It’s been more than ten years since the passage of the California Solar Initiative (CSI) and Federal Solar Tax Credit legislation. Since then, public & private entities across California have deployed solar as a part of their sustainability and energy cost management strategies. For those who structured their projects under a Power Purchase Agreement (PPA), many are now eligible or are approaching eligibility to buyout their PPA provider and take ownership of their system. The question is, how can you determine whether or not it makes sense for you?
A BRIEF OVERVIEW OF POWER PURCHASE AGREEMENTS
Before we dive into the details of how to assess the potential benefit of a PPA buyout, we need a framework to better understand these agreements. A PPA is a popular financing mechanism for developing solar projects, especially for tax exempt entities (public agencies, non-profits) who are not able to capitalize on the benefits of the Federal Investment Tax Credit (ITC). Under a PPA, a solar energy system is built, owned, operated, and maintained by a third party. The PPA provider sells 100% of the energy produced by the system to the power purchaser. The PPA provider also harvests rebates (like the CSI rebates), revenues (through the sale of Renewable Energy Certificates or RECs), and tax incentives (like the ITC) generated by the system.
These agreements have stated energy rates that will be paid by the power purchaser for all of the energy produced by the system. Often, especially in the earlier years of these agreements, there are annual rate escalators that increase the price per kilowatt hour owed to the PPA provider. In most cases, these agreements also have options for the power purchaser to purchase the system from the PPA provider. The window for these buyouts typically begins after the 6thyear of operation, based on IRS requirements around the ITC.
WHY CONSIDER A PPA BUYOUT?
In many cases, a buyout can save you money. The cost of solar has dropped considerably, lowering the market value of these systems, and making the prospect of a buyout much more attractive. If your PPA rate has an escalator (and it likely does), you may be paying more for your solar generated energy now than if you had purchased that same energy from your local utility. In other words, you might be upside down on your PPA rate relative to your avoided energy costs. In other cases, some PPA clients have had difficult experiences with their provider’s performance on maintenance, washing, and billing issues, and they want to restructure the arrangement for their solar projects to minimize the headaches and increase the cost benefits.
So, without further ado, let’s address some of the most important considerations when assessing a PPA buyout.
STEP 1: REVIEW YOUR EXISTING AGREEMENT
The first step to approaching a PPA Buyout, is reviewing your existing power purchase agreement / contract. You’ll want to find and take note of the following:
- The Power Purchase Rate: the amount of money per kilowatt hour that you are expected to pay your PPA provider for the energy generated by the solar energy system
- The Purchase Rate Escalator: your agreement may or may not include an annual amount by which your power purchase rate increases
- Your Buyout Options: most agreements will include a window, or several windows when the system can be purchased
- The Buyout Process: there may be language explaining how and when to approach your provider regarding your interest in a buyout
- Purchase Prices / Valuation Process: your agreement may have a schedule for buyout amounts, but more likely will have language explaining how the system will be valued at the time of a buyout
STEP 2: EXPLORE YOUR OPTIONS FOR SOURCES OF CAPITAL FOR THE PURCHASE
How will you come up with the cash needed for the transaction? Do you plan to use your own funds or to finance the transaction? How much will it cost to borrow the money? You should consider engaging your financial advisor to explore your options and the associated costs.
There is an emerging transaction type taking place in the market now that could be considered a PPA Refinance, where PPA clients / purchasers are able to engage a new PPA provider to provide them with the cash needed to buyout their existing provider and offer them better rates and terms in a new agreement. TerraVerde Energy is currently in the process of developing a Request for Proposal for a California agency for this very type of transaction.
STEP 3: ASSESS THE CURRENT CONDITION OF YOUR SYSTEM
A thorough system inspection & assessment will be essential to give you insights into the current & future energy production capacity of your system, as well as the types of maintenance, repairs, or upgrades that may be needed to bring the system back into optimal operating shape. This assessment should include a piece-by-piece visual inspection of the system from the panels themselves all the way through to the point of interconnection. This assessment should also include electrical tests such as an I-V curve trace which will help you better understand the true condition of each string of solar panels in your solar energy system. You will likely need to engage your PPA provider before engaging in these types of assessments. When you contact them, you should request copies of their maintenance logs, as well as copies of the warranties for the equipment & installation. With these assessments and documents, you should be able to address the following questions:
- To what extent is the system producing the amount of expected electricity?
