of cost vs benefit. It will be unsurprising to many that Coronal Energy was the first sponsor to employ the Solar Revenue Put.
In this interview, Ed shares insights relevant to sponsors planning their 2018 activity: What makes a great solar developer, what it takes to scale a development business, and how to think about the latest policy uncertainty.
Sailing into an Unlikely Start in Renewables
Richard Matsui: You first established your career as a lawyer and co-chair of the Global Project Finance practice at Milbank, Tweed, Hadley & McCloy. What is the story behind your shift from lawyer to solar developer?
Ed Feo: I had planned to gain experience in a law firm for five years and then move into something more entrepreneurial. My five-year legal career kept extending with each interesting opportunity that came along.
I got my start in the renewables business by a fluke. I was a young maritime law associate, and my law firm had a request from a client to finance a wind farm. Nobody knew what a wind farm was, but because I sailed, the partners figured I might know something about wind. That’s how I started in renewables.
One thing led to another, and over time I worked on projects involving all generation technologies, international energy projects, the California market restructuring, the 2001 energy crisis, and the resurgence of renewables in the aftermath of all of that. I first worked on financing solar projects in 2005. Project costs were just a little bit higher then than they are now.
It was not until 2010 that I finally pulled the trigger and left the practice of law. My then-clients Jim McDermott and Lee Bailey at US Renewables Group had an idea to start a finance company, and they asked me to run it. That was a bit of a wild ride because we were tied in with the DOE loan guarantee program. That was really cool to start with, and we raised a lot of money. It became very un-cool as the program garnered some pretty harsh attention.
For my next adventure, I joined Jonathan Jaffrey in early 2013 and started Coronal as a solar energy finance and asset management company affiliated with Panasonic. Jonathan had worked in private equity for years and had formed a solar company a few years before. He’s a financial magician, and one of the smartest people I’ve ever worked with. Here we are, five years later.
Richard Matsui: That’s a fantastic backstory. I did not know that you got into renewables because of sailing.
Ed Feo: Yeah, it is bizarre. People have asked, “How did you have this vision that renewables would grow into such a big deal?” The fact is that I had no particular vision at all—when asked to work on the first wind deal, I thought it was interesting and quirky, that was about it. From that start, I later did some research and became enamored of a study by Royal Dutch Shell showing the successive waves of energy sources, with renewables being at that time a miniscule but future part of the mix—over the succeeding fifty to seventy-five years. So directionally it seemed like a good place to be. Anyway, my brief career advice to people is: Be open to opportunities and do work that interests you. If it turns out to be the next big thing, terrific. If it does not, then you are still engaged in work that has meaning to you.
What Makes a Great Solar Developer
Richard Matsui: In a previous #Solar100 interview, Keith Martin named you first when I asked him for the most impressive developer. What do you think a developer needs to excel in solar?
Ed Feo: Well, Keith clearly is a person of superb judgment!
Seriously, energy development is an odd and complicated business. I know some people think it is simple. Keith cited in his interview one client who said even his grandmother could develop a solar project. And I thought, “Man, he must have a pretty smart grandmother.”
Development is a multi-level game in which the rules and variables are constantly changing. The essence of what you’re doing is forecasting a need for a product for delivery years away from today and finding a customer for that future product, all in the context of moving legal, regulatory, engineering, and financial variables. It is, at some level, a little crazy.
I think being a successful development company comes down to three things: One is being able to take a strategic view; two is the ‘how-to’; and three is timing.
The ability to rapidly switch from a tactical lens, which dominates our day-to-day, to a strategic lens is critical. Developers need to see the path to the best upcoming opportunities—even if they are years away from fruition.
The ‘how-to’ is a combination of almost oppositional skills—on the one hand, you need to be extremely process- and detail-oriented, but on the other hand, good development firms are also driven by intuition and gut. In its focus on process and detail, development really is an engineer’s dream. For example, in our company, we spend an enormous amount of time on the process of quantifying the risks and the costs associated with each variable, all to better educate ourselves about the potential of delivering a successful project far into the future. And the numbers do inform the process. But, ultimately, the decision to proceed also includes an instinct for how the variables will turn out—and that part is hard to quantify.
When we started Coronal, I was very impressed by how many people were in the business. After looking at 150 projects, I was really impressed by how many people did it poorly. They were essentially long on gut and short on process. But at the same time, I would see some big companies doing development without a great deal of success because they were long on process but short on instinct. I think you need to have both to succeed.
Finally, so much of development is about timing—knowing when you ought to be developing, when you ought to be buying, when you ought to be selling. It’s not easy.
All that said, I’m fortunate to work with a group of very smart, dedicated people in our shop who do an excellent job of collectively bringing these three strands of development together.
Policy Implications for Solar Developers
Richard Matsui: How does the current policy uncertainty change the way you think about your development pipeline today?
Ed Feo: Uncertainty is just part of this business. If we look back ten years, policy uncertainty, price uncertainty, or supply uncertainty have always been around to some degree.
