The Nellis Solar Power Plant in Nevada, deployed by SunPower and financed by MMA Renewable Ventures; the Nellis Air Force Base buys the energy produced under a power purchase agreement (PPA).
Source: Wikipedia, US Air Force

Did you know that Google has a team dedicated to making investments in solar energy projects? I got to meet some people on the group during my time as an intern, and while I found their work to be super exciting, I didn’t think to ask why there would be such a group at Google. As a summer analyst with Credit Suisse this summer, I found that the firm also has a small team dedicated to deploying the bank’s capital to finance renewable energy projects. Making balance sheet investments of this sort is quite rare for a company like CS, so I began connecting the dots. There’s a reason for everything in business, and this principal investment activity is no exception.

Thank you Uncle Sam

The answer comes down to federal incentives around investments in solar projects. Chief among these is the Investment Tax Credit (ITC), which allows a buyer to take a tax credit on 30% of the cost of the solar project. In addition, the buyer can depreciate the investment over five years using the Modified Accelerated Cost Recovery System (MACRS). This is valuable because while under normal circumstances a solar power facility would be depreciated over 30 or more years, the accelerated depreciation creates a large tax shield in just five years. If we look at $100 in depreciation as a tax deduction – which is intrinsically valuable – the time value of money applies to it just as it would to a cash flow. In other words, taking all that depreciation over a shorter period of time creates more value for a company.

Most buyers of solar power systems don’t have a big enough tax liability to take full advantage of the 30% tax credit. Take SolarCity for example, which still has negative operating income: if the company kept and deferred the tax benefits of building its solar systems, it would take years to be able realise any tax shield, by which point its value would be significantly discounted. For a company like Google, which paid nearly $2.3bn in tax last year, the opportunity to earn some tax benefit makes sense.

Most industrial-scale solar projects, then, are primarily funded by a tax equity investor who receives payments from the end consumer. A solar power company like SunPower or Sunrun builds the facility for the investor (e.g. Google, Credit Suisse, or Goldman Sachs to name a few), who then receives payments from the end-user through a lease or power purchase agreement (PPA). If you want to dig a bit deeper into the specific structures used, this article might be helpful.

Solar panels dot the roofs of the Googleplex
Source: Austin McKinley, Wikipedia

Must all good things end?

In 2016, the federal subsidy on solar power will decline from 30% to 10%. This could have a major effect on the solar industry, as tax equity investors would have a diminished incentive to put money into these projects, raising costs of capital and ultimately making solar energy less attractive to the ultimate buyer. While it’s plausible that the government could extend the higher tax benefit, does anybody want to bet on the government actually doing something?

Wind power might be a good indicator of the future of a reduced-subsidy solar industry might look like. Windmill owners received 2.3 cents per kilowatt-hour produced through the Production Tax Credit (PTC) before it expired in 2013, and investment went from adding over 12,000 megawatts of capacity in 2012 to less than 2,000 in 2013. Congressional debate on renewing the incentive has been blocked by conservative Republicans and Democrats, who are often backed by petroleum companies (there’s something politicians come together over – money!). A proposal to renew subsidies on solar energy might have a similar fate should it find its way into Congress in 2016.

Should these incentives even be in place, though? They distort the market for energy and cultivate an industry heavily dependent on the government. When the incentives are cut back in solar, new projects will likely stall and higher costs of production will be passed on to utilities. Utilities in turn, must seek out the most efficient sources of energy and may end up reverting to coal and other fossil fuels.

It’s hard to consider the implications of subsidised renewables without recognising that fossil fuels are also subsidised. Billions of dollars in state and federal incentives go to oil, gas, and coal each year, and clean energy advocates often point to this data in a push for more “green” subsidies. The reality is that, while fossil fuels receive more subsidies in agreggate, renewables are much more heavily subsidised on a per-unit basis. According to this WSJ opinion piece, coal is subsidised at about 0.05¢ (or $0.0005) per kilowatt-hour, while wind gets 5¢ per kWh and solar gets 77¢ per kWh.

The ITC for solar power is extremely generous at 30%, and I wouldn’t count on the federal government moving to keep it that high past 2016. So, what will happen to tax equity investing? Google’s last wind power investment was in December of 2013 – just before the 2.3¢ per kWh incentive ran out. A 10% tax credit for solar investments may not be enough for large corporate players like Google and Credit Suisse to stay involved in this space. Independent financing companies may fill some of the void, and securitisation of renewable energy receivables may create a deeper capital market for this type of liability.

Companies investing in large-scale renewable energy projects have had an important role in the development of alternatives to fossil fuels. Without the ITC for solar and PTC for wind, renewables might still be prohibitively expensive in the US. It remains to be seen how solar project finance evolves post-2016.