Helping Clients Improve Economic Return with Energy Project Financing Energy Tax Savers, Inc. Charles Goulding [email protected] Why Finance an Energy Project? Rapid economic payback – 2 Large, immediate energy savings can be realized sooner Match the debt with the energy savings Outdated building equipment can be retrofitted immediately Many market finance options now available that did not exist just a few years ago Energy Project Financing Building energy products & alternative energy investments offer excellent economic returns In recent years multiple energy-financing project strategies have become quite popular – 3 CPA's to assist their clients in reducing operating costs while enhancing their ability to obtain related tax incentives Leading lenders are increasingly interested in this strong expanding market Financing Options 4 Vendor Provided Financing Bank Financing On Bill Utility Financing State/Municipal Loan Programs Municipal LeasePurchases Property Assessed Clean Energy Bonds (PACE) Preferential Treatment for Green/EE Buildings Performance Contracting Power Purchase Agreements Energy Service Agreements Vendor Financing Capital Lease: – 5 End users with tax capacity are advised to structure these as capital leases to take the EPAct tax benefits Operating Lease: – Lessor owns the equipment and leases it out for a pre-determined contract period – Lessor takes the tax benefits, and lessee writes off the lease payments as a business expense With energy efficiency equipment, vendor often guarantees that the customer will pay no more for the lease than the energy savings it generates Vendor Financing The energy efficiency savings realized from new equipment can offset the lease payment – 6 This will result in a positive cash flow situation for the company. Cost and length of available finance terms will depend on the equipment itself as well as the parties’ own creditworthiness Vendor Financing 7 Often tailored to the product being sold. – E.g., vendor lighting will typically cover installation and old fixture removal. – Bank financing is often limited to hard costs and won't cover soft costs, such as: Installation Removal of old equipment. Bank financing is often document intensive. Bank financing usually requires: Additional security Down payments Vendor Financing 8 Try to piggy-back existing credit approvals – This may save you and your client a lot of time and effort. – For example, multiple major hospital equipment lenders such as GE, Philips and Siemens are also in the lighting business and the same lines of credit can be used for energy projects. Bank Financing: Mortgage-Backed Energy Efficiency Financing 9 Energy Efficient Mortgage (EEM): – Provides additional borrowing capacity – Better terms to borrowers buying new energyefficient home or investing in energy improvements in existing home Energy efficiency financing is rolled into home mortgage Requires compliance with the Home Energy Rating System (HERS) Bank Financing: Mortgage-Backed Energy Efficiency Financing Either for purchase or refinancing EEM assumes that energy savings exceed amortized cost of improvements – 10 Results in NOI positive investment that improves the borrower’s ability to pay, hence lowering risk of default Bank Financing: Mortgage-Backed Energy Efficiency Financing 11 Energy Star Mortgage programs in Maine, New York, and Colorado inject capital into mortgage products to “buy down” the interest rate charged to borrowers as an incentive to finance energy improvements CPE Questions Should clients with tax capacity structure vendor financing as an operating lease or capital lease? – 12 What are the ramifications of each? What is the major benefit to using vendor financing over traditional bank financing? On Bill Utility Financing The utility, fuel commodity supplier or a third party financier covers the up-front cost of an energy efficiency upgrade – Customer repays the investment through a charge on their monthly utility bill Major advantage: – Overcomes program set-up barriers 13 Leverages existing billing relationship utilities have with customers and builds on access utilities have to energy use information On Bill Utility Financing 14 Two types: – Loans tied to the customer: if the customer moves, the balance must be paid – Loans tied to the meter: if customer moves, the next building occupant has an obligation to pay Most utility-administered on-bill financing programs offer low or no interest loans and short repayment periods On Bill Utility Financing Utility Examples: – – – – – – – – – 15 – United Illuminating Hess Public Service Company of New Hampshire New Hampshire Electric Cooperative National Grid Sempra Utilities Manitoba Hydro (Loans) Midwest Energy How$mart (tariff) Nstar PG&E – – – – – – – – New London Resource Project Electric Cooperatives of South Carolina Clean Energy Work Oregon AFC First Financial MACED: How$martKY City of Portland Housing Bureau ECG NYSERDA State/Municipal Loan Programs American Recovery and Reinvestment Act: – 16 $11.6-bil in 2010 to state and local governments States allocate funds from: – General fund – Federal grant allocations – Ratepayer funds Loans to ratepayers cover up-front project costs State/Municipal Loan Programs Ratepayers pay loan back via an additional charge on their utility bill Example: Pennsylvania’s Keystone HELP – Secured loans for basic retrofit improvements – 5-7% over 3, 5, or 10 year terms 2011: California, Connecticut, Hawaii, Maine, New Hampshire, New York, Texas, and Washington – 17 Made critical advancements to unlocking financing for energy efficiency and green building State/Municipal Loan Programs 18 Biggest advantage: consolidation of information and resources across governmental agencies Biggest disadvantage: Access to secondary sources of capital are typically necessary, such as: – Bank debt – Foundation investments – Municipal bonds CPE Questions What are the two types of on-bill utility financing? – 19 What are the differences between them? What is the major benefit to using vendor financing over traditional bank financing? Municipal Lease-Purchases A conditional sales or installment sales agreement – Lessee’s payment obligation usually terminates if lessee fails to appropriate funds to make lease payments – 20 Market alternative to a cash purchase or municipal bond issue So lease may be kept off balance sheet Municipal Lease-Purchases During term of a municipal lease: – The municipality holds title to the leased equipment – Lessor retains a security interest – With each payment municipality establishes an equity interest in the equipment. At the end of the original lease term: – 21 Security interest is removed and the municipality has clear title to the equipment. Municipal Lease-Purchases Interest is tax free to the investor – May not be considered debt by municipality – Right to walk away if funds not annually appropriated; no credit for prior payments Lessor tries to control as much as possible – 22 If rate is lower than commercial rates Eg. Municipality prohibited from engaging in further similar project transactions if in default on this one Municipal Lease-Purchases Two key ancillary forms – 838G – Opinion of Counsel 23 Confirms tax exempt municipal instrument Signed by municipality’s counsel Municipal bankruptcies 1. 2. 3. 4. 5. Central Falls, RI Birmingham, AL Vallejo, CA Stockton, CA San Bernardino, CA – Other California cities are in a precarious position Property Assessed Clean Energy (PACE) - Residential City/municipal liens on home value to enable community-wide energy efficiency funding A secured benefit district of land or real property City/municipality will provide financing for the project – 25 Typically by selling bonds secured solely by payments made from participating property owners Property Assessed Clean Energy (PACE) - Residential Homeowners who receive a financing benefit from the municipality accept a property tax assessment or charge for up to 20 years Problem: – 26 Objections by the Federal Housing Finance Agency have largely closed this PACE options for residential energy efficiency financing PACE - Commercial Program funds energy improvements on: – – – Long-term loans Secured by a lien on owner’s property – 27 Multifamily (>4 units) Commercial Industrial Paid back via a charge on property tax bill PACE - Commercial Municipal loan pools funded by: – – Mortgage-holder’s consent required DOE: – 28 Issuing bonds State/federal grant funding Reduced monthly energy bills should more than offset the additional charge on property tax bill PACE - Commercial Carbon War Room (think-tank) example: – – – Project developer obtains exclusive right to market PACE Creditworthy contractor implement efficiency measures Contractor guarantees energy savings – Capital provider offers low-interest short-term loan 29 Works with third party to underwrite insurance policy to back guarantee Loans bundles into long-term bonds and sold to institutional investors CPE Questions 30 What results if a municipal lessee fails to allocate the funds to make a lease payment on energy-efficient equipment? How does a commercial property owner repay the municipality for PACE loans? Preferential Treatment for Green/EE Buildings So far mortgage lenders and insurance providers largely do not recognize the lower risk/higher return attributes of investments in energy efficient buildings – 31 Despite documented findings about the innumerable benefits to a “green” building, These parties need to be convinced with robust data to give preferential treatment Preferential Treatment for Green/EE Buildings 32 Being a first mover in this area could be attractive to institutional investors to received positive PR benefits and gain access to a high-quality demographic with substantial opportunities for add-on services and brand loyalty. Performance Contracting A method for developing and implementing comprehensive energy efficiency or clean energy projects Typically provided by an Energy Service Company (ESCO) – 33 Typically