One could accuse George Clooney of “piling on” recently when he made public his irritation at Elon Musk’s car company Tesla and how getting stuck by the side of the road one too many times caused him to dump his $100,000 car on a benefit auction. We got a copy of the Auction Item description.
Elon Musk was already having a bad week, loosing about $1.5 Billion on paper due to the fact that on Wednesday a Tesla Model S caught fire in Tennessee. This was the third incident of fire. Then the government started investigating the safety of the vehicles.
Then Senator Sessions wrote a letter calling for an investigation of SolarCity and called it the next Solyndra. And finally, his SpaceX rocket launch had to be aborted 3 times.Now the ratio of car fires for the Tesla is low compared to the industry average for gasoline engine vehicles, and politics aside, there is really no comparison between SolarCity and Solyndra. And the rocket did ultimately make a successful launch. The stock price recovered and continued on its own meteoric trajectory. Investors just seem to like the SolarCity story. The New York Times recently referred to investor’s love affair with SolarCity’s stock a ” craze.”
And there was more good news for SolarCity. The company announced a new financing model that many believe could “revolutionize the industry.” SolarCity will place $54 million in securities backed directly by its solar power leases. This approach will allow SolarCity to utilize lower interest rates and thus offer to their customers lower payments. Other residential PPA companies like Sunpower, REC, and Sunrun could soon join in. The approach promises to be “a very big deal for the solar industry,” according to Richard Matsui, chief executive and co-founder of kWh Analytics, a firm that advises clients on solar-panel projects. The bonds received a BBB rating from Standard & Poor’s, which qualifies for a 4.66% interest rate.
Under the plan, SolarCity will “bundle” a large number of contracts of residential solar-panel systems it has installed. The homeowners will pay monthly fees to SolarCity for the electricity the panels generate. This will cover the interest payments. SolarCity will use the “bundle” of contracts to service the debt.
In setting up this financing model, SolarCity avoids the higher bank rates, and also avoids the bank’s rigorous requirements. It has been getting increasingly difficult for solar financing companies to secure moneys from Wall Street. Sunpower last month ceased all leasing programs in states with SRECs, Solar Renewable Energy Credit programs, due to their lender’s risk aversion to SRECs volatility. Because of the unpredictability of the solar market, and the constant changes in government subsidies, along with the lack of long term data, many lending institutions are simply unwilling to take the financial risk on solar.
Like any new field, solar is dynamic and competitive. SolarCity continues to lose money. We know this because it is publicly traded. We do not have ready access to the finances of Sunrun, Clean Power Finance, Sungevity, Vivint, or the other privately held solar financing entities. Though the BBB+ bond rating given to SolarCity’s offering comes with an attractive interest rate of 6.44%, the rating is only one step above junk bond status. SolarCity’s new method of raising money sidesteps many of the hurtles of acquiring investment capitol from traditional sources, getting a lower interest rate in the process.
PPA/Lease Providers now represent over 80% of the residential solar market
Though SolarCity is still unprofitable, Bob Kelly the CFO, assures investors that the company is building a massive revenue stream. He describes the company’s solar installations as having an asset value of 30 years. The thousands of solar electric systems that the company is installing will generate cash flow for the company for 20 years as contracted with an additional 10 year extension. He is confident that signing the extensions on these contracts will not be an issue.
Standard and Poors generated a report on SolarCity along with their rating, and it is a relative treasure trove of information in an industry devoid of data. Of the 36,000 installations studied in the report, SolarCity had close to 900 PPA reassignments – (meaning people who moved and needed to transfer their PPA to a new homeowner.) Of the 900, the report states that less than 10% could not be reassigned. According to company records, of these, 87% of the investment was recovered. It doesn’t say how they “recovered” their investment – presumably by forcing the homeowner to buy out the system – as per the schedule in the contract. This amounts to a loss of less than 1% which is an extremely low rate.
According to a recent article in Greentechmedia this relatively low “reassignment” rate bodes well for SolarCity. It should be noted that although SolarCity has been selling PPAs for 5 years, the average length of the agreements studied by Standards and Poors was less than 2 years. This means that of these 36,000 contracts, 900 people signed a twenty year contract not foreseeing life altering events occurring in less than 2 years. That’s 2.5% of all contracts signed discovered that they had to move on average 1.9 years into a 20 year commitment. If you were to extrapolating this reassignment rate out over a 10 or 20 year period, depending on what annual increase you plug in, things for SolarCity might not look so rosy. They may look even worse for those homeowners holding those 20 year agreements.
Unforeseen events is the legal term for events that occur which could not have been predicted. The question is; if 2.5% of SolarCity’s customers didn’t see a life altering event 1.9 years out, what is going to be the percentage of people unable to foresee life altering events 10 years out?
