Elements of Solar System Financing

Solar Economics

Powering a business or home through a solar lease or PPA is financially attractive for two reasons ' first, electricity bills are lower every month, and second, any dramatic rise in the cost of electricity over the next couple of decades is avoided. Leases and PPAs generally extend from 15-20 years, and the aggregate payments made by the customer throughout the term are priced by solar lessors or servicers to be competitive with the customer's utility company's current monthly rates. While lease payments tend to be fixed, PPAs are structured so that the amount customers pay under the arrangement is increased by 3-5% each year ' which can still yield substantial savings for the consumer over time considering that the cost of power has jumped over 5% per year nationally in recent years, and by as much as 15-35% in certain utility districts.

Generally, PPA customers are not charged any upfront costs, but pay more for their power every month than under a lease, while solar lessees incur a relatively substantial one-time installation cost, but realize lower rates throughout the term of the lease. Lessees are often charged an upfront installation fee. However, the solar leasing industry is becoming increasingly competitive as new lessors enter the market, so it is likely that the installation fee will be negotiated or waived by the lessor to win the business. Thereafter, the lessee makes a flat monthly payment, which is pre-determined by the lessor as a fraction of the cost of the system, netted against the amount of tax credits the lessor receives. The overall cost of the system depends upon the size of the system needed to supply the amount of power the customer requires given the quantity of sunlight available, plus installation. Lessors then assess the amount of tax credits offered by the federal government and the customer's state government, municipality, and potentially even the utility company. In sum, the lessee's monthly payments can be priced at about 80% of a customer's monthly utility bill, and sometimes significantly less.

On the other hand, PPA contracts generally do not have any upfront costs; PPA customers usually instead pay more per kilowatt hour than customers under leases. A solar developer will determine a price per kilowatt hour based on the cost of the system to the developer (net of tax credits), and PPA customers receive monthly bills that vary depending on the number of kilowatt hours used. Generally, the cost per kilowatt hour is higher under PPAs than it is calculated to be under leases, as one may anticipate in light of the costs incurred by the servicer.

From a financial perspective, whether a solar lease or PPA is preferred by a customer may be driven by the amount of cash it has available. Another factor is whether the customer wants to make a long-term investment in a solar system; if so, leases provide the option to purchase the system on specified occasions over the duration of the lease. The lessor wants to capitalize on all of the accelerated depreciation deductions it has factored into the overall cost of the system, and will not want to offer the lessee the opportunity to purchase the system and terminate the lease for a specified period of time (usually six years or more). During the remainder of the term, the lessor may provide the customer with an option to purchase at a price determined in part by the present value of the remaining lease payments. For this reason, leases may be better suited to the needs of residential consumers, whose energy consumption is mostly predictable over the long-term and can be met for a decade or more by a system installed today. Commercial users may be more interested in going solar through a PPA to stabilize their future cost of energy as an effort to manage expenses, and are less motivated by the need to actually own the system.

Maintenance and Performance Guaranties

The level of on-going monitoring and maintenance offered by the lessor or servicer could be one of the primary reasons a customer may opt for a PPA or a lease rather than outright ownership of a system. Both lessors and servicers will offer some level of continuous monitoring of the solar system's performance in order to ensure that energy is being produced and provided in the quantity anticipated. For example, some companies link the solar system to the Internet so both the company and the consumer can view on their Web browser how the system is performing according to various metrics.

However, when it comes time to make significant repairs, the services provided under the contract may differ between a lease and a PPA. Under a PPA, the servicer most often will bear the cost of all routine maintenance and system repairs, including the full cost of any replacement parts needed. For this premium service, however, the cost of energy to the consumer is almost always more expensive than under a lease. Lessors provide routine maintenance at no additional cost to the customer, but usually require lessees to bear part of the cost of significant repairs. For example, the inverter (which converts the DC current produced by the solar panels into an AC current) is at the heart of a solar system, and a faulty inverter can reduce a system's total output by up to 40%. Inverter replacement is a repair that most systems will need after 10-15 years. The cost to replace an inverter in residential applications is about $2,000, and more for commercial applications. Most residences will have only one or two inverters; but in commercial contexts, the number of inverters required will be determined by the size of the system. Who bears the cost of major repairs or replacement may differ under leases and PPAs: The cost of a new inverter may be shared by the customer and the lessor under a lease agreement, but under a PPA the entire cost may be covered by the servicer.

