Driving through many parts of California, it seems like everyone and their grandma can now afford to go solar, often with no money out-of-pocket. Given the valuable technology involved, how is this possible?
The key is the concept called a Power Purchase Agreement (“PPA”). A solar PPA is a long-term contract in which one party owns a solar system (Party A, an investor), and another party commits to buy the solar electricity generated by that system over the long term (Party B, which may be a homeowner, a church, a school, a business, etc.). The solar system is often installed on the property of the party that enjoys the electricity, Party B, but the ownership and all the tax incentives are retained by the Party A. These tax incentives – a 30% Federal Tax Credit, combined with accelerated depreciation (MACRS) and potentially additional bonus depreciation – are extremely generous, recouping about half of the solar system’s cost in the first year alone.
Utility companies have used PPAs for decades; in other words, a utility, like PG&E, doesn’t need to own the power plants that feed its grid. The utility can simply buy its power from power producers and resell the electricity to customers at a higher price.
More recently, PPAs have enabled some small- and medium-sized commercial facilities to go solar, as well as many homeowners. In these instances, a developer installs a solar system with little or no upfront cost to the property owner, while the property owner is under contract to purchase the solar power for 20 to 25 years at a known and fixed price. Meanwhile, a third-party investor provides the upfront capital, owns the system, monetizes the tax benefits, and receives payments for the solar electricity generated by the system.
In this way, the traditional PPA offers a win-win: the property owner benefits from clean solar energy at a lower price than they would pay the utility, and the investor receives a nice ROI from the tax incentives combined with the revenue from the property owner’s solar electricity payments. So what’s the catch?
With a traditional PPA, just one word: RISK.
Inc. magazine reports that 96% of businesses fail within 10 years, and according to Ben Carson, 9 out of 10 nonprofits fail as well. As a result, many commercial properties cannot qualify for a traditional PPA, as most medium-sized businesses and nonprofits cannot pass underwriting criteria and provide confidence that they will be around for the entirety of a 20-year contract. While Fortune 1,000 companies may not have this problem, this limitation affects many thousands of smaller businesses and nonprofits that would benefit from going solar. Furthermore, because nonprofits do not pay taxes, they cannot monetize the government tax incentives for going solar, so purchasing a solar system is rarely feasible for them – and certainly much less advantageous.
However, to address this need, a new financing solution has recently been introduced: the Prepaid PPA.
Pioneered by K12 Solar, the leading developer of solar systems for nonprofit institutions, the Prepaid PPA is structured similarly to a traditional PPA, except that the property owner pre-pays for the solar system’s estimated electricity generation over the term of the PPA (often 20 years). With all electricity revenue paid upfront, the investor no longer has to worry about the business or nonprofit going bankrupt and failing to uphold its end of the contract.
Programs such as the government-sponsored Property Assessed Clean Energy (“PACE”) program can finance 100% of the solar Prepaid PPA cost upfront, solving one of most difficult issues for going solar for businesses and nonprofits. The property simply needs to meet a few qualifying criteria, and solar must provide significant annual energy savings.
Under the Prepaid PPA, K12 Solar provides solar electricity at a lower price than a traditional PPA, encouraging nonprofits to go solar. Furthermore, because Prepaid PPAs do not require annual payments – just one full initial payment – there are no annual escalators as there often are in traditional PPAs. The result is that the Prepaid PPA allows nonprofits to achieve significant annual savings, with a lower cost than purchasing the system outright – and, as an added benefit, they are not responsible for maintaining the system.
Major Benefits of a Prepaid PPA for Commercial Property Owners (Small Businesses & Nonprofits) Include:
• Third-party monetization of tax benefits, with an associated discount provided for the property owner.
• Lower price than a traditional PPA.
• Fixed cost per kWh. Energy is prepaid for upfront, so the cost per kWh is averaged over the 20-year term. This means that while the utility’s electricity might cost $0.22/kWh today, with the cost increasing by 6-7% each year, the property owner can benefit from 20 years of electricity at a fixed rate of $0.09/kWh. Unlike traditional PPAs, there is no escalator.
• No maintenance costs. The solar system owner is responsible for maintaining the system. Usually, the developer’s contract will include warranties so that they take care of the system on behalf of the investor.
• Monitoring and performance guarantee. Because the property owner purchases power upfront, the developer guarantees that the system will produce the estimated output.
• No upfront cost, if financed through the PACE program or other financing.
Major Benefits of a Prepaid PPA for Investors Include:
• 30% Federal Tax Credit Discount: A dollar-for-dollar reduction in income taxes, equal to 30% of the solar system cost, which can be claimed during the solar system’s first year of operation. Example: for a $100k commercial system, the investor can obtain a $30k reduction in his or her income taxes.
• 5-year accelerated depreciation (MACRS). A further 85% of the solar system’s cost can be claimed as depreciation during the first 6 years. For a $100k system, this means an additional $85k reduction in income taxes for the investor.
• Solar electricity revenue collected upfront. For a $100k solar system, the Prepaid PPA cost may be around $70k, and the investor receives the entirety of this revenue once the system is operational. Combined with the 30% Federal Tax Credit, this allows the investor to recoup the entire investment during the first year, with additional major tax benefits (the aforementioned depreciation) to enjoy in future years.
• Elimination of risk that the property owner will go bankrupt and fail to make 20 years’ worth of electricity payments, as all payments are made upfront.
Traditional PPAs revolutionized the solar industry by making solar accessible for utility companies, homeowners, and some commercial properties. The Prepaid PPA is taking solar to the next level by extending solar’s accessibility even further to nonprofits, who had previously been largely shut out. Meanwhile, investors in Prepaid PPAs can enjoy an impressive, low-risk ROI, along with the satisfaction of knowing they’re providing clean energy and financial savings to an organization that’s bettering our world.
Do you know a nonprofit that would benefit from a solar Prepaid PPA, or are you interested in Prepaid PPAs as an investment opportunity? Contact us, and we’ll be happy to connect you.