Time to read: 8 minutes
Hello and welcome back to our series on commercial finance!
In this post, IES energy solutions manager Justin Charles discusses another incredible finance option that you should consider when going solar: PPA’s or Power Purchase Agreements.
New to this series? If you are, then we recommend starting with our first installment on Cash Purchases to get an in depth look at tax incentives and depreciation incentives.
Justin has 12 years of experience in the solar industry and runs the solar division of IES where he focuses on building commercial opportunities, particularly in regard to creative design, engineering, and helping customers with finance solutions that allow them to afford the projects they want.
What is a PPA and How Does It Work? What are the Benefits?
“The first four scenarios we discussed were cash purchases, bank loans, capital leases, and operating leases. Today, we’re going to discuss power purchase agreements, which is probably the last common option and is likely the most complicated. There are commercial entities that choose to enter into power purchase agreements for a variety of reasons, but the most common entity that chooses a PPA is a nonprofit or government entity. Nonprofits and governments don’t pay taxes, so there is no tax credit and there is no depreciation eligible for them.”
“The only method that our government currently allows for a nonprofit or government entity to pass that tax credit value to someone else is through a power purchase agreement. They can’t do it with an operating lease. With an operating lease, the entity that is the end recipient has to have had tax liability to begin with or has to have been a tax paying entity.”
“A PPA is really the only method that a school, church, or government can get any credit for those tax benefits. A power purchase agreement works where a private entity, an investor of some sort, buys and installs the system. They then sell energy to that third party entity like the school, church, or township at a rate that is, in theory, less than they could buy from the utility company directly.”
“If you are paying 10 cents per kilowatt hour from the utility company, the PPA investor agrees to sell it to you for 90 cents or 8 cents or 6 cents. It’s no money out-of-pocket, and typically, it results in immediate savings. There are different scenarios that this could set up, and sometimes you might even pay a little bit more. Let’s say that you’re paying 10 cents now, but you think energy is going to go up. You might agree to pay 10-and-a-half cents now, but you’re only going to pay 10-and-a-half cents for the next 25 years. It’s a consistency that you’re locked in.”
“You can usually get an agreement with your utility company to fix a rate but they’ll agree to fix it for three years, maybe five years. With a PPA, you can get an agreement for a utility rate for the next 25 to 35 years from a solar provider. That is security and stability. Sometimes you’re doing this for security and stability and sometimes you’re doing it for savings. Sometimes you pay a little bit more upfront for that stability.”
“The biggest advantage that you have in a PPA and the reason that some places will choose a PPA over having more savings is that there is no upfront cost and very little risk. The PPA provider is responsible for all of the maintenance on the system. They have to keep it running. In fact, they are incentivized to keep it running at its peak potential because their income and revenue stream is based on the system producing as much energy as possible.”
“At the end of the PPA term, they have to either remove the system and restore the area to original condition, extend the PPA term, or sell it to you for fair market value. Most people are counting on buying the system at the end of the term and fair market value. What’s the value of a 25, 30-year old PV system? It’s probably pretty minimal.”
“At the end of that term, they say, ‘Hey, we want $50,000 for the system’ and you say, ‘nevermind, take it out, restore it to factory or original settings’ and they do the math and say, ‘it’s going to cost us $100,000 to do that, nevermind, forget it, you keep it’. That’s what a lot of them are banking on. They hope that by the end of it, it’s going to be worth less than restoring it, so they’re going to force them to either sell it to them stupid cheap, or they’re going to get the system for free, which isn’t a guarantee, but that’s what they’re hoping for.”
“Keep in mind that the PPA company has been updating this system, maintaining the system, replacing the inverters, and keeping the panels in their peak condition because the system only makes revenue for that investor as long as it’s making energy. When they get the system at the end of that PPA period, they’re going to get a really well performing system, not a dilapidated piece of junk.”
“That is one of the ways. Now, PPAs are a great methodology, but there’s a hardship with them in Texas, and that is that a lot of the utilities in Texas have made them against the rules. I don’t want to say illegal because there is no law, but it’s against the utility rules for anyone but the utility company to sell by the kilowatt hour. So a PPA is a hardship in certain parts of Texas, but it’s still an opportunity in a reasonable share of the state.”
How Does This Work For Customers in Texas?
“So, retail electric providers can charge by the kilowatt hour. One of the ways that you can do it is if you are in an area that has retail electric providers. If you’re in a deregulated area of Texas, sometimes you can even get your retail electric provider to be the PPA provider. You would work with somebody to buy the PPA system and that investor might be your retail electric provider. Also, it’s good for their financial portfolio to then buy those systems and provide you with that kilowatt hour rate. That’s one way around them but again, you have to have the right size business and incentive.”
“People don’t want to do a PPA for a 30, 50-kilowatt system. Those are usually 500 KW, one megawatt, two megawatt systems. So, big purchases, big consumers. One other thing with government entities, one other option typically, can be a municipal lease or what’s called a muni lease. It’s for government purchasing.”
“In many cases, they’ll look at floating a bond, but that is a pretty expensive proposition and has a long shelf life. With the municipal lease, you’re somewhere in between the cost of floating a bond and buying a retail price. Municipal leases have a reduced interest rate versus what you could get from a traditional capital lease. They also have appropriations clauses in them that allow municipalities to get out of them if funds aren’t appropriated to them.”
“It allows a municipality or a government entity to get systems at a more affordable rate that makes it so that if a PPA isn’t an option, even the fact that they can’t get a tax credit, it doesn’t destroy the economics of a deal. Sometimes purchasing outright through this muni lease vehicle looks reasonably attractive. You can even package financing with design and build services in a way that makes it so they don’t have to put them out to bid, which also becomes very attractive because if you have to put it out to bid, then you’ve also got the cost of a bid engineering services, bid review, and all those other things. Depending on the size of the project, even doing the bid process may make it non-attractive and non-viable. So for smaller municipal purchases, doing a muni lease can be a very attractive way to get something done.”
Solar is a phenomenal and stable financial investment for almost any and all types of businesses and the best way to figure out if it’s right for your business is to talk to a consultant. Start by getting them at least one, but preferably 12 months, of your energy bills to see what kind of opportunity there is for you in savings. We can then look to see if there is a perfect financial vehicle for you. If purchasing it outright with cash isn’t the right option, there are several ways to do it with no money out-of-pocket. Don’t make cost a barrier to entry for you. Doing a lease can start for system purchases as low as $50,000.
If you are considering switching to solar for your home or business, reach out to us by going to our website, iestxsolar.com, or by giving us a call at (855) 447-6527.