Last month New York City’s major electrical utility announced that it would work with solar developers toward a more modern grid. Although such progressive utility policies are not universal across the nation, it is clear that more solar will be installed. It is important for building owners to consider the options for solar financing. This article will help you avoid common mistakes.
I want to thank Lance Weislak for contributing most of this article’s information. Lance Weislak is an investment banker at Wulff, Hansen & Co. He can be reached at firstname.lastname@example.org.
When developing solar programs, facility owners often spend most of their time considering the physical attributes of the equipment, such as how many megawatts it will generate. The financing of the project is an afterthought decided at the last minute — and may be dictated by the vendor. This is a mistake because a project’s financing dramatically affects the outcome. The seven most common energy project financing mistakes are listed below.
1) Using inflated utility escalation rates
Savings calculations are only projections and are highly dependent on estimated utility rate increases. Any project can be made to look good by using aggressive escalation assumptions. However, if rates increase by less than the assumption, savings could be diminished.
Do your best to evaluate whether the proposed escalation rates are realistic. For example, look back at your billing history and review your utility’s press releases to see if it forecasts higher rates. Run your economic plan using a variety of rate escalation scenarios (high, middle and low).
2) Neglecting to consider options for direct ownership and Power Purchase Agreements
Solar equipment can rented under a Power Purchase Agreement (PPA) or owned outright by the building owner. The PPA option allows the owner to lock in steady and potentially low electricity rates for 20 to 25 years. PPAs are indirectly subsidized by a 30% Federal Investment Tax Credit and accelerated depreciation. Substantial state incentives (which can disappear suddenly) may also be available. Operations, maintenance and system upkeep are the responsibility of the solar equipment’s owner. The building owner pays only for the electricity the system generates, shifting all system risk to the solar owner.
On the other hand, solar systems are fairly easy to maintain and don’t have much risk associated with them. Owning the system holds the potential for nearly free electricity once the system is paid off. Consider both options carefully as they have very different pros and cons in their financial underpinnings.
3) Misunderstanding the savings warranty/guarantee
The guarantee is a large part of the value a solar company brings to the table, so ask questions until you understand it. Some companies even promise to write a check if savings don’t materialize. Don’t confuse your guarantee with the performance bond that insures construction, because they are entirely separate.
Make sure you understand exactly what is being warranted (dollars, electricity savings or production?) and by whom. Is the guarantee the responsibility of the company or the equipment manufacturer? For how long? What happens if the company is sold or goes bankrupt? What rights do you have? In what ways can the company make good on its warranty/guarantee? Furthermore, a warranty or guarantee is only as good as the company providing it. Does it have the operational and financial strength to stand behind its promises? You should examine a company’s track record, claims history and audited financial statements before you sign.
4) Neglecting operation and maintenance costs
To generate the savings projected, systems and equipment must be maintained. For example, inverters need to be replaced every 10 to 15 years and panels need to be washed regularly. Whether performed by external companies or facility staff, the cost of maintenance must be included in the project economics.
5) Neglecting a competitive process
Many facility managers wouldn’t consider purchasing goods or services without first conducting a competitive process, yet sometimes these same facility managers accept the first energy-financing package presented to them. You almost always get a better financing package by employing a competitive process.
I’ve seen dramatic differences in interest rates offered to similar clients for a similar project by the same bank. The only difference was that one borrower obtained unbiased third-party financial advice and used a competitive process, while the other one did not. Small differences in interest rates can have a major impact over time. For example, a difference of 20 basis points in a $10 million financing package over 15 years adds $300,000 in interest cost.
6) Making a decision based solely on the interest rate
The interest rate is not necessarily the most important criterion for financing. Terms and conditions must also be examined. For example, some proposals may include all transaction fees while others do not. Similarly, one bank may accept a validity opinion from your own counsel while another may specify an expensive external counsel. Prepayment terms often have a dramatic impact on overall value – one proposal may allow for prepayment at any time, another may prohibit it, and another allow it but only with a substantial penalty or premium. Similarly, a lender may require the borrower to pledge an asset in order to obtain financing. Pledging the wrong asset could have negative consequences down the road.
Look before you leap at the lowest nominal interest rate.
7) Ignoring low-cost and subsidized financing
Numerous federal and state programs offer attractive financing for green projects. At the federal level, both Qualified Energy Conservation Bonds (QECBs) and Clean Renewable Energy Bonds (CREBs) offer long-term financing for more than 20 years at rates typically less than 2% and sometimes less than 1%. The actual rate depends on your credit. At the state level, there are several programs that can offer both 0% and 1% loans for smaller projects. Cost-free grants may also be available. Don’t count on your vendor to identify these for you – explore these sources first and then fill in any gaps with traditional methods.
To avoid the mistakes above, don’t hesitate to bring in outside expertise if you need it. You can also invite a member of your finance department to be a part of the project team. Be sure to shop around for the best package and don’t be afraid to ask questions.
Eric A. Woodroof, Ph.D., is the Chairman of the Board for the Certified Carbon Reduction Manager (CRM) program and he has been a board member of the Certified Energy Manager (CEM) Program since 1999. His clients include government agencies, airports, utilities, cities, universities and foreign governments. Private clients include IBM, Pepsi, GM, Verizon, Hertz, Visteon, JP Morgan-Chase, and Lockheed Martin. In August 2014, he was named to the Association of Energy Engineers (AEE) Energy Managers Hall of Fame.
In a free webcast, Dr. Woodroof provides his 2016 update on the environment and energy management solutions. This webinar's information will impact most areas of energy management, including tax benefits and utility adaptation. It will help you get approval for your energy conservation project. To view the webinar, click here.