- Has your provider followed through on annual maintenance & inspections?
- Are the equipment & installation warranties still intact?
- When do they expire?
- What type of maintenance, repairs, or upgrades will be required to bring the system up to its operating potential?
- How long until the inverters will need to be replaced?
Most inverters have a warrantied performance span of between 10-15 years, where (in contrast) the solar panels themselves are typically warrantied between 20-30 years. For most solar energy systems there will be at least one round of inverter replacements. When assessing your system, it is important to determine when your inverters will need to be replaced.
STEP 4: UNDERSTAND THE COSTS & RISKS OF OWNERSHIP
If you plan to take ownership of your solar energy system, it is important to understand and quantify the costs associated with owning that system. These costs will include:
- Your Cost of Capital (if you plan to borrow money to purchase the system)
- Asset Management Costs (explained further below)
- System Washing
- Inverter Replacement
Taking on the ownership of your system will mean that you are at greater financial risk related to the potential underperformance and future maintenance requirements of the system. A well-executed asset management strategy is crucial to maximizing the financial benefits of these systems and minimizing the operational costs. You will need to have a well-defined asset management strategy in place that includes: daily monitoring of your system, annual inspections & maintenance, efficient response to corrective maintenance needs, and regular analysis of the energy & financial performance of the solar energy system.
STEP 5: ANALYZE THE FINANCIAL BENEFIT
At this point, you should have a thorough understanding of your current PPA, your financial benefits, the current condition of your system, and the costs you can expect when taking ownership of the system. Now it’s time to analyze the cost vs. benefit of purchasing your system. This analysis should account for:
- Your PPA Rate & Escalator
- Projected Solar Production Performance (factoring degradation)
- Cost of Capital
- Asset Management
- System Washing
- Inverter Replacement
Once you’ve built a financial model, you and your team can begin to assess different scenarios that you feel makes the most sense, given your situation. You can manipulate some of the variables (such as the buyout price or the source & costs of the cash to purchase) to try and envision the scenarios you think would be most advantageous and realistic.
STEP 6: REACH AN AGREEMENT WITH YOUR PPA PROVDER ON THE BUYOUT PRICE
Now that you’ve done your homework, it’s time to engage your PPA provider and start negotiations. One of the key points in the negotiations will be the price. Depending on the language in your existing PPA, you may or may not have much room to negotiate on the valuation method used to set the price of the purchase. If at all possible, you should push for a “blend” of valuation methodologies to consider key variables related specifically to an aging, operating system. Here are three valuation methods that may prove useful:
- The Income Approach: a valuation based on the capitalization of the net earnings or cash flows expected from the property, discounted to adjust for time value of money. How much revenue can your current PPA provider expect based on the agreement and the historical performance of the system? Note: be sure to factor in the degradation of the panels and inverters.
- The Cost Approach: a valuation based on the proposition that an informed purchaser would pay no more for property than the cost of producing a substitute property with the same economic utility. How much would it cost to build a new solar system that would have the same energy production capacity of the existing system given its current age and performance?
- The Market “Comps” Approach: a valuation based on analysis of recent sales of comparable property. Note: it may be difficult to find a comparable transaction given the location, size, performance capacity, and age of your system
WE’RE GLAD TO HELP
At TerraVerde Energy, our Asset Management team partners with public & private sector clients to ensure that they realize the maximum financial benefit from their energy systems. Our dedicated, experienced team actively monitors our fleet of solar and battery systems daily, responding to reactive maintenance needs, managing preventive maintenance schedules, and providing regular performance reports to our clients. We optimize the performance and management of these systems so that you can realize maximum savings with the minimum amount of time and resource investment. We also provide consulting on PPA Buyouts and will work with your team to ensure you achieve the best transaction possible.
For a free copy of a performance report, and to learn more about our Asset Management Services, email us at firstname.lastname@example.org