Shrips Ilango, Executive Vice President, Soltage
By Shrips Ilango, Executive Vice President, Soltage LLC
Few events have been as momentous for America’s solar industry as the ITC extensions. The industry began 2016 with significant tailwinds including the long-term ITC, increased state-level renewable energy targets, and growing corporate demand for clean energy. But despite all this, corporate funding for solar projects declined in the first half of 2016.
Total corporate funding including venture capital, public market, and debt financing fell 41% in Q2 2016 to its lowest level in three years – but this is a short term aberration. Solar investment will even out over the long term and financing opportunities still abound for the savvy developer if they know where to look.
Solar’s stable returns create significant appeal
The U.S solar industry has experienced significant changes in recent years – consider how yieldcos created intense activity then ramped back, or how the pre-ITC rush has evened out post-ITC extension. Changing investor risk perceptions across residential, C&I, and utility spaces have also created unique opportunities for developers. And coming off Solar Power International 2016, one cannot miss the consensus that system-wide costs continue decreasing.
All these bode well for the industry by creating interest from a wide variety of investors. A fundamental attraction of solar assets is that, for the large part, returns are disconnected from oil and natural gas volatility. Private investors are interested in stable long-term cash flow, especially coupled with an ability to put their money to work with reliable returns over a very long period of time.
Solar projects are appealing here, because they have long-term revenue contracts and construction is a fixed upfront expense and once interconnected, ongoing costs are minimal. Sophisticated investors can take further advantage of market displacement with their understanding of these assets.
Solar projects can be especially attractive investments for large institutional investors such as pension funds, which use the stable cash flow generated by solar assets to match their liabilities, and have become increasingly active in solar investing. Such institutional investors have larger total dollar investment constraints, but sophisticated developers can utilize a diversified portfolio building strategy to take advantage of this source of capital.
How solar developers can increase their investment appeal
Solar developers can work to make themselves more attractive to private investors by applying quantum of capital. The amount of work going into a $25 million investment is nearly the same as a $100 million investment, so think big and put more capital to work on larger projects to net larger investments.
Project scale is important to private investors. Remember they’re looking for larger capital deployment, so it is easier to construct an investment level portfolio with larger assets than smaller ones. Typically, assets between 2 and 5 megawatts are good building blocks to build a robust portfolio with broad investor appeal.
Given the choice, developers should also seek portfolio-level financing to reduce risk and enable easier financing on a set of investments. A portfolio with five projects provides diversification across geographies, off-taker credits, as well as some operational risks, thereby mitigating risk to investors. Diverse portfolios offer ample opportunity to achieve the optimal cost of capital by mitigating across the risk spectrum – price risk (fixed vs. floating), solar incentives (SRECS vs. none), credit risk (C&I vs. small utility), weather (snow belt vs. sun belt) and so on.
Don’t forget larger developers or financial institutions for investment
When early-stage developers desire to access capital to complete asset development, they can always consider partnering with larger developers to access capital. This approach can also be beneficial in accessing the most optimal capital source, by aggregating into other sizable portfolios.
It’s helpful for developers to think of institutional investors or independent power producers as long-term partners. The investment partner can provide real time feedback on contract risks and shepherd development assets into successful investments – this may make them more cautious in development, but it helps ensure success in the long run.
In some cases, financial institutions are also willing to help with development capital either in the form of loans or other convertible products, or even equity – these may be good venues for acquiring development capital to scale up. While such development capital may not be as attractive as solar developers would like them to be, they are good long term solutions that can help them grow.
Smaller sources of funding can also add up
Even though private institutional and yield-co financing are still primary sources of capital in the U.S. solar industry continued growth, it’s impressive how many other alternative sources of capital have emerged in the market.
For instance, retail investment funds focused on renewable energy are aggregating smaller retail-level investors to make their mark in this space. Similarly, laws opening up the retail market have allowed the crowd-sourcing model to become relevant for solar, albeit at a smaller scale.
America’s solar industry is highly localized and specialized. Accessing local sources of capital plays into this well by taking advantage of local investors who are greatly vested in their region with a specialized understanding of any risks – over other larger players who may miss local specifics or nuances.
Don’t forget the two biggest drivers underpinning solar investment – tax equity through the ITC, combined with growing demand for renewable energy from state-level renewable portfolio standards. For the next four years, the tax equity market will remain strong and continue expanding to provide extensive opportunity for developers of all sizes. Strong interest from corporate off-takers looking to add renewables and utilities looking to meet state-level renewable energy mandates also add to this market support.
Stay flexible to continue generating investment
While existing large investors in the solar space may be easier to work with than new entrants into the space, developers should keep their options open because it’s just a matter of time before these different sources of capital converge to the same set of opportunities.
Even though overall corporate funding may have fallen in 2016, the overall investment outlook remains quite strong for solar developers, as long as they take a flexible approach to which type of investors they pursue and what kind of projects they develop.