To ensure that customers receive the amount of solar power they bargained for, lessors and servicers may guarantee that the installed system will produce a minimum amount of electricity throughout the agreed term. This performance guarantee assures customers that their system will produce and deliver a certain amount of kilowatt hours per year ' which is generally about 90% of the expected level of energy a system will produce given the number of solar panels installed and the amount of sunlight available. It is important for lessors/services to communicate, and customers to understand, that the guaranteed amount of energy produced will decline each year. As solar panels age, the conversion of sunlight into electricity becomes less efficient. After 20 years, the same solar system may produce around 15% less energy than it did during its first year in operation. For this reason, the term of a lease or PPA is unlikely to extend beyond approximately 15 years.

In the event a system fails to provide the amount of energy guaranteed, the obligations of the lessor or PPA servicer to make the customer whole vary by the terms of the performance guaranty. When a customer is charged by the kilowatt hour under a PPA, the servicer may be obligated to reimburse the customer for the difference between the rate per kilowatt hour under the PPA and the rate charged by the customer's utility company. A lessor, on the other hand, will not have any reimbursement or other monetary obligations to the customer. Lessors may only be obligated to make the necessary repairs or take the corrective action required to bring the solar system's output up to the guaranteed level.

Solar-Specific Covenants

A leased solar system or PPA imposes some restrictions and affirmative responsibilities on the customer specific to the system and its purpose; these may impose additional costs on the customer or at least require some pre-planning.

Of primary importance to the lessor or servicer, the customer must be prohibited from applying for or claiming any tax credits or incentives related to the solar system. Solar companies can price solar power at or below the cost of energy generated by conventional means in part due to the massive governmental and municipal incentives offered to owners of solar systems. In both the lease and solar services model, the owner of the system for tax purposes is the financing source. Customers' payments under the lease or PPA, and the resulting return to the financing source, are determined based upon the cost to purchase, install, and operate the solar system, net of these tax benefits and incentives.

Who bears the cost of insurance is another difference between leases and PPAs. Under most leases, the customer is required to increase its homeowners insurance policy (and businesses must do the same with their commercial policies) to cover the cost of the system. Lessees must consider and plan for this additional, annual cost they incur. Some PPAs, however, allocate the responsibility of obtaining insurance coverage and paying premiums to the servicer, as the owner of the system.

Regardless of who pays for insurance, solar contracts must be explicit about placing the affirmative responsibility for providing adequate security on customers. Solar panel theft has surged as residential owners, businesses, schools, and even wineries have found their solar panels gone missing overnight (and perhaps turning up in the hot market for them on online). The contract should provide for appropriate insurance coverage and payments in the event of casualty or loss.

With the installation of a solar system, customers give up some rights to deal exclusively with their real property. Solar leases and PPAs include an express easement or right of access to the property on which the system is located, to allow the lessor/servicer and its contractors or agents on the premises for inspection and maintenance purposes. An easement, which is an interest in real property, is rarely required in other types of personal property leasing. In addition, customers should be made responsible for maintaining their property in a manner that provides for the optimal exposure of the system to sunlight. This means that trees must be kept in check, the amount of sunlight the panels receive should not be changed due to shading by growth or other structures, and new construction must be carefully planned around existing panels, to keep the environment the same as upon installation, or the cost of moving and reinstalling the panels by the solar company will be borne by the customer. The lease or PPA contract must also include an agreement by the customer that the system does not and will not constitute a fixture or part of the real property. It is settled law in California that parties may, by an express agreement, decide property that the law would normally consider fixtures be considered personal property separate from the realty. The system owner needs to assure itself that any other creditor with an interest in the real property will not acquire rights to the system, and might consider providing notice to mortgagees. Additionally, the system owner will obtain an express agreement in the lease or services contract permitting it to remove the system, most typically as a remedy for a default by the customer. California provides in its Civil Code that when a person affixes property to another's land without an agreement permitting its removal, the thing affixed, except as otherwise provided, generally belongs to the owner of the land. Anyone financing solar systems that are located on the customer's real property must be aware of the laws of that jurisdiction that are applicable to the situation.