20 years is a very long commitment
In the US, the average 30 year mortgage is held for 7 years, and the average marriage lasts 7.8. Every couple swears to a lifelong commitment and then most fall far short. “Why I divorced my husband after 10 days of marriage.” If you combine the tendency toward short term planning with the increasing odds of unforeseen events occurring over time: job relocation, divorce, foreclosure, too many kids, too few, annoying neighbors, job loss, illness, hitting the jackpot, kicking the bucket – you are looking at a probable large percentage increase in required “reassignments,” in solar leases. We might assume that financial entities factor in this sort of risk into their future projections. This may be one reason companies like SolarCity are finding that money for solar financing is increasingly difficult to find via traditional sources.
Using the Standards and Poor data on reassignments, we generated a few models projecting forward. Column 1. If we were to take the 2.5% reassignment rate in the first 2 years and flat rate it at 1.25% per year, and keep this rate constant, it would add up to a total of 12.5% reassignment rate in 10 years. Column 2. If we incorporate a modest 10% annual increase in reassignments starting the first year @1.19% and year firstname.lastname@example.org% (for the 2.5% 2 year total,) we would reach an 18.97% reassignment total in 10 years. Column 3. If we increase, or accelerate this reassignment rate by a factor of .5% percentage each year the rate climbs to 5.5% in year 10 for a total of 31% of leases reassigned by the 10th year. Column 4. If we accelerate this reassignment rate by just 1% annually we come close to a 10% reassignment rate in year 10 for an accrued total of 50% of all solar leases being reassigned by year 10.
These projections are based on too little data to be anything but speculative. However, it seems reasonable to assume that unforeseen events will increase and accelerate over time causing greater percentages of lease reassignments. And if the number of required reassignments were to accelerate and total anywhere near 50% over the course of these 20 year contracts, then the crucial question will become:
Will homeowners in the future, be as eager to take over these PPA agreements as they are today?
In order for these solar systems and PPA/lease contracts to remain attractive, they will need to offer “a good value” to homeowners. The equipment must remain functional, and competitive with the market – the PPA itself must continue to offer attractive savings going forward to the new homeowner.
Technology. Solar panels do loose efficiency – industry average is calculated at .05% per year. Though this is a very small percentage, the technology and solar cell efficiency continues to increase every year. Once installed, solar cells will degrade and solar equipment will gradually deteriorate when exposed to the elements.. The technology applied in all installed solar electric systems will become almost immediately outdated. The engineering of future solar equipment will continue to improve. The probability is that solar panels will continue to become more efficiency and more cost effective. Therefore as solar electric systems age, their less efficient technology of will be increasingly less attractive to homeowners in the future. As time passes, new homeowners may become increasingly reluctant to take over leases of aged technology.
Maintenance. Even the highest quality solar panels are not bullet proof. Additionally, many PPA companies, in order to offer the most competitive price, have installed the cheapest equipment they could find. Solar panels have limited 25 year warranties, but the strength of these warranties has yet to be tested. The strategy of utilizing the lowest cost equipment, while good for the consumer and good for sales numbers as well as market share for the short run, may prove problematic over the twenty year contract period. Though new and virtually devoid of data, the solar industry is already experiencing maintenance issues with some low-cost solar panel installations. 20 year cash flow projections laid out by solar financing companies is contingent on the uninterrupted production of electricity via thousands of individual installations. O and M of this multitude of small installations in diverse locations, could prove extremely costly. If there were to be any increase in panel failure or any unaccounted for increase in maintenance costs, this would cut severely into industry profits. O and M issues would also result in making prospective homeowners much more wary of taking over reassigned leases. One of the big selling points for the PPA industry to-date, has been its promise that solar is “worry free.”
Competitiveness. If there are significant improvements in the efficiency and the cost of solar electric systems, the lease agreements of today may not be competitive with future product offerings. Many PPA agreements have been written with escalated rates included. So if electric rates do not climb significantly these leases will offer minimal to no savings and will not be attractive to new homeowners. If other financing models are developed that offer greater value to the homeowner, reassigning old leases to new homeowners will become extremely difficult . And if an increasing number of negative stories emerge about unhappy lease holders for any of these reasons, if leases become viewed as a liability, these contracts will become difficult to transfer. Present lease agreements are written to protect the financing companies from loss. Financing companies are to be made whole in most cases at the expense of the lease holder. If there are increasing defaults on leases agreements for the reasons stated above, the industry in the short run may not suffer financially. However solar companies depend on continued growth of their revenue stream through the signing of new lease agreements. If people become aware of reassignment issues and their financial liability in these agreements, the PPA model will no longer be attractive.
How did the PPA take over the Residential Solar World?
Through a confluence of factors the PPA financing structure has emerged at a very beneficial time.
1. A large amount of Federal incentive money has been pumped into the industry to subsidize commercial solar projects. During the “Great Recession” the treasury department was literally giving this money away to solar projects, to ensure that the industry did not falter. The result of this supercharging one sector with cash was that it attracted a tremendous amount of players from businesses that were, at best, treading water. Competition has exploded.
