Historically, renewable energy financing has predominantly come from major banks and other limited sources of tax equity. In previous posts, I've mentioned the need to broaden the sources of capital, including pension funds and other institutional investors. To do so, projects need to be standardized to reduce development and operating risk and enable the creation of portfolios that can be securitized, thus allowing ownership shares to be easily procured, traded, and priced by the market. NREL is helping the industry meet that goal by developing standard contracts, engaging the rating agencies on risk perception, and building consensus on best installation and operation and maintenance (O&M) practices.
Recent articles have described the central utility model as a downward cycle whereby solar and other "disruptive technologies" eat into utility market share causing utilities to raise rates, which amplifies the loss of market share. Interestingly, as the industry changes around them, investor-owned utilities (IOUs) remain largely un-invested in solar deployment or emerging storage technologies. In my mind, that's a real lost opportunity because:
- Utilities have access to very low-cost capital
- Utilities need capital investment to ensure healthy returns to their shareholders
- Distributed generation and storage assets — especially in combination — can provide the grid valuable resiliency in the wake of storms and other natural disasters.
According to Edison Electric Institute, IOUs held roughly $771 billion in assets at the end of 2012, with 57 percent coming from long-term debt and 43 percent from common and preferred equity. The sector is projected to invest roughly $90 billion annually to ensure adequate supplies of generation and stable transmission and distribution networks.
To feed that investment, electric utilities interact with capital markets — raising equity and debt — continually. The sheer volume of funds required and the regulated monopoly status provided to utilities enables them to raise capital at extremely favorable rates. In the last quarter of 2012, the average coupon rate for electric utility debt was 3.4 percent — the lowest level over the past eight years.
And yet solar and other renewable energy investment is made primarily by non-utility entities at far higher costs. This occurs, in part, because a significant portion of the "capital stack" or source of funds comes in the form of private tax equity, although examples of IOU investment in renewables do exist (e.g., see NREL's market insight on San Diego Gas & Electric's example). Utilities, however, are not a primary contributor due to a variety of reasons, including:
- The complex financial structures applied to capitalizing renewable energy assets require very specific expertise;
- Concerns that solar remains uneconomic compared to traditional generation technologies;
- The fear of market dominance or self-selection by utilities, causing regulators to preclude them from generation asset ownership in their restructured service territories or otherwise from solar investment;
- "Normalization" accounting rules that require tax benefits spread over the asset life, which appears to favor non-utility investment.
But IOUs and their regulators alike might consider re-assessing utility investment in distributed solar and storage technologies as costs have declined rapidly over the past several years and these assets — alone or in combination — can provide generation free of emissions or fuel-price risk, avoid or defer transmission and distribution (T&D) upgrades, and provide valuable grid resiliency benefits. And perhaps most importantly, utility investment in distributed solar and storage technologies support the traditional rate base utility revenue model and leverage utilities' access to the capital markets — and in a manner that doesn't crowd out private solar developers.
Conceptually, I break potential utility investment into three buckets, although various derivative versions are possible:
Short-term investment: The utility (or its subsidiary) invests in assets for a limited period of time to either enable construction or until assets can be pooled and sold into a secondary market, perhaps after 1 year of operation. Pooled assets — deployed by third-party developers or "originators" would apply standard contracts as well as installation and O&M best practices to ensure quality consistency and minimize risk to the utility investment. The secondary market could be either bilateral or, as the industry is currently developing, a structured finance option openly priced and traded by institutional investors such as pension funds.
Medium-term investment: The utility offers its low-cost balance sheet to provide traditional tax equity through the 5-year "clawback period" during which the tax benefits are still required to be held by the entity claiming them. After the clawback period, the investment is recapitalized through "take-out" financing, essentially selling off the interest to an entity interested in the remaining cash flows, which is also potentially available as a sale into structured secondary markets. As the tax credits can be realized immediately for market activities outside utility service territories, perhaps IOUs can arrange mutual investment agreements with neighboring utilities or a similar cooperative mechanism.
Long-term investment: The utility invests and holds the asset over the expected life for purposes of traditional depreciation and regulated return application. These assets can provide long-term rate-base and shareholder return benefits. The equipment is placed at customer sites similar to common equipment lease arrangements. Under certain conditions of solar resource and customer load profile, PV/storage combinations may be able to provide discounts to the customer's usual demand and energy charges. The utility and the customer split the savings, thus ensuring customer continuity to repay the overall rate base. Perhaps the total payment to the utility declines, but the utility can "bank" the ancillary benefits, including the reduced emissions of greenhouse gases and other pollutants, avoided T&D, grid resiliency benefits, and avoided loss of critical customers.
Granted, short- and medium-term investment might be considered outside of a utility's business mandate as providing financing to private activities. However, whether holding assets over traditional long-term durations or holding revolving funds that repackage assets for resale into structured finance markets, modern utility investment can take on many forms to accomplish the goal of grid and financial stability. And utilities and their regulators might recognize that such investment strategies enable IOU participation in distributed asset models envisioned by NRG CEO David Crane and other industry leaders.
Utilities can benefit their customers, shareholders, and regulatory mandate to provide uninterrupted service by putting their powerful balance sheets to work and by viewing distributed generation and storage assets as part of the solution rather than purely a competitive threat.
http://www.renewableenergyworld.com/rea/news/article/2013/10/are-utilities-missing-an-opportunity-to-finance-solar-and-storage
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