Avoiding Early Termination, Or Paying for It

What happens when the lessee or purchaser under a PPA wants out early? The financing source typically offers three options under either type of contract: assign to another customer, move the system and continue the lease or PPA, or terminate. First, in the event the customer is selling the property, the contract may be assigned to the new owner of the property, who agrees to assume all of the terms of the existing contract. Many owners want to include the solar system and the assumption of the contract in the terms of sale of their property, and lessors and service providers may condition such assumption on the credit of the new owner. If the new owner's credit does not meet the standards set by the financing source, the current lessee will have to keep the lease or PPA going by moving the system to its new property at its own expense, or if this is not possible or desired by the financing source, by paying the price to terminate the lease or PPA. A leased system, once purchased, can be included in the selling price of the property, and the new owner can separately arrange for monitoring and maintenance. Most leases and PPAs require the customer to compensate the solar company for its lost revenue upon a termination. Lost revenue is calculated as either the present value of the remaining payments under the lease, or as the present value of the contracted rate per kilowatt hour under the PPA multiplied by some formulation of the customer's projected usage. In addition, customers are required to reimburse the solar company for the cost of removing the system or for the value of the system if left in place.

Conclusion

Financing a solar system is an attractive opportunity for consumers of electricity to realize the financial benefits of stable electric bills in a volatile energy market, and forward-thinking lessors and providers of capital are making available a variety of financing arrangements to do so. As more and more individuals and businesses switch to solar power, sources of financing can play a key role in helping communities realize the many benefits of renewable energy.

Pamela Martinson, a member of this newsletter's Board of Editors, is a partner in the Silicon Valley office of Bingham McCutchen LLP. Josh Holt is an associate in the firm's Los Angeles office. They are members of the Banking and Leveraged Finance practice group, and Green Technology Lending specialty practice. They may be reached at [email protected] and josh.holt@bingham. com, respectively.

“Going green” has never been more popular, and financing the acquisition of renewable energy equipment has never been more affordable, both for commercial users and individual consumers. A wide variety of government and private programs are available, providing acquisition dollars as well as tax credits, deductions, and exclusions, and other incentives intended to stimulate clean energy development and adoption. In “A Solar Grand Plan” in its January 2008 issue, Scientific American magazine contended that “a massive switch to solar power” is the logical answer to reducing our dependence on fossil fuels and eliminating the resulting emissions. While there are programs and incentives aimed at a number of clean or renewable energy options, this article focuses on solar systems, which may be either photovoltaic energy systems involving arrays of cells that convert sunlight directly into electricity, or solar thermal energy systems that convert sunlight into heat for swimming pools, water, or other uses.

Consumers of energy, whether commercial or residential, are motivated to install solar systems to reduce their cost of electricity and make long-term utility expenses more predictable. In a lease of a solar system, typically the lease payment plus the new cost of electricity is less than the old bill for electricity alone. Lessors who offer solar systems for lease can take advantage of a variety of tax credits, grant payments, renewable energy credits, and rebates. Many companies engaged in the manufacture or installation of solar systems are now also actively offering lease financing, such as the SolarLease' marketed by one such provider.

An alternative financing vehicle is the solar power purchase agreement (“PPA”), a financial arrangement in which a third-party developer owns, operates, and maintains the photovoltaic system, and a property owner agrees to allow the system to be located on its roof or elsewhere on its property. The property owner purchases electricity produced by the system from the system's owner. This financial arrangement allows the hosting customer to receive electricity at a stable, and perhaps lower, cost, while the solar services provider receives tax credits and income generated from the sale of electricity to the hosting customer. In the leasing model, the property owner leases the system itself, with the ultimate goal of purchasing the system in most cases. Under a PPA, known as a “solar services” model, the property owner merely buys the services produced by the solar system. In deciding whether to offer a lease or a PPA, the financing source must understand the economics of the products to the consumer.

Solar Economics

Powering a business or home through a solar lease or PPA is financially attractive for two reasons ' first, electricity bills are lower every month, and second, any dramatic rise in the cost of electricity over the next couple of decades is avoided. Leases and PPAs generally extend from 15-20 years, and the aggregate payments made by the customer throughout the term are priced by solar lessors or servicers to be competitive with the customer's utility company's current monthly rates. While lease payments tend to be fixed, PPAs are structured so that the amount customers pay under the arrangement is increased by 3-5% each year ' which can still yield substantial savings for the consumer over time considering that the cost of power has jumped over 5% per year nationally in recent years, and by as much as 15-35% in certain utility districts.

Generally, PPA customers are not charged any upfront costs, but pay more for their power every month than under a lease, while solar lessees incur a relatively substantial one-time installation cost, but realize lower rates throughout the term of the lease. Lessees are often charged an upfront installation fee. However, the solar leasing industry is becoming increasingly competitive as new lessors enter the market, so it is likely that the installation fee will be negotiated or waived by the lessor to win the business. Thereafter, the lessee makes a flat monthly payment, which is pre-determined by the lessor as a fraction of the cost of the system, netted against the amount of tax credits the lessor receives. The overall cost of the system depends upon the size of the system needed to supply the amount of power the customer requires given the quantity of sunlight available, plus installation. Lessors then assess the amount of tax credits offered by the federal government and the customer's state government, municipality, and potentially even the utility company. In sum, the lessee's monthly payments can be priced at about 80% of a customer's monthly utility bill, and sometimes significantly less.

