The U.S. solar industry has entered an increasingly mature phase, where falling equipment costs and rising consumer demand open new markets and attract a stable base of investors with a firm understanding of the large and medium solar asset classes. But this rising demand and funding interest are creating a new challenge for utility-scale and commercial and industrial (C&I) solar developers – a market long on investment dollars but short on investment-ready projects.
A confluence of events has generated the current solar market situation. Interest rates remain low, meaning investors with good credit can raise large amounts of capital. Utility-scale and C&I solar projects have evidenced steady yields for many years, making them attractive to investors seeking consistent rates of return. Utilities and energy funds are looking to expand their solar capacity, adding competition for project acquisition. Finally, new tax equity investors are increasingly comfortable with the solar investment tax credit (ITC) subsequent to its extension and want to enter the market.
Jesse Grossman
However, the move to available markets and the rush to beat the ITC cliff picked off most of the low-hanging development fruit, leaving scarce options for the funds flowing into the non-residential solar markets. There’s never been a perfect balance between investment opportunities and investment funding, but right now as a market, we’re seeing more dollars than investment opportunities. The challenge currently facing the U.S. utility-scale and C&I solar industry, therefore, is how to build a valuable pipeline and create or acquire projects.
Open up the fundamental developer toolbox
Given all this, how can developers capitalize on solar’s more mature market dynamics? Although the variables have changed, the same scalable business formula that has always underpinned solar success remains constant: understanding local markets and pursuing the development process with the right partners.
This starts with what we call the “fundamental developer toolbox” – the skills, knowledge, and pattern recognition needed to take a project from concept to notice to proceed. At the local level, this includes understanding land entitlement, a knowledge of interconnection and how to get power to the market, and being able to put the right contracts in place to sell power and renewable energy credits to generate revenue streams.
We’ve seen plenty examples of what happens when fundamental development skills aren’t employed. For instance, developers agree to project power purchase agreements (PPAs) at rates that are attractive to the customers but are too low to produce adequate revenues needed for financing, leading to difficulty in getting the projects financed or sold.
In this instance, utility-scale and C&I developers should leverage historic low solar component prices with off-takers that might be willing to consider traditional energy market volatility and strike a PPA that’s slightly above market value with an escalator. This way, developers and customers can catch the low part of the market and hedge out pricing volatility in order to move forward in a way that generates energy cost savings and consistent profits for asset owners.
We’ve also seen developers pursue plenty of projects in states with favorable solar incentives or targets that seem promising from afar but face local market challenges – such as being located at nodes where the value of electricity is too low to make a profit, or in areas without enough existing infrastructure to provide interconnection points.
For example, solar development has been successfully concentrated in some parts of southern New York, where higher tariffs are offered to projects, but it is challenging in other regions that maintain lower tariffs under the current state program design. In New Jersey, interconnection is difficult in southern utility service territories despite favorable state incentives. Even in Virginia, where favorable project development opportunities are linked to the liquid PJM markets, power prices in some regions of the state are extremely low.
In selecting and addressing development opportunities like these across the U.S., functional partnerships between developers and investors are often key to success. These partnerships help drive both the developer and investor through the decision-making processes, from site selection and entitlement, to engineering and interconnection, and right through permitting and accurate PPA pricing. If a partnership like this is locked in early on, projects will be developed with an investment exit in mind, de-risking the all-important question of who will ultimately take over the project ownership once it has been successfully developed.
Understanding the solar investment thesis
Beyond fundamental development skills, building a replicable business strategy requires adapting to market-proven investment standards by understanding the current and evolving solar investment thesis. This includes awareness of the risks and rewards project owners are looking to sign onto, if they are willing to assume long-term ownership through asset investments, and how developers can ensure projects have sufficient funds to take asset development through construction into term ownership.
The solar investment thesis is slightly different in each market, but it ultimately comes down to whether or not projects clear the economic hurdles to ownership. The return side of this equation is cut and dry: Do the benefits of the project’s long-term value offset the risks and costs associated with its development?
The risk side of the investment thesis is specific to each project: What are the regulatory regimes each project will interact with? What off-taker contracts and lengths will make financial sense? Will projects be developed for a single credit-rated utility, or will they be community solar developments with 150 to 200 entities per megawatt on the other side of the contract?
Evolving interest rates also complicate the solar investment thesis and investment universe dynamic. General industry consensus is that interest rates have nowhere to go but up, and this will likely translate to a universe in which projects with lower investment rates of return and lower PPAs will face a more challenging funding environment.
Here, developers will have to be careful about how they’re pricing PPAs so that they are anticipating the equity returns needed when they’re ready to build projects six or nine months into the development process, even if debt goes up 50 or 100 basis points.
