Four Financial Risks For Solar Developers To Consider In Today's Market

Today’s solar market is booming, and developers are at the center of an incredible opportunity to bring projects to market. But, developers looking to cash in on the solar rush should beware several financial risks – ones often avoided by securing investors early in the process.
 
Countless deals have fallen apart at the last minute in the past 20 years in the energy industry, but some developers have gained competitive advantages in evaluating assets and bidding on development opportunities through these four lessons learned:
 
Start from the start: What makes a project financeable? 
Ask what makes a solar project financeable: How should contracts be structured? What kind of returns does the market demand? What contractual provisions will bring an asset through construction to operation?
 
Solar projects are often considered analogous to real estate investments – install panels, wire them together, then sit back and collect returns. This is true to a degree, but these are energy investments with operational risks such as performance of equipment, repairs, and maintenance, etc. As assets age and markets change, operational risks should also be priced in.
 
Another area of importance is revenue assumptions. For instance, for a project with a 10- to 15-year power purchase agreement (PPA) and an asset life of 35-40 years, what pricing can be assumed for the second half of a project’s lifespan? Many developers aggressively price projects on the back-end to look good from an internal rate of return, but to a financing party, this seems risky and raises red flags. 
 
Avoid assumptions on financial requirements
Developers without take-out financing should avoid assuming return requirements on long-term equity or debt, because this could limit financing. For instance, a yieldco’s 3% yield could be translated into an equity retirement of 3% to 4% internal rate of return, but these are two very different things. 
 
Long-term equity does not come at these low rates, meaning poor guidance on financeable market pricing can strand a project, costing developers all the capital they’ve risked.
 
Considering pricing requirements in the asset finance process also enables smarter financial decisions. For instance, when bidding PPA pricing to an RFP, developers with financing in place know their take-out commitment instead of just expecting project finance at an assumed rate of return. 
 
Keep regulatory changes in mind
Consider how regulatory impacts may affect projects, especially with an eye toward sealing a deal under known circumstances instead of holding out for a potentially bigger payout down the road. Fast-evolving market dynamics mean a project ready for financing today could be stranded in a few months.
 
Federal Investment Tax Credit uncertainty is a well-known example – today’s 30% tax incentive could fall to 10% in 2017, completely changing project economics. There is also an influx of capital entering the market to take advantage of today’s ITC rates, meaning developers who wait too long to lock in a financial partner may miss the rush. 
 
State policies also mean developers shouldn’t wait too long on project financing. Consider Massachusetts – installation targets have fostered a solar boom, but projects must reach completion by a certain date to monetize their full benefits. With net metering at or near mandated caps in several utility territories, now’s the time to get financing done to prevent running short on construction timelines and losing project value.
 
Be a little leery of LOIs
Beware of putting too much faith in a letter of intent. Recent analysis contained in a New York Public Service Commission order estimated 80% - 90% of LOIs don’t mature into binding agreements, this is seen particularly across the Northeast U.S. where entities are eager to get assets out of the market. An LOI certainly gives financing parties exclusivity and can add to a pipeline, which makes sense for larger entities concerned about pipeline valuation, but smaller developers should carefully consider LOIs.  It’s a free option in many cases, and one party can take months on due diligence while a developer is losing precious days on other deadlines. 
 
Most responsible financiers will do their diligence before putting out an LOI. They will strive toward financeable and executable LOIs while deferring to a developer’s needs and the capital they’ve risked, but some parties may issue LOIs to get a project off market before deciding to pass toward the end or requiring much lower pricing.
 
What’s a solar developer to do?
If these risks mean developers should lock in financial partners early on, what constitutes the right investment opportunity? Ironically, it often depends on the financing party’s risk tolerance. Early-stage projects may have a site option with completed interconnection applications, ongoing environmental studies, and visibility into an off taker, but financiers may still back away from development-stage risk. 
 
Developers can also get creative to increase returns, for instance negotiating fees for time spent getting a notice to proceed, asking for project equity, or tying compensation to delivering on development milestones.
 
Project returns also increase through long-term financing relationships – building a bridge, not a pier. Developers may face a learning curve on their first or second transaction with a particular investor, but by the third or fourth deal it’s a seamless process where everyone speaks the same language under the same set of expectations. With time, developers learn what a successful financing package looks like, while investors, in turn, learn about development cycles and can optimize the risk/reward perception of development.
 
Above all else, play the long game. Many deals fall apart at the last minute, and in some instances they’re worth putting back together, but always question if a faltering deal is worth saving. Maybe they’re falling apart for a reason, and stretching to get one deal done may look good now, but might be the wrong long-term decision.
 
Solar is considered an upstart stealing from the incumbent energy space, which creates long-term paradigm perceptions of low single-digit returns, but solar is already becoming accepted among the traditional energy industry. As the waters become less frothy, developers with long-term relationships to financing parties will be better positioned to keep building pipeline investment – even in times of reduced funding sources. 
 
 
 
 
Sripradha “Shrips” Ilango is the executive vice president of finance for Soltage LLC.
 
Soltage,,LLC. | www.soltage.com

Volume: July/August 2015