On the other hand, PPA contracts generally do not have any upfront costs; PPA customers usually instead pay more per kilowatt hour than customers under leases. A solar developer will determine a price per kilowatt hour based on the cost of the system to the developer (net of tax credits), and PPA customers receive monthly bills that vary depending on the number of kilowatt hours used. Generally, the cost per kilowatt hour is higher under PPAs than it is calculated to be under leases, as one may anticipate in light of the costs incurred by the servicer.

From a financial perspective, whether a solar lease or PPA is preferred by a customer may be driven by the amount of cash it has available. Another factor is whether the customer wants to make a long-term investment in a solar system; if so, leases provide the option to purchase the system on specified occasions over the duration of the lease. The lessor wants to capitalize on all of the accelerated depreciation deductions it has factored into the overall cost of the system, and will not want to offer the lessee the opportunity to purchase the system and terminate the lease for a specified period of time (usually six years or more). During the remainder of the term, the lessor may provide the customer with an option to purchase at a price determined in part by the present value of the remaining lease payments. For this reason, leases may be better suited to the needs of residential consumers, whose energy consumption is mostly predictable over the long-term and can be met for a decade or more by a system installed today. Commercial users may be more interested in going solar through a PPA to stabilize their future cost of energy as an effort to manage expenses, and are less motivated by the need to actually own the system.

Maintenance and Performance Guaranties

The level of on-going monitoring and maintenance offered by the lessor or servicer could be one of the primary reasons a customer may opt for a PPA or a lease rather than outright ownership of a system. Both lessors and servicers will offer some level of continuous monitoring of the solar system's performance in order to ensure that energy is being produced and provided in the quantity anticipated. For example, some companies link the solar system to the Internet so both the company and the consumer can view on their Web browser how the system is performing according to various metrics.

However, when it comes time to make significant repairs, the services provided under the contract may differ between a lease and a PPA. Under a PPA, the servicer most often will bear the cost of all routine maintenance and system repairs, including the full cost of any replacement parts needed. For this premium service, however, the cost of energy to the consumer is almost always more expensive than under a lease. Lessors provide routine maintenance at no additional cost to the customer, but usually require lessees to bear part of the cost of significant repairs. For example, the inverter (which converts the DC current produced by the solar panels into an AC current) is at the heart of a solar system, and a faulty inverter can reduce a system's total output by up to 40%. Inverter replacement is a repair that most systems will need after 10-15 years. The cost to replace an inverter in residential applications is about $2,000, and more for commercial applications. Most residences will have only one or two inverters; but in commercial contexts, the number of inverters required will be determined by the size of the system. Who bears the cost of major repairs or replacement may differ under leases and PPAs: The cost of a new inverter may be shared by the customer and the lessor under a lease agreement, but under a PPA the entire cost may be covered by the servicer.

To ensure that customers receive the amount of solar power they bargained for, lessors and servicers may guarantee that the installed system will produce a minimum amount of electricity throughout the agreed term. This performance guarantee assures customers that their system will produce and deliver a certain amount of kilowatt hours per year ' which is generally about 90% of the expected level of energy a system will produce given the number of solar panels installed and the amount of sunlight available. It is important for lessors/services to communicate, and customers to understand, that the guaranteed amount of energy produced will decline each year. As solar panels age, the conversion of sunlight into electricity becomes less efficient. After 20 years, the same solar system may produce around 15% less energy than it did during its first year in operation. For this reason, the term of a lease or PPA is unlikely to extend beyond approximately 15 years.

In the event a system fails to provide the amount of energy guaranteed, the obligations of the lessor or PPA servicer to make the customer whole vary by the terms of the performance guaranty. When a customer is charged by the kilowatt hour under a PPA, the servicer may be obligated to reimburse the customer for the difference between the rate per kilowatt hour under the PPA and the rate charged by the customer's utility company. A lessor, on the other hand, will not have any reimbursement or other monetary obligations to the customer. Lessors may only be obligated to make the necessary repairs or take the corrective action required to bring the solar system's output up to the guaranteed level.

Solar-Specific Covenants

A leased solar system or PPA imposes some restrictions and affirmative responsibilities on the customer specific to the system and its purpose; these may impose additional costs on the customer or at least require some pre-planning.

