California’s Bold Experiments with Feed-in Tariffs

On Sunday, October 11^th, California Governor Arnold Schwarzenegger signed new legislation that creates a solar Feed-in Tariff paralleling solar policy in the EU.  A Feed-in Tariff (FiT) is a premium price paid for renewable energy, in this case solar power.  Under the new law, if you build a solar facility in California with a rated capacity of 1.5 to 3.0 megawatts, the local utility is now required to pay between $0.15 and $0.17 for each kilowatt hour of solar power produced.

Under this legislation, FiT projects benefit from US DOE 30% cash grants, and, if applicable, Federal accelerated depreciation.  But because FiT is a wholesale program, these projects will not tap incentive funds from the California Solar Initiative. 

In sharp contrast, a California solar developer might finance a commercial power purchase agreement with five separate funding sources:

• DOE cash grant
• Accelerated depreciation
• $0.10 to $0.14 per kilowatt-hour for the life of a 15-20 year power purchase agreement
• $0.15 to $0.22 per kilowatt-hour in CSI incentive payments for five years
• $0.005 to $0.015 per kilowatt-hour for RECs

Smaller commercial PPAs may have revenues of up to $0.375 in years 1-5.  It should be added that commercial PPAs may also have a yearly increase in the kW price of 2% to 3%.

Projects of this size are not built out of pocket.  Equity investors and tax equity investors (banks) have profit and due-diligence requirements that must be met before funding a multi-megawatt solar project.  Along with basic equipment costs, investor expectations and document costs take a large bite out of potential revenues.

I’m not satisfied that the $0.15 to $0.17 legislation is strategically sound. Will solar developers deliver viable solar projects at an abrupt and steep rate decrease of $0.095 to $0.1675 per kilowatt-hour?  Will they be able to walk away from about $3.1 million or more in revenues to build a 1.5 megawatt project that generates a $0.17 per kilowatt hour?

In most cases, NO.  When we ran cash flows, we found that under ideal conditions, a 10 MW, ground mount, thin-film project might work at $0.17 as long as the 30% DOE cash grant is available.  When solar finance returns to the 30% Investment Tax Credit in January 2011, $0.17/kWh may not work at all.

On the other side of the equation, the California Public Utility Commission is working through a staff proposal to award Feed-in Tariff contracts to solar developers through a “reverse auction”.  Solar developers will propose power purchase agreements with the lowest responsible price per wholesale kilowatt.  The CPUC will award power purchase agreements to the lowest bidders.

Can the CPUC experiment in FiT fill the gap in 1 MW to 10 MW solar projects? 

Suntech Power Holdings Co. Ltd., SunPower Corp., and Applied Materials Inc. are quoted as favoring the auction approach to establish market price for mid-scale solar projects.  As seasoned solar developers, Suntech and SunPower already thrive in the competitive RFP environment.

If the CPUC is willing to accept proposals with tariff rates that approach the return on investment derived from commercial PPAs negotiated with large university and municipal customers, for example, then the CPUC experiment may succeed.

The CPUC program has some other advantages.  As a public agency, PPA terms and the kWh pricing will become publicly available.  As such, the availability of the data could produce a model for a national Feed-in Tariff.

There are drawbacks.  Only a handful of solar developers specializing in power purchase agreements are qualified and financially capable of participating in the auction.  Many will be shut-out without the economies of scale that a vertically integrated company like SunPower brings to the competition.

Second, multi-megawatt projects require a tax equity investment partner.  When the banking industry collapsed in 2008-09, so did the market for tax equity investment.  Though that market is gradually recovering, only a few solar developers have the funding commitments to deliver on CPUC auction projects.  This constrains the pace of development.

With the goal in mind of powering solar development, I suggest two different questions:

• Instead of asking if solar developers can meet the financial challenge of either price structure, how about: what tariff price per kilowatt-hour would allow solar development to proceed like a conventional business?
• Under what circumstances might a solar developer invest 20% to 30% of the initial capital, borrow the rest at 6.5%, and produce clean-energy at a modest profit for 15 to 20 years?

Ultimately, California’s Feed-in Tariff programs must be viewed as experiments.  After all, solar finance as we know it today emerged in 2005.  Properly managed and amended, they may contribute to a renewable energy future.

[1] US DOE cash grant as part of the ARRA stimulus package.

[2] Accelerated Depreciation, also known as MACRS is governed by the US Tax Code and is subjest to limits and restrictions

[3] PPA rates per kWh are linked to retail utility rates

[4] CSI incentive rates vary by utility service area and the terms of the CSI program

[5] Renewable Energy Credits or Certificates (RECs) represent the green aspect of clean energy and can be monetized at very low rates.