The SPPA – Shedding Light on Power
Purchase Arrangements for Solar Projects
Complimentary Webinar and Tutorial
November 14, 2011
D. Cameron Prell
McGuireWoods, LLP
Washington, DC
www.mcguirewoods.com
Example PV Business Models
New PV Business
Models
3rd party or Customer
Controlled
3rd party or Customer
Owned
1
Utility Controlled
3rd party or Customer
Owned
Utility Owned
2
3
Increasing level of utility involvement and complexity/time to implementation
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Implications of Solar Deployment on Key Stakeholders
End User
PV System:
•
•
•
•
•
Cost-effective alternative to grid
Improved reliability (over grid)
Helps meet Customer s environmental concerns
Generates range of value streams (driven in part by environmental and climate change policy)
New technologies to improve energy service at end use and reduce costs as costs drop
o
o
o
o
Low-cost energy storage
Distribution system automation
smart homes
Plug-in hybrid/electrical vehicles
System Owner
•
•
Multiple value streams to make PV competitive to grid power
Indentify and capture multiple value streams
Distribution Utility &
Vertically Integrated
Utility
•
•
•
Reduced throughput leading to revenue loss under traditional tariff structures
Need for control of PV systems and/or new distribution system architectures to ensure safety, operational
integrity and reliability of distribution grid
New technologies could radically change utility operations and product/service offerings to customers
Wholesale Generator
•
Competition in wholesale market to more expensive generating assets
Regulator
•
Creates major transformation of utility regulation
Transmission
Company
•
Impact on demand for transmission services
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Ok, But What About the SPPA?
–  Elements of Third-Party SPPA Model:
• Customer/host signs PPA with Project Developer
• Developer builds, owns and operates system on
Customer s site (Host Site)
• Developer sells power back to Customer/Host
via long-term PPA
–  Purpose/Effect: transfers up-front capital costs to
entity designed to capture tax benefits (i.e., lower
cost of capital) and can forgo logistics of financing,
building & maintaining system
–  Rightfully viewed as a financing vehicle where
power is paid per Kwh
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The Third-Party PPA Model
Source: Solar PV Project Financing: Regulatory and Legislative Challenges for Third-Party PPA System Owners. Author: Kollins, K.; Speer, B.; Cory, K
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Third-Party SPPA Contract
Again, SPPAs should be viewed as a financing structure!
–  Developer receives combination of revenues and incentives
•  Electricity sales
•  Environmental attributes (SRECs)
•  Cash incentives
•  State and federal tax incentives
–  Customer/Developer determine right commercial mix of upfront costs and payments for electricity sales to meet
Developer s ROR
up-front costs: a
huge barrier to deployment of solar PV systems
–  As stated, SPPA model overcomes high
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Obstacles: State Laws and Regulations
–  Basic Rule: Party that sells power to retail customers is likely
to run into possibly being regulated by utility commission in
some fashion (utility, CSP)
–  Regulatory language varies from state-to-state
•  Need to factor in regulated vs. deregulated market impacts
•  Energy monitoring and auditability
•  Behind-the-fence vs. Utility-scale.
–  Complicated third-party ownership in monopoly territories
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Challenges
•  Role of the Utility – Need to engage utility early on
–  Who owns the site electric lines?
–  Tie-in options (choose renewable size/location that is compatible
with the site electrical system)
–  Any expected electrical upgrades required?
–  Inverter location options
–  Is your site tied to a network distribution system?
•  Regulated as a Utility or CSP
–  Would require Developers to be regulated by PUC (equals additional
administrative costs and development time)
•
•
•
•
Power Generation Equipment included in definition of Electric Utility
Net Metering Potential? SRECs? Tax Ownership?
Munis and Coops are Sometimes Different!
Is there a State or Utility Standard or Custom Form? Auction of RFP
requirements in the Utility Footprint?
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Summary of Basic SPPA Contract Terms
Term (hopefully 10+ Yrs, 15-20)
Description
Market/Program
Interconnection/Net Metering
Product (bundled, unbundled)
- Physical energy-only
commodity (derivatives possible)
- Bundled SRECs
- Allocation of SREC Rights/
revenues
-  Spot, Forward, Option (for
SRECs)
Price per MWh or KWh
- scheduled price; indexed
- Escalators, adjustments?
Payment/Invoicing
Construction, Testing, COD
O&M /Metering
Performance Guarantees
Contract Assignment
Change in law (Regulatory
Continuing)
Force Majuere
Default/Termination Rights
Early Term/End of Contract
Options
Creditworthiness (assurances)
Reps and Warranties (covenants)
Insurance
Exhibits/Schedules
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Now, Onto the Transaction:
Project Financing Issues
•  Receive the electricity and other benefits it contracted to receive
–  Timely commercial operations date – after NTP, guaranteed COD
date
–  Output
•  Capacity must be tested and confirmed at COD
•  Operate per PIP so as to maintain capacity at expected annual output
•  Appropriate metering and testing
–  Reliability and warranties
•  System output guarantees? Minimum Delivery performance?
•  Typically pass-through of long vendor warranties (be sure effective)
–  SRECs
•  Developer usually keeps SRECs, but benefits may be shared
•  But beware 7701(e)(4)safe harbor financial benefit test
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Project Financing
System Ownership and Investment Funding
Three common arrangements have developed:
1.
