In a PPA, the project developer pays to install the solar and, in exchange, the host facility's owner agrees to buy the solar energy for the next 15 to 20 years. Companies like SunEdison and SolarCity are successfully using this brilliant approach to line up residential customers and large facility customers. The problem is virtually no one offers PPAs to the millions of small-to-medium size businesses in America. Why? Transaction costs. They eat up all the savings on small systems.
Making solar PPAs available to small businesses requires understanding what currently drives these transaction costs, and then developing a new deal structure geared specifically to avoid those costs. When a business like a car dealership, small hotel, or 100-person office wants solar, they are typically looking for a 10kW to 20kW system. Right now, most PPA providers will not touch a commercial project under 40kW. The reason is the transaction cost for a 10kW PPA is the same as for a 100kW system. Often the costs are so high that they cannot beat utility prices on systems under 40kW.
Current PPA Transaction Cost Drivers
After examining these deals closely, Greenzu found three components of the deal structure significantly drove up transaction costs by consuming time through negotiations, lawyers fees, and expensive auditors. The good news is, we have developed a solution that can avoid these issues. But first, the three transaction cost drivers at issue are:
1. Negotiating Price: Logically, the central point of negotiation is what price the host facility will pay for electricity. In addition to the initial price per kWh, PPA providers push for an "escalation rate," i.e., the rate energy will go up each year, arguably as close to the amount utilities' rates will rise. As a result, before agreeing to an escalation rate, many hours are spent on both sides haggling over what utility rate inflation will be over the next 20 years.
2. Negotiating Allocation of Risk: PPA providers usually are backed by an outside investor. The investor wants to push as much equitable risk as possible to the building owner. Many owners have not installed solar before, so they push back on taking responsibility for risks they do not understand. That means issues like indemnification, force majeur, and liability for system downtime are heavily negotiated.
3. Due Diligence: At current prices, solar installations take about 10 years to break even, meaning that the PPA provider's profit comes entirely from the last half of contract term. In such a scenario, PPA investors require extensive due diligence to assess whether it is safe to expect the building owner to be in business 20 years from now. After all, these days even GM is not a safe bet. The financial due diligence is expensive. In addition, the high credit standards imposed weed out a huge percentage of interested building owners.
A Three-Part Solution To Transaction Cost
After working with dozens of mid-size businesses to line up small-scale PPAs, Greenzu found the transaction cost drivers above could be eliminated by restructuring the deal as follows:
1. Take-It-Or-Leave-It Contract Where Seller Takes the Risk: Stop wasting time negotiating risk allocation. Banks will not negotiate with you on small loans. The PPA provider should do the same. If the building owner wants a different contract provision, tell him to find a different PPA provider (hint: at 10kW, there aren't any). However, to stop owners from simply walking away every time, allocate most equitable risks to the seller. The seller is more knowledgeable, more able to respond to problems, and likely to receive greater benefits from the deal. The one exception is damage caused by the buyer's intentional or negligent conduct. Again, think of the cell-phone contract: if you break the phone, you pay. If anything else goes wrong, the service provider takes care of it.
2. Index Pricing. Stop trying to convince building owners they'll save money with your escalation rate. Put your money where your mouth is by using index pricing. Simply price the solar electricity at five percent less than whatever the equivalent utility rate would be at that moment. Sure, investors will balk since this makes projected revenue an unknown. However, every solar sales rep claims utility rate escalation is inevitable. If true, then index pricing turns that escalation into a windfall of profits for the investor.
3. Plug and Play Solar. Stop assuming each solar install must be custom designed. The due diligence on each deal is so extensive because PPA providers assume the investment in solar installation is lost entirely if the host facility goes under before breaking even. This is a valid assumption when each system is custom designed. A standardized system, however, could be quickly removed and redeployed. By cost-effectively redeploying a "plug & play" solar system at another facility, we radically diminish the risk of loss from the fist facility closing. In that scenario, the financial stability requirements can be lowered. As a result, the due diligence inquiry can go from the expensive third-party audit to a simple credit check akin to what banks undertake for a small business loan. The bonus here is that with reduced financial stability requirements, millions of additional businesses become viable PPA targets.
Challenges to the Three-Part Solution
Admittedly, this three-part plan is a bit of a wish list. Currently, we see at least three challenges that emerging companies could address to help make this plan a reality. First, the long-term efficacy of plug and play systems like Solyndra's is unproven. Second, index pricing is easier said than done. When a few large PPAs tried it, they found it more challenging to implement than expected. Third, it will take an enlightened investor to sign off on a deal akin to the one described above. The current returns on PPA deals are so thin that installers try to force heavy-handed contracts onto building owners just to get the investor to sign off. A savvy investor, however, can use our proposed approach to reduce risk while blowing open the market for PPAs, thereby capturing the upside of a higher deal volume.
We'd love to hear from anyone who knows of vendors with plug and play installs or index-pricing technology. Feedback from potential PPA investors is also most welcome.
***
Brandon Conard is an attorney helping companies purchase clean tech, as well as the founder of Greenzu.com, the home of several interesting Energy Efficiency Payback calculators. He'd love feedback on this article. Send it to info@greenzu.com.