Economic Modeling Basics for A Solar Project

Happening on the  Solar Executive MBA Discussion Board…

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Construction Debt/Loans, SRECs & Purchasing vs. Leasing a Site

Student 1:

1. What is the difference between project debt and the construction loan?
2. What is SREC and Single SREC?
3. If the site is purchased and not leased, would one discount the purchase price with the same hurdle rate as the Customer NPV discount rate to make it a comparable?

Chris Lord: Student 1, good questions.

1. Construction debt comes before the project is completed and producing revenue (commercial operation date, or COD). Construction debt is taken out at COD by proceeds from tax equity, cash sponsor, and sometimes project debt. So think of project debt as being incurred at COD (after construction is complete) and used in part to pay back the construction debt.
2. An SREC is a Solar Renewable Energy Certificate which is used to satisfy a load-serving entity (e.g., a utility or competitive retail power seller) obligation under a state’s Renewable Portfolio Standard (RPS) program which mandates they buy a certain minimum amount of renewable energy. That amount is satisfied with RECs or SRECs depending on the state. See lectures in class 4 on incentives for more.
3. You are right that purchasing a site makes a big difference compared with leasing. When you purchase, capital is used to acquire that land, and that capital is not eligible for the ITC or MACRS depreciation. Lease costs are incurred annually (so they are not a capital cost) and are deductible as an operating expense when you calculate taxes. So, leasing sometimes looks like a way of spreading out site costs over the life of the project. Run the model both ways (be sure to exclude the land purchase costs from your ITC and depreciation basis) and you will see the impact on your IRR.

As for discounting the land purchase costs, if the purchaser is the investor, you should use the investor discount rate. By the way, there are companies out there that specialize in purchasing land for renewable energy projects and leasing them back, such as American Wind Capital (Chuck Hinckley’s company).

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Fixed Project Charges:

Student 2: Regarding the true cost of energy calculation, in addition to the demand charges, can you advise what other charges on the electric bill are fixed? i.e. what won’t go away with the addition of a solar system?

Keith Cronin: There are fixed charges on bills for sure. Administrative items and other add-ons imposed by local public utility commissions (PUCs) generally don’t move. In our market, we index commodities, like oil. This is a variable cost. It’s published monthly and this is an example of how to extrapolate it.

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Electricity Bills: Usage and Demand

Student 3: Hi, Keith-

Can you please elaborate a little more about the difference between actual usage and demand? Thanks.

Keith Cronin:  In the US, electricity bills in most areas around the country carve out usage and demand charges.

Think of demand charges like this: You have a large manufacturing facility and at 8 a.m. from Monday to Friday, your assembly line starts up all the motors, machines, and equipment at 8:01 a.m. The utility needs to be there for you when you need the power, as at 7:59 a.m., the employees’ shifts haven’t started and the machines are sitting idle. So, to compensate the utility for your “behavior,” they charge a premium to be ready “for you” and support this spike in usage.

As it relates to the assignment:
While some would argue that solar can reduce demand, this is only partially accurate. If we have a period of inclement weather, then the solar can’t reduce demand. Also, the utilities usually set demand on an annualized basis and track the characteristic curves of your usage and peg the peak usage as the reference for your demand charges.

Translation: solar, in general, is not the best mechanism to shave demand, due to the variable nature of the resource. Therefore, when sizing a system for a commercial/industrial client, it’s best to exclude this from the calculation on designing a system and finally, determining how much they will save by going solar.

Often in a competitive bidding environment, you will have multiple bidders suggesting to the client that they can eliminate the whole bill, while others will deduct out the demand.

This creates confusion on behalf of the customer, as they get excited that their bill will be zero (as an example.) This is misleading and often inaccurate. Customers need to understand demand charges and how they work and influence the bill.

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The Solar Executive MBA Training course, with Keith Cronin and Chris Lord, gives you the financial modeling background and perspective often lacking in deal negotiations that will help you quickly and easily navigate the most complicated projects to find the quality projects you want to develop, own, and operate. Approved for 6 NABCEP Advanced Credit Hours.

Additional Resources:

• Continue learning with GreenTech Media and Keith Cronin, Chris Lord. Take the Solar Executive MBA Training, enjoy our FREE Commercial Solar PPAS 101 and Understanding Solar Renewable Energy Credit (SRECs) courses.

 

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