But now there is additional policy uncertainty at the federal level given the direction of the current administration. In looking at our pipeline, we have had to consider the effect of the section 201 trade case, the tax law changes, and the FERC reliability notice of proposed rulemaking, among other matters.
During the pendency of the trade case, we concluded that we needed to cover ourselves by acquiring panels where we could before a tariff would be in effect. As for assets where we couldn’t cover ourselves, we either sold our position or deferred the delivery dates until we thought there would be more certainty. In times of uncertainty, it is nice to be able to say, “Okay, we can sit tight and wait for things to resolve themselves.”
Thinking long-term still requires that we take a view on how these issues will turn out and the subsequent impact on costs. Every developer has a cost curve for every project component with different assumptions about the outcome of the trade case, etc. We build our curves into our models, identify a projected time frame, and try to get as much room in that time frame as possible to mitigate the downside risks associated with the policy uncertainty and other issues.
The tariffs announced this week are unfortunate in terms of driving up costs and thereby affecting the attractiveness of solar in certain markets. That said, the tariff rates are within the range of what we were expecting after the ITC recommendations. Having greater certainty on cost is a plus. We also expect states and customers with an interest in promoting renewables to lean in a bit. So, we might shift our market focus a little, emphasizing some markets more than otherwise would have been the case. And of course, a number of factors still need to be played out— the detailed rules on the tariff, the potential for exemptions, the duration of the tariffs in light of possible retaliatory actions by other countries, other cost savings, and so on. The game definitely isn’t over.
Richard Matsui: When you think about the various items that factor into your pricing, what variables have the biggest room for improvement?
Ed Feo: Overall, cost reductions will continue. Everybody’s lived off of panel price reductions. These will continue over time, but obviously will be affected by the outcome of the trade case. Installation is also continuing to make cost improvements. When you build larger projects, you realize that the implementation of a solar plant has more in common with a manufacturing assembly line than with traditional construction. Improved processes on installation will result in lower costs.
The soft costs—specifically the combination of the costs of funding plus transaction costs—also have room for improvement.
For much of its history, our industry has been built on highly structured financing models involving tax equity, project-level or back-leveraged debt, and third-party equity. It’s a project finance lawyer’s dream. That structure is expensive. Over time, I expect we will be seeing more debt, and more standardized terms, and as a result lower capital and transaction costs.
Richard Matsui: Keith estimated that tax equity’s share of the capital structure will shift from 40-50% of the stack to 30-40%. Debt will inevitably play a bigger role in our capital structure; the question has always been one of timing. The industry is already beginning to make this shift. We have already seen seven lenders issue term sheets at 1.10x or 1.15x DSCR on P50 revenue, assuming the solar Revenue Put is in the structure. Our hope is to help usher in more debt capital into the market and fill in that gap, which is clearly going to be a big issue for everyone in solar in 2018.
Ed Feo: You are right on the mark. That is what we have been doing with Panasonic. Their production guarantee results in more favorable debt service coverage ratios. Your Revenue Put does the same thing, and the arbitrage is made possible by your data, whereby you and your insurers can see a lower risk level in system performance than what the banking community is currently willing to consider on an individual asset basis.
Richard Matsui: Yes, there is an arbitrage element, though it’s also true that panels, inverters, and projects are not all equal, in terms of quality. We see a wide range in our quotes for the Revenue Put, which reflects this variation. Fundamentally, the missing piece has historically been the lack of performance data to quantify this difference in quality. But now that we are managing data from nearly one in five American solar projects, we are able to quantify the risk, and bring in global insurance capacity at attractive rates. We consider ourselves privileged to have worked with your team on closing this first Revenue Put transaction.
Ed Feo: I agree with you regarding the quality of equipment and projects—not all are equal and there are ramifications in terms of long term performance. Given the continuing cost pressures facing developers, your solution is reaching the market at a good time. Over time I would expect coverage ratios to come down and tenors to extend because of the availability of the insurance products in the near term and ultimately because of greater acceptance and understanding of the system performance risks by the finance community and their advisors.
Richard Matsui: Returning to your point on installation, there is an ongoing debate in our industry about how integrated a developer should be when it comes to EPC. Some vehemently argue in favor, citing better cost and quality control. More vehemently argue against, citing overhead and reduced flexibility. How do you see this?
Ed Feo: At Coronal, we started as a finance shop. We just bought projects and financed them. When we grew tired of paying premiums to developers, we bought a development shop. And then, we decided, “Gee whiz, we’re giving away margin,” and so we bought an engineering and construction management firm. We added our own asset operation and management team, so now we can develop, build and hold an asset if we so choose.
But these investments and the integration of all of the parts into one organization haven’t stopped a lively debate internally, and I’ll bet the same debate is happening at every company that has integrated capabilities. There will be an eternal argument about whether the additional margin capture is better or if it’s better to gain best practices and risk mitigation from working with third party firms. Developers and project managers will be arguing about this as long as there are solar projects to be installed.