Of primary importance to the lessor or servicer, the customer must be prohibited from applying for or claiming any tax credits or incentives related to the solar system. Solar companies can price solar power at or below the cost of energy generated by conventional means in part due to the massive governmental and municipal incentives offered to owners of solar systems. In both the lease and solar services model, the owner of the system for tax purposes is the financing source. Customers' payments under the lease or PPA, and the resulting return to the financing source, are determined based upon the cost to purchase, install, and operate the solar system, net of these tax benefits and incentives.

Who bears the cost of insurance is another difference between leases and PPAs. Under most leases, the customer is required to increase its homeowners insurance policy (and businesses must do the same with their commercial policies) to cover the cost of the system. Lessees must consider and plan for this additional, annual cost they incur. Some PPAs, however, allocate the responsibility of obtaining insurance coverage and paying premiums to the servicer, as the owner of the system.

Regardless of who pays for insurance, solar contracts must be explicit about placing the affirmative responsibility for providing adequate security on customers. Solar panel theft has surged as residential owners, businesses, schools, and even wineries have found their solar panels gone missing overnight (and perhaps turning up in the hot market for them on online). The contract should provide for appropriate insurance coverage and payments in the event of casualty or loss.

With the installation of a solar system, customers give up some rights to deal exclusively with their real property. Solar leases and PPAs include an express easement or right of access to the property on which the system is located, to allow the lessor/servicer and its contractors or agents on the premises for inspection and maintenance purposes. An easement, which is an interest in real property, is rarely required in other types of personal property leasing. In addition, customers should be made responsible for maintaining their property in a manner that provides for the optimal exposure of the system to sunlight. This means that trees must be kept in check, the amount of sunlight the panels receive should not be changed due to shading by growth or other structures, and new construction must be carefully planned around existing panels, to keep the environment the same as upon installation, or the cost of moving and reinstalling the panels by the solar company will be borne by the customer. The lease or PPA contract must also include an agreement by the customer that the system does not and will not constitute a fixture or part of the real property. It is settled law in California that parties may, by an express agreement, decide property that the law would normally consider fixtures be considered personal property separate from the realty. The system owner needs to assure itself that any other creditor with an interest in the real property will not acquire rights to the system, and might consider providing notice to mortgagees. Additionally, the system owner will obtain an express agreement in the lease or services contract permitting it to remove the system, most typically as a remedy for a default by the customer. California provides in its Civil Code that when a person affixes property to another's land without an agreement permitting its removal, the thing affixed, except as otherwise provided, generally belongs to the owner of the land. Anyone financing solar systems that are located on the customer's real property must be aware of the laws of that jurisdiction that are applicable to the situation.

Avoiding Early Termination, Or Paying for It

What happens when the lessee or purchaser under a PPA wants out early? The financing source typically offers three options under either type of contract: assign to another customer, move the system and continue the lease or PPA, or terminate. First, in the event the customer is selling the property, the contract may be assigned to the new owner of the property, who agrees to assume all of the terms of the existing contract. Many owners want to include the solar system and the assumption of the contract in the terms of sale of their property, and lessors and service providers may condition such assumption on the credit of the new owner. If the new owner's credit does not meet the standards set by the financing source, the current lessee will have to keep the lease or PPA going by moving the system to its new property at its own expense, or if this is not possible or desired by the financing source, by paying the price to terminate the lease or PPA. A leased system, once purchased, can be included in the selling price of the property, and the new owner can separately arrange for monitoring and maintenance. Most leases and PPAs require the customer to compensate the solar company for its lost revenue upon a termination. Lost revenue is calculated as either the present value of the remaining payments under the lease, or as the present value of the contracted rate per kilowatt hour under the PPA multiplied by some formulation of the customer's projected usage. In addition, customers are required to reimburse the solar company for the cost of removing the system or for the value of the system if left in place.

Conclusion

Financing a solar system is an attractive opportunity for consumers of electricity to realize the financial benefits of stable electric bills in a volatile energy market, and forward-thinking lessors and providers of capital are making available a variety of financing arrangements to do so. As more and more individuals and businesses switch to solar power, sources of financing can play a key role in helping communities realize the many benefits of renewable energy.

Pamela Martinson, a member of this newsletter's Board of Editors, is a partner in the Silicon Valley office of Bingham McCutchen LLP. Josh Holt is an associate in the firm's Los Angeles office. They are members of the Banking and Leveraged Finance practice group, and Green Technology Lending specialty practice. They may be reached at [email protected] and josh.holt@bingham. com, respectively.