Investors wooed by low-risk solar finance - BNP Paribas CIB
Monday 25 June 2018

Despite rising interest rates and solar import tariffs, investment in renewables in the US may surge, driven by low-risk and attractive margins.

Amid a backdrop of rising US interest rates, financing for most large-scale infrastructure projects in America is becoming more costly; however, one sector stands out as an exception: solar energy.

Last year, the U.S. installed enough new solar panels to power 10 million American homes, a third of all the extra electricity coming onto the grid, with installations predicted to surge ahead in 2019 and 2020, according to Bloomberg New Energy Finance.

Despite the recent solar panel import tariffs, the market seems confident that the push into solar will continue, with renewable energy, which already comprises 10% of the US electricity consumption, set to dramatically rise as solar, wind and hydropower projects already in the pipeline come on-stream.

While any change in the regulation or tax structure could recalibrate the market, the promise of a drive into renewables has brought new investors flooding into the sector, allowing the developers of solar projects to take out seven-year loans for as little as 137.5 basis points above Libor.

In particular, it has attracted the attention of Asian banks keen to diversify their portfolios and lured by the more attractive margins offered by the US market compared to their own domestic solar sector.

Pension funds, assets managers and sovereign wealth funds have identified solar projects as low-risk investments, backed by federal tax credits and long-term pricing contracts.

Given the long payback period for these projects, their builders might have feared the same rising borrowing costs that have afflicted other capital-intensive industries, but investors' appetites have only grown for what they believe will be solar's stable and predictable returns.

Making a difference

Industry veterans were sceptical in 2009 when the Golden State said it would source a third of its energy from renewables within 10 years. However, not only did it achieve the goal, but it did it two years ahead of schedule, and is now on track to hit its 2030 target of generating 50% of its electricity, by 2020.

"California is really focused on making a difference, and they've got good solar and wind resources," says Frank Delaney, the Managing Director of BNP Paribas' Power & Utilities Coverage, who has been financing deals in the power sector for more than 30 years.

While most power stations have a lifespan of more than 20 years, wind and solar power projects are special because all of the costs are incurred at the beginning of the project, during the installation of the wind turbines or photovoltaic cells.

Once those facilities are connected up to the grid, the operating costs are minimal. By contrast, a fossil-fuelled power station might be cheaper to build, but the furnaces need to be fed with gas or coal every day.

While the solar and wind industries were in their infancy, Washington provided tax credits and, in states like California, regulators endorsed long-term pricing agreements under which independent producers knew the price at which they'd be selling electricity in 10 or 20 years. That allowed wind and solar providers to develop more efficient technology and achieve economies of scale.

When state governments like California's started setting targets to raise the proportion of renewable energy, the utilities had to add new sources of clean energy.

This created opportunities for independent producers like Nebraska-headquartered Tenaska, which put its money into renewables, driven by these federal tax incentives and power purchase agreements with state utilities.

Take, for example, Tenaska's recent $500 million CSolar IV West project in California's Imperial Valley. When construction began in 2014, with funds raised through the commercial bank market, it was one of America's largest solar facilities to be funded in this way.

Subsidies supporting sector growth

The solar field covers 1,130 acres in southern California and can produce enough power for 55,000 homes. It is the second such utility-scale solar venture Tenaska has developed in the Valley; the first being the Solar Energy Center South. This produces up to 130 MW of electricity under a 25-year power purchase agreement with San Diego Gas and Electric (SDG&E).

CSolar IV West began full commercial operation in April 2016 also under a 25-year power purchase agreement with SDG&E. Like all utilities in the state of California, SDG&E must meet the state's target of procuring at least half of its electricity from renewable resources by 2030.

These long-term power purchase agreements have been essential to the development of independent generators in the renewables sector, allowing firms to foresee their cash flow far in advance without having to take a bet on future market prices.

The other essential factor for the development of solar has been federal tax subsidies. As soon as CSolar IV West was connected up to the grid, Tenaska received an investment tax credit representing 30% of the construction cost. There are similar incentives for firms building wind turbines, but those tax credits are spread over 10 years, rather than being granted immediately. Having achieved their aim and stimulated investment in the sector, both forms of tax credits will be phased out over the next few years.

At the end of 2017, Tenaska refinanced its CSolar IV West project through a private placement green bond with the fundraising organised by BNP Paribas. The initial order book was four times oversubscribed, a sign of the appetite for green bonds.

The senior secured notes had a 23.5-year final life, and an average of 12.2 years, with an average interest coverage ratio of 1.42%.

Predictable income system

"Solar facilities are a high-quality asset for long-term investors. That's why we've seen so much money flooding into the sector from sovereign wealth and pension funds," says Wyatt Toolson, director of Project Finance at First Solar, one of America's largest manufacturers of solar panels.

"There's no variability. OPEC can't change the rules and mess with your pricing models," says Toolson.

In order to receive the tax credits, companies need to have contributed equity capital to get the wind or solar facility built. However, the steady predictable income stream that they generate means that these investments really resemble debt.

"They're equity holders but they look at the investments like a lender," says Jessica Adkins, co-chair of the power projects practice group at law firm Bracewell.

Meanwhile, US solar panel manufacturers are ramping up production, in part in response to the new tariffs but also due to the new tax overhaul unveiled by the White House, which will allow companies to immediately write off investments in assets.

In the fast-changing energy investment environment, solar stands out due to its lower risk and stability. Backed by federal legislation and key support from some US states, notably California, investors are betting on solar's sunny future.


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