Given the intrinsic volatility and complexity of the business, it’s undeniably useful to have the tools to build your own projects. Full stop. But you don’t necessarily want to build all of them, for the same reason that it’s not necessarily true that you want to own all of your assets. Committing to always doing everything is dangerous.
Our approach is to develop each project as if we are going to own it, base case. The question is always: “If I had to build it myself, could I make some money and be okay with the risk profile?” But maintain the mental flexibility to say, “You know what? I’m better off selling this asset today because pricing is strong” or “I’m not happy with the risk profile I see going forward, and it’s time to de-risk.” This ability to carry a project through completion means that we avoid the pickle of a pure-play developer forced to sell into an unfriendly buyer’s market before or at NTP.
On Scaling a Development Business
Richard Matsui: How do you think about scaling up your business?
Ed Feo: Development is a kind of business where you have to be ready to proceed where there’s opportunity and stop where there isn’t. If you commit yourself to fixed growth targets, then you are also explicitly ignoring the dynamic of the market. That gets you into trouble. Others could have different views.
Richard Matsui: A VC once asked me why the solar industry feels so volatile. I told him that the leading developers in the solar industry are, almost by definition, successful gamblers. A developer that attains national scale is one that has successfully made dozens of “bet the farm” moves to get there. As a result, these survivors make moves that are consistent with that personal history, even if the risk now seems inconsistent with their current scale of their business. It’s a “risk on” mentality, which works—until it doesn’t. And when it doesn’t, we see big explosions and many journalists come to cover the scene. I hear you making the case for flexibility, but where does process and discipline fit into the picture?
Ed Feo: My personal definition of a good developer is someone who approaches every project with the same amount of rigor, and really thinks through the timeline, inputs, and contingencies. And who can make intelligent bets (that’s the combination of data, process and instinct). There are a number of development companies for whom we have huge respect because they take that approach.
Discipline is a critical part of the process. You need to know what risks you are willing to take. And not. You need to know what you are willing to pay for. And not. It is also important to not get swept up in frenzies that occur along that path.
The long-term picture of solar is obvious: There will be much more solar five years from now than today. The question is how to get there. You cannot—must not—assume that it will proceed linearly and think strictly in terms of market share. I just don’t think it makes sense in this business.
SunEdison is a good relatively recent example of a company that decided that they were smarter than the market, and committed to aggressive growth. When that growth could only be achieved unsustainably, relative to the opportunities being presented—well, that didn’t turn out well.
When you look at the energy business outside of solar, you’ll see that there are developers of energy projects that have been around for a very long time. They know how to develop energy projects, and they have discipline. And they are not Fortune 100 companies; they are midsized companies that may sit on the sidelines for a long time before finding the opportunity they want to act on. I like to study those models, and ask, “Who are those really smart guys who have been doing this for 20 years, and how do they do it?”
Richard Matsui: I strongly believe in that, this idea that being a historian of sorts, a historian of business models, is uniquely valuable in this new industry. Though it’s also worth noting that sometimes you can draw the wrong parallels. When I first entered solar in 2007, everyone agreed that solar panel manufacturing was going to be just like semiconductor manufacturing. Therefore, manufacturers made large capex and R&D bets on the assumption of great gross margins that never materialized. On the flip side, being able to identify the right analogy grants you valuable context. We looked at conventional asset classes like mortgages and consumer credit, and realized the role that CoreLogic and Experian play as repositories for that performance data. It’s provided a powerful template for us to think about growing our business, in the solar industry.
Ed Feo: Absolutely, I really like that point. One of my criticisms of the solar industry is that it’s myopic, and more than a little bit driven by missionary zeal. Yes, we are doing great things for the environment and society, but it’s important to temper the enthusiasm for what we are doing with a clear eye on the harsh realities we face. In this business, people can be mesmerized by the passion and glamorous part and forget that it’s important to do the unglamorous part, too. I’m the curmudgeon of our company because I’m not that enthused about enthusiasm. If I had to choose between someone with a low level of passion (and even a difficult personality) but with good execution skills, versus someone with a lot of passion but less skilled execution—I will choose the former any day of the week.
Richard Matsui: When you think about the financing parties that you’ve worked with, who strikes you as being the most creative?
Ed Feo: Well, anybody who gives us money is creative, intelligent, and good-looking, so…
Richard Matsui: [laughs] That’s fair.
Ed Feo: Our approach is to limit the number of people we work with, and drive as much business as we can to those handful of people so that we achieve high transactability—meaning certainty of closing, timing and costs. I’m looking to get the job done, and then making sure our next deal is easier to close than the one we just closed. All that being said, we work with PNC, U.S. Bank, SMBC, Rabobank, and Bayern LB. They all do a fantastic job.
Richard Matsui: Last question. What’s your biggest non-consensus bet for 2018?
Ed Feo: Well, from a solar development standpoint, 2018 is in a way already over. I’m more concerned about what we have to deliver in 2020 and beyond. This year does look like a challenging year for developers and we will see some fallout. But to succeed in solar, you need to look at a five-year timeframe. That should be a consensus view. In terms of non-consensus bet: The Cleveland Browns go .500 next season.