2. Also due to the recession, far fewer homeowners have had the resources necessary to cover the upfront costs of solar, and they have also been much more reluctant to make the investment.
3. Depressed property values have also been a factor. Though interest rates are low, banks are still unwilling to lend money. Many homeowners are still under water on their mortgage and can’t qualify for financing.
4. Many people are still not making enough money to take advantage of the tax credits. For these reasons leases and PPAs are thriving. “Free” solar under present conditions is attractive. But will this be the case in the future? PPA companies may someday find themselves, in the same position of cable and phone companies, desperately fighting to pass on or renew their lease agreements against competitive offerings.
Does the PPA residential solar model have a future?
In the future, new solar financial models may emerge that will challenge the present day PPAs. If banks grow more confident in loaning to homeowners, or if interest rates and requirements relax for loans making them more attractive. Many believe that PACE , the government supported loan program may very well become the best approach to financing solar in the future. Micro financing and various forms of cloud funding already are beginning to emerge on the internet targeting solar projects. Any one of these models or others yet to emerge may disrupt the growth projections of present day PPA programs.
The scheduled loss or reduction of the ITC in 2016 will be a major hurtle for the entire solar industry. Bob Kelly states that he believes SolarCity can make up for most of this 30% tax credit loss through a strategy of reducing installation costs (5.5% each of the next 3 years) and by increasing the retail rate of the lease. Historically, the industry as a whole has averaged a cost reduction of 7% per year, so this goal is attainable. But no matter how much costs are reduced – there is no way to eliminate the shock of the loss of the federal tax credit. The PPAs will be doubly hurt by the loss of the ITC. They will loose the 30% cost reduction which will make their model less competitive to other financing models. And they will loose one the incentives that attracts customers to them: those who cannot use the tax credit themselves.
Many utilities, fossil fuel companies, and conservative organizations are fighting back against the expansion of solar and are lobbying hard to eliminate or reduce net metering rates and mandates. This could have a crippling effect not just to the PPAs but on the entire solar industry. Any change in the billing structure utilities use could negatively impact the viability of the PPA structure.
As pointed out in our blog post Green Bubble 2, there are increasingly aggressive sales tactics employed in the pitching of these PPA programs. If customer dissatisfaction grows, if the downside and liabilities of the lease program are given exposure. If these programs begin to be viewed in a negative light, people will be reluctant to sign the lengthy contracts necessary for these programs to work.
It could be Yelp that brings down the high flying PPA market.
There are a number of branch points that will impact the attractiveness of solar PPA/leases in the future. Some agreements will fair better than others. Not all PPA/ leases are the same. There is an argument to be made that success will be on a case by case basis. If electric rates continue to climb, fixed rate agreements, rather than those with escalators, will remain attractive, having locked in historically low electric rates. If SRECs prices remain positive, those leases that allow the homeowner to keep their SRECs will continue to offer great economics to the homeowner. Some well timed PPA agreements that incorporated one time government/state subsidies, as well as pre-pay PPAs, because of their great economics, will remain attractive. If certain subsidies are eliminated and solar prices do not drop to match the lose of those programs, older lease agreements will continue to offer relatively higher savings, and thus will remain competitive.
Because of the newness of solar industry, the issue regarding long term operation and performance is an open question. Maintenance issues could have a dramatic impact on PPA profitability by reducing income from the electrical production and increasing labor and equipment costs. If there are large scale failures in present installations, the value of thousands of installations may quickly turn from an asset into a liability. If there is even perceived investment risk, funding will become much more difficult and more expensive. Risk characterization could break down the PPA model.
The PPA model presently dominates the residential solar market. Because the savings to the homeowner is so much greater with ownership, the biggest threat to the PPA’s continued dominance – may simply be an easy path to solar ownership. Lower equipment costs, an easier financing model, short ROI, combined with a good extended warranty could end the reign of the PPA model.
PPA companies have done their part in lowering the threshold and dramatically increasing the growth and acceptance of solar. There will always be a place for the PPA model within the solar community. However whether this model will continue to dominate the residential market remains to be seen. The solar industry is fast moving. The first residential PPA was signed in 2008. The over night growth of companies like SolarCity, SunRun, Sungevity, Vivint, and Clean Power Finance have been very positive for the residential solar industry. With size comes clout; both financial and political. These companies will continue be in a position to affect policy and use their scale to stay competitive. The more solar that is installed, the better it is for everyone. However, failure or mass dissatisfaction with the PPA model would reflect poorly on the industry as a whole.
Ultimately, the future growth path of residential solar will be determined in the court of public opinion. As more people have solar electric systems for a longer periods of time, as the actual field data becomes available, and as the details of the different financing models become more transparent, the pros and cons of the different models of acquiring solar energy will finally be available for everyone to evaluate.