Utilities in non-traditional solar markets: a promising new vertical
Using fundamental solar development skills alongside an understanding of emerging solar investors and owners reveals promising opportunities to turn development work and investment dollars into projects through emerging solar industry verticals.
Just as declining costs and steady returns have broadened the opportunity for solar development and investment across the U.S., the market has seen the emergence of investor-owned utilities and independent power producers buying into non-traditional renewable energy markets as they seek greater exposure to solar generation and associated investment opportunities.
This trend has been most prominent in the southeast U.S., where utilities are effectively creating their own markets by announcing significant new solar capacity targets within their service territories. For instance, Georgia Power is targeting 1.6 GW of new renewables capacity, Duke Energy has an 8 GW renewables by 2020 goal, and Alabama Power has been approved to add 500 MW of renewables, including large-scale solar.
Utility solar demand is also being driven by PURPA requirements, which GTM Research forecasts will supplant renewable portfolio standards to spur a majority of new solar capacity installations starting in 2017. This trend has been on display across solar-leading states like North Carolina and is projected to be increasingly evident in non-traditional markets like Montana, Oregon, Nevada and South Carolina.
Across these markets with large energy participants, developers are traditionally employing one of two models. With development for third-party ownership, the focus is on establishing interconnection and striking PPAs with the utilities at rates that will support efficient financing of the solar asset, as well as the creation of a long-term valuable investment or ownership opportunity.
In other cases, utilities can be interested themselves in buying projects developed in their service territory. In this scenario, the developer will be developing and contracting the solar asset with a view to ultimately selling the solar project in whole or in part to the utility. Either of these strategies creates a credible pathway for solar developers to build portfolios in these service territories, with the goal of selling power or projects to utilities seeking to grow their solar capacity.
Dig deeper on corporate renewables for new opportunity
The developer toolbox and investment thesis also open up solar investment opportunities in the medium- to small-corporate client market, even if they’re a bit more difficult to finance and develop. Large corporate renewable clients are no secret, but developers are targeting all of the same opportunities, and that market has become a crowded space.
Looking outside the Fortune 50 or Fortune 100 list reveals numerous good-credit entities in the U.S. that aren’t on the radar of every development shop. Although these smaller corporate clients may not represent massive portfolio potential, they’re an untapped market, and the investment thesis holds true regardless of whether they’re seeking behind-the-meter or off-site generation options. As with any buyer of power, corporate clients seek credible developers, and companies should play up their deployment track record while they put a specific cost-savings solution on the table.
The small- to medium-commercial solar space has been called a “no man’s land” for developers because developers often either don’t have the bandwidth to approach smaller businesses or they don’t have the ability to invest in such projects. This has certainly been a difficult part of the market to scale up, with consistently less capacity added than residential and utility-sale solar since 2014.
However, companies can capitalize on small and medium corporate solar opportunities by using a finance-first approach under which developers set up a financial vehicle able to manage numerous smaller investments. Provided that firms build out the ground game or local partnerships to establish a robust project pipeline, multiple scalable project opportunities can set up a meaningful pipeline addressing this underserved part of the market.
Brownfields and landfills shine in a cloudy solar market
Last but not least, developers looking for investment opportunities should consider solar projects built on the U.S.’ estimated 10,000 closed landfills or 80,000 brownfields and contaminated lands. These sites offer development benefits including high insolation levels, transmission access, and proximity to energy-intensive customers. In addition, saturated markets like Massachusetts, New Jersey and Illinois offer specific economic incentives and permitting advantages for landfill and brownfield solar projects to create a “win-win” where land returns to productivity and developers generate profits.
This market vertical poses challenges like steep slopes, impenetrable surfaces, and environmental remediation costs, but it is a viable opportunity. Good development fundamentals are key here – saving time and money over the long run through understanding the required state and local permitting and inspection processes. Addressing these types of solar projects also requires an expanded view of the solar investment thesis, as project lifecycles are typically longer than with most other kinds of projects due to extended permitting and design concerns, leading to larger budgets and longer investment timelines. (To learn more about the benefits and challenges of landfill/brownfield solar, check out the cover story in Solar Industry’s February 2017 issue, titled “Putting Useless Land To Good Use.”)
The potential of landfill and brownfield solar projects has just started to be realized, and if developers focus on creating a strategic and competitive advantage now, they can get a leg up in terms of capturing market share in any geographic region.
Keep evolving with a maturing market
Although the U.S. solar market has matured, utility-scale and C&I developers can still keep absolute numbers of installations growing and find a profitable home for the influx of investment coming into the solar sector by applying traditional approaches to non-traditional verticals. Promising projects still abound for solar developers – provided we keep our eyes open for financeable opportunities and keep evolving with market dynamics.
Jesse Grossman is co-founder and CEO of renewable energy company Soltage LLC, which has invested over $300 million into more than 50 solar projects across eight states.
