In part one, Dan Seif, principal with Rocky Mountain Institute’s electricity and industrial practices, and Jesse Morris, Senior Associate for electricity and transportation practices at Rocky Mountain Institute, discussed the importance of lowering the soft costs of solar PV – all the related solar energy system costs besides the hardware. They covered two cost areas addressed in RMI and NREL’s new roadmap report on solar PV soft costs: 1) permitting, inspection, and interconnection (PII) and 2) customer acquisition. This time, they are looking will look at reducing financing and installation labor costs.
Finance: Lowering the Cost of Capital
From 2011 to 2012, the U.S. solar residential market grew by 62 percent and the commercial market by 26 percent in capacity installed. This growth was due in no small part to the revolution in third-party financing that funded about three-quarters of residential installs and half of commercial installs. But lower-cost-of-capital finance will be needed to enable further growth.
For example, financing for German residential systems, through its government-backed development bank KfW, is achieved at just ~5 percent interest rates, roughly half the average cost of financing available in the U.S. To put this in perspective, imagine the slowdown in the U.S. housing market and broader economy that would result from 30-year mortgage rates suddenly spiking to 8 percent from today’s average 4 percent rates. In the U.S., solar financing currently lives in that high (credit card-like) cost of capital world and will only reach mainstream acceptance by transitioning to a much lower cost of capital environment. Some significant opportunities to bridge the financing cost of capital chasm are:
- New solutions for the commercial market: Simply stated, there needs to be some financial innovation to get past the dichotomy of cash purchases and high-credit-quality financings in the small commercial market. The 90 percent of other solar project opportunities for which neither funding route works needs solutions and fast! C-PACE, utility ownership, and government-backed bonding/credit enhancing programs should make a dent into this underserved market, but likely new financial tools are still needed. So go forth ye brave financial entrepreneur!
- Asset-backed securitization: This is an area of considerable industry focus, including the impressive efforts of NREL’s Solar Access to Public Capital working group run by Mike Mendelsohn. Initially, securitization may primarily provide “take-out” financing for existing pools of PV projects rather than a major influence on upfront financing terms. Once it lives as a viable secondary market, cost of capital imposed by initial financiers should come down.
- Mortgages and other loans: With the housing market picking up, newly built homes with solar PV systems might become a significant factor in the growth of the solar market. As for adding solar to existing homes, there are new loan products such as the home improvement loan from Admiral’s Bank. Loans, however, will be challenged to make a significant dent into the residential solar market unless the solar system’s value can be meaningfully included in bank-appraised real estate values. Banks loan against appraised values. If it’s not in the appraisal, you’ll pay for it in cash. Appraisal practices are still lacking for solar (systems are typically valued at $0!), and that makes it impossible to include the value of solar PV systems in the largest securitized asset category (real estate) in the country. Solar, therefore, risks missing out on this low cost of capital financing, particularly after 2016 when lending products can more easily compete with leasing products (leases capture all tax benefits, which will be smaller after 2016).
- Yield-oriented public capital vehicles: Many investors would like a way to invest in the cash flows from operational solar PV projects. To meet that demand, real estate investment trusts (REITs) and master limited partnerships (MLPs) have garnered a lot of attention as new opportunities that could bring retail and institutional investors into solar at lower cost of capital than today’s solar finance sources. Both entity types are also tax advantaged (little/no taxation at company level). Unfortunately, they both also share a limitation—they rely on federal government action to enable their solar investment activity to be scalable. As such, the hoopla around these opportunities has begun to taper, though our interviewees felt REITs would likely prevail (i.e., receive positive IRS treatment) in the near term and be impactful in the commercial PV market. But there are other ways to skin the yield-oriented investment cat, such as “C” corporation YieldCos, which don’t require legislation and already exist (e.g., NRG Yield), although to date there exist no pure-play solar YieldCos.
- Corporate financing: There are no large (Fortune 500) corporations involved in both solar development and full financing for the commercial and residential PV markets. Chevron dabbled in the past for public/governmental building PV, and some unregulated utilities are active in commercial PV development, but they usually look for outside financing partners. In other words, using the auto market as a rough analog, there is no solar equivalent to Ford-plus-Ford Credit. That’s too bad, as deeply capitalized, high-credit-quality companies can bring lower cost of capital into the solar market. Several reasons exist for this gap, two of which are: 1) most large corporations don’t want long-term cash flows, but want liquid markets to sell these cash flows for upfront capital in the nearer term (e.g., as auto loan-backed securities enable), and 2) the tax benefits of solar are too large for such companies to reliably monetize. Growth of a solar securitization market and the reduction of the ITC from 30 percent to 10 percent of a project’s value in 2017 help solve these two limitations. Today’s leading solar developers might become tasty acquisition targets for larger companies, enabling them to immediately play at scale in the solar market.
The costs associated with “boots on the roof” are the soft cost category where there is the greatest cross-stakeholder alignment on the desire to get cheaper. Ironically, however, NREL and RMI’s research indicates it is perhaps the most challenging soft cost reduction category. RMI is hammering on this cost area with our SIMPLE BoS project in partnership with the Georgia Tech Research Institute. But we can’t crack this nut solely by ourselves, and improved industry focus and innovation is needed in several areas, notably:
- Integrated racking: Interestingly, solar installers don’t spend most of their time on the roof working with the actual solar panels. Instead, a majority of their time is spent assembling, positioning, and attaching the racking systems that fix the solar panels in place. Integrated racking systems that combine panels with mounting structures can significantly reduce the amount of time needed to attach solar panels, and manufacturers like SunPower and Zep currently offer systems with a basic level of integration.
- Plug and play: Plug and play systems that could be installed by non-electrician laborers and connected to a PV-ready circuit within a building have the potential to eliminate nearly 90 percent of the cost attributable to installation labor for a typical rooftop system. Innovation on this front has begun with offerings like AC modules with integrated microinverters, but true “plug and play” designs have yet to come onto the marketplace.
- Commercial PV module integrated electronics: Products like DC optimizers or embedded microinverters in commercial systems improve system-level PV harvest by reducing electrical losses between panels and strings, effectively lowering installed costs through efficiency gains. We estimate that about 10 percent of the U.S. market currently takes advantage of these solutions, but higher penetration rates of these technologies will help reduce the cost of solar in more places.
- Undefined solutions: Outside of the installation labor solutions identified in the soft cost roadmap, a number of other currently undefined solutions will need to be deployed in order to hit the SunShot targets. These likely include new system designs that avoid roof penetrations and additional standardization of racking equipment across manufacturers.
The solar industry will remain a small story in America’s electrical system unless it can tame the soft cost beast. Progress to date has been uninspiring, due to limited focus and a dependency on government- and nonprofit-funded activities. Cross-competitor and cross-stakeholder (particularly utilities and solar developers) antagonistic dynamics have undoubtedly contributed to the lack of progress. The industry needs to grab the bull by the horns and take soft costs much more seriously. Stepping up soft cost engagement requires both increased pre-competitive actions supported by the industry, and additional cross-stakeholder solutions that provide value more broadly across the playing field.
This article was written by Dan Seif, principal with RMI’s electricity and industrial practices, and Jesse Morris, Senior Associate for electricity and transportation practices at Rocky Mountain Institute, and first published at RMI Outlet.