Prepay is a Good Way for Solar

David Feldman's picture

Prepaying for energy, an arrangement that has grown popular in the wind industry, can also benefit solar project developers.  This arrangement is predicated on the fact that an energy purchaser, such as a utility or municipality, has access to cheaper capital than a solar energy developer.  Residential solar systems have completed prepays on a limited scale.  Although prepayment has not yet been used on larger scale projects, there are potential deals in development. 

Prepayment - How it Works

Solar facilities and most other renewable facilities are different from energy facilities that depend on fuel; renewables require most of their capital upfront during the construction or purchase of a facility.  By prepaying for expected electricity generation,A stand-alone photovoltaic panel with inverters and diesel generator at the Distributed Energy Resources Hybrid Test Facility. the project receives cash when it is needed most.  It also has the potential to be great for the energy buyer; after the initial payment, the long-term price of electricity can be deeply discounted because of the upfront nature of the payment. 

This prepayment arrangement is expected to work particularly well with solar. Compared to other technologies, solar has a relatively high initial cost per unit of energy.  Prepayment can help lower that large early burden.   In addition, several states require energy suppliers provide solar generation to their customers through renewable mandates and portfolio standards.  Customers can purchase this power or renewable energy certificates at a discount.  Finally, solar technologies produce energy during peak periods of the day when electricity is more expensive, making the power more valuable to the utility.  Prepayment allows the solar power purchaser the ability to get this high priced electricity at a discount.

Government incentives help mitigate some of the initial cost of solar; the investment tax credit or cash grant contributes $0.30 on the $1.00 for solar, and the MACRS depreciation schedule for commercial and utility scale projects and state rebates where available can further lower the upfront cost for solar.  However, there is often still a big price tag even after these benefits.  Traditionally, grants, discretionary funds, tax equity and debt have filled the funding gap (depending on the size of funds needed).  Prepayment arrangements allow the buyer of the electricity to step in and act as one of the financiers. 

Obtaining Funds for Prepayment

Different types of power purchasers may have several options available to them to act in the financier role.   Many utilities need both the electricity produced from a solar system and the green attributes associated with the generation of renewable energy energy.  Utilities can either prepay for the wholesale electricity, for the solar renewable energy certificates, or for both.

Municipal utilities may be able to leverage their abilities in other areas in order to get a discount on energy.  A group of municipal utilities, Southern California Public Power Authority (SCPPA), closed a deal recently to prepay for wind energy; however, it did not have to fund the lump sum payment of $547M itself.  Instead, it raised the money through issuing municipal bonds.  Because SCPPA has a high credit rating, it could raise cheaper capital than a developer.  SCPPA still made payments over time, but instead of making electricity payments, they made smaller sum bond payments.

SunRun, a developer and installer of residential solar systems, currently offers customers an option to prepay for electricity under a power purchase agreement (PPA).  SunRun installs systems on customers’ roofs and instead of selling the system, sells the electricity produced by the solar panels.  A homeowner can pay for the electricity on a monthly basis as it is produced, or they also have the option of making one upfront payment for all future electricity produced for the next 20 years.  According to their website, the prepay option has customers, “spend(ing) 30% less than purchasing a home solar system outright.”

Prepayment Considerations

Certain factors affect how much benefit prepayments can provide.  First, as mentioned earlier, the discount rate plays an important role.  If raising equity would cost a developer a large amount of money (i.e., the expected rate of return on that money is high), then they may offer a significant discount for receiving that money through prepayment.  Likewise, the energy buyers’ cost of capital is also important.  The discount on the energy price for receiving the money early has to be higher than the rate at which the purchaser discounts its own capital.  Usually, because the buyer has a more established, stable business, their cost of capital is less. 

There are also accounting procedures that affect the value.  If the revenue has to be recognized immediately, then the government will tax a portion of that which becomes profit.  However, in certain instances, the revenue is allowed to be spread over the life of the contract, and thus, the tax burden is spread as well.

Prepayment contracts are also written so that “true-up” events occur periodically.  A true-up event compares the amount of energy a company prepaid for with the amount of energy produced, and it can compensate either party if the energy is more or less than expected.  The amount of compensation to either party and the number of true-ups for a given transaction are dependent on the contract.

Prepayment Analysis

So, how much can prepayment really help?  According to recent industry analysis, utility scale solar PPAs are currently being signed around $0.19/kWh.  Over a 20-year period, those revenues could add up to about $5.4MM/MWdc (1,500 MWh/MWdc x $190/MWh x 20 years = $5.4MM).  However, if the cash flows were discounted by 9% to determine their present value, we can see that a utility would only have to pay $2.5MM/MWdc now for a revenue stream of $5.4MM—a pretty good savings for the utility.  The solar system owner won’t get to keep the full $2.5MM due to taxes.  However, with solar system prices falling, even taking into account the taxes and the liability of operating the system for 20 years, a prepayment of this size could pay for 20%–40% of the cost of a solar system (see Table 1).

Table 1. Present Value of Cashflows for 1 MWdc System

Determinants of Cash Flow Calculation Present Value of Cashflows ($ Millions)
A: Solar System Cost  Cost of system at $4/W -$4.00
B: 30% Investment Tax Credit $4.00 x 30% = $1.20
C: Depreciable Solar Cost (with 100% Bonus Depreciation) -$4.00 x (100% - 30% ÷ 2) = -$3.40
D: Tax Benefit of Depreciation -$3.40 x -40%* = $1.36
E: Undiscounted PPA Revenue 1,425 MWh x $0.0019** x 20 years = $5.41
F: Prepaid PPA (discounted) NPV of $5.41 cashflow at 9% $2.50
G: Taxes on Revenue $2.50 x 40%* = -$1.00
Total Cashflows  Sum of Rows A, B, D, F, G $0.06

*Assumes tax rate of 40%,  **Assumes $0.19/kWh PPA price.

Table 1 outlines the major costs and benefits for a 1 MWdc solar system.  A system costing $4.00/Wdc can receive $4.06/Wdc in benefits in the first year through the ITC, 100% bonus depreciation tax benefit, and a prepaid PPA (after taxes).

The scenario is not too bad for the developer for not having produced any power.  And from the buyer’s perspective, the sun will probably keep shining, so the solar electricity should still be producing even if the owner goes away.  It’s a win-win.