Partnership Flip Structure
–  Originated in wind energy transactions and adapted for solar
2. Lease (Sale/Leaseback) Structure
–  Sale/leaseback used only in ITC (or Grant) deals
3. Lease Pass-Through (Inverted or Reverse Lease Structure)
–  Originated in historic tax credit (HTC) transactions and adapted for
solar
–  Sandwich lease structure
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Project Financing Issues
•  Protection of Host s facility
–
–
–
–
Construction damage
Roof damage (roof warranties)
Access and security (during O&M and otherwise)
Premises liability issues
•  Off-balance sheet obligation
–  If SPPA, treat as service contract under 7701(e) safe harbor
–  If lease, treat as operating lease
•  Avoid interference with Host operations
–  Relationship of Developer s solar financing and Host current and
future financing arrangements
–  Future Host building renovations, expansions or shut downs
•  State utility laws
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Project Financing Issues
•  Remedies on Developer default
–  What if things go wrong?
–  Are standard remedies practical?
•  Terminate and require removal (what if doesn t remove?)
•  Exercise purchase option at FMV less direct damages
–  Lousy remedy if system isn t performing
•  End of term
–  Getting rid of or owning solar array
–  Beware non-FMV purchase options or puts
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Project Financing Issues
•  Financeable Agreement (e.g. SPPA)
–  May require development and COD/PIS flexibility to mesh with tax
requirements
•  For flip, partners must be admitted before PIS
•  For sale-leaseback, have 90 days after PIS
•  Build in conditions to deal to enable this flexibility
–  Project lender rights
–  Suitable remedies – LDs that are financeable
•  Suitable access rights to Host facility
–  For construction and O&M
–  Property easements and solar access easements
•  State utility laws
–  Retail sale and distribution rules – avoid utility status
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Project Financing Issues
•  Ability to assign SPPA to fund or affiliate or sell LLC
–  Developer may want to aggregate projects into fund or sell to larger
player
•  Tax ownership rules
–  Developer needs to be tax owner vis a vis Host
–  Must retain sufficient risks and benefits of ownership
–  7701(e) rules re PPAs and service contracts
•  LDs, purchase options and puts
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Alternative to Third-Party PPA Model
•  Solar Lease or Services Agreement
•  Same concept as traditional equipment leases
•  Customer enters into service contract with lessor of PV system
and makes fixed monthly lease payments (regardless of system
generation)
•  Customer consumes electricity generated by leased system, net
meters NEG or pays utility rate for additional required power
•  More risk transferred to Customer
–  fixed payments
–  O&M risks
•  Solar Lease involves sale-leaseback financing
–  agreement between lessee and host customer must be service
agreement and recipient of service cannot operate system (or lose
federal tax benefits)
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Tax Considerations?
•  Section 7701(e)(3) of IRC
–  Safe harbor for service contracts (e.g. SPPAs) for the sale of electricity
produced from an alternative energy facility unless disqualified
•  Section 7701(e)(4) of IRC – specifies disqualifying features
–  The service recipient or related entity cannot:
•  Operate the facility;
•  Bear any significant financial burden if there is non-performance under the contract
(other than for reasons beyond the control of the service recipient);
•  Receive any significant financial benefit if the operating costs of the facility are less
than the standards of performance under the contract;
•  Have an option to purchase, or be required to purchase, all or part of the facility
at a fixed and determinable price (other than for FMV).
•  Accordingly, a put or call option based on a schedule of values would
generally preclude a SPPA from qualifying for this safe harbor
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Tax Considerations
Service Contract and Lease Rules
•  Section 7701(e)(1) of IRC:
–  If PPA not in safe harbor, it generally will be treated as a lease of property if
properly treated as such for tax purposes, taking into account all the relevant
factors, including whether or not:
•  ... the service-recipient physically possesses, controls or has a significant possessory
or economic interest in the property,
•  ... the service-provider does not bear any risk of substantially diminished receipts or
substantially increased expenditures if there is nonperformance under the contract,
•  ... the service-provider does not concurrently use the property to provide significant
services to entities unrelated to the service-recipient, and
•  ... the total contract price does not substantially exceed the rental value of the
property for the contract period.
•  If SPPA is not respected as a service contract or a lease for tax purposes
(such that the service-recipient is considered the tax owner under the
arrangement), this will ruin the parties desired tax treatment
•  Lessor must possess sufficient benefits and burdens of ownership
–  A lessee purchase option for an amount less than FMV at the time of exercise
may cause lessee to be treated as tax owner
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Tax Considerations
What these rules mean for SPPAs if want to be in safe
harbor:
–  No puts or calls at less than FMV, even upon default
–  No puts or calls at schedule of values or formula unless the
purchase price is determinable under a formula which the
parties, when agreeing to it, reasonably expected would
produce a price approximately equal to fair market value at
the time of exercise
•  This might include schedule of values based on expected future
FMVs at time SPPA entered into
–  Recommend appraisal to support any schedule based on expected
future FMVs.
–  Purchase options or puts at higher of FMV or schedule of
values may not satisfy safe harbor
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Questions or Comments?
cprell@mcguirewoods.com
www.mcguirewoods.com
© 2011 McGuireWoods LLP
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