used for projects in federal government buildings and in public institutions such as municipalities, universities, schools and hospitals (MUSH) Performance Contracting 34 Dodd-Frank: – ESCO’s won’t be able to administer programs or originate loans unless they are registered Municipal Financial Advisors – Administrator/originator role will be taken by 3rd party companies who will add full finance consulting to their loans or to specialty brokers Performance Contracting After project completion, the ESCO monitors energy savings and maintains equipment The savings produced typically exceeds the loans payments over the term of the contract During the contract: – After contract term: – 35 Customer shares in a portion of the savings Customer ceases payments and enjoys all of the residual energy savings Performance Contracting 36 In nearly all of these projects implemented in public buildings the ESCO guarantees the savings to the customer If retrofits produce less than the guaranteed savings, the ESCO will pay the difference The value of savings in excess of the guaranteed savings remains with the customer Performance Contracting These projects take several months to develop, involve complex contracts, and blend several sources of funds: 37 Utility incentives and rebates Public revolving loan funds State/federal government grants Bonds Tax equity Loans Leases Performance Contracting Advantages and Disadvantages Advantages – – – – Disadvantages – – 38 Reduced risk involved in comprehensive retrofits Can be combined with other incentive programs to enhance project returns Rigorous monitoring and verification A time-tested, standardized methodology – Substantial negotiation and documentation Increased transaction costs Difficult to finance smaller projects CPE Questions 39 What incentive is there for institutional investors to become first movers in the field of preferential financing for “green” buildings? What result for the customer after the performance contract term has ended? Power Purchase Agreements 40 Contracts between two parties: – Seller generates electricity – Buyer who is looking to purchase electricity Various forms of Power Purchase Agreements differentiated by source of energy harnessed – Solar – Wind – Geothermal Power Purchase Agreements 41 Financing for the project is delineated in the contract, which also specifies: – Relevant dates of the project coming into effect – When the project will begin commercial operation – Termination date for which the contract may be renewed or abandoned. Power Purchase Agreements All sales of electricity are metered to provide both seller and buyer with information about the amount of electricity generated and bought – 42 Rates for electricity are agreed upon in the contract between both parties Such agreements play a key role in the financing of independently owned (i.e. not owned by a utility) electricity generating assets Power Purchase Agreements 43 The seller under the PPA is typically an independent power producer, or "IPP." Commercial PPA providers can enable businesses, schools, governments, and utilities to benefit from predictable, renewable energy Solar Power Purchase Agreements (SPPA) From EPA’s website: – 44 “A Solar Power Purchase Agreement (SPPA) is a financial arrangement in which a third-party developer owns, operates, and maintains the photovoltaic (PV) system, and a host customer agrees to site the system on its roof or elsewhere on its property and purchases the system’s electric output from the solar services provider for a predetermined period. This financial arrangement allows the host customer to receive stable, and sometimes lower cost electricity, while the solar services provider or another party acquires valuable financial benefits such as tax credits and income generated from the sale of electricity to the host customer.” Solar Power Purchase Agreements (SPPA) From EPA’s website: – 45 “With this business model, the host customer buys the services produced by the PV system rather than the PV system itself. This framework is referred to as the “solar services” model, and the developers who offer SPPAs are known as solar services providers. SPPA arrangements enable the host customer to avoid many of the traditional barriers to adoption for organizations looking to install solar systems: high up-front capital costs; system performance risk; and complex design and permitting processes. In addition, SPPA arrangements can be cash flow positive for the host customer from the day the system is commissioned.” States with Renewable Energy Portfolio Standards 46 Arizona: 15% by 2025 California: 33% by 2030 Colorado: 20% by 2020 Connecticut: 23% by 2020 DC: 20% by 2020 Delaware: 20% by 2019 Hawaii: 20% by 2020 Iowa: 105 MW Illinois: 25% by 2025 Massachusetts: 15% by 2020 Maryland: 20% by 2022 Maine: 40% by 2017 Michigan: 10% by 2015 Minnesota: 25% by 2025 Missouri: 15% by 2021 Montana: 15% by 2015 New Hampshire: 23.8% by 2025 New Jersey: 22.5% by 2021 New Mexico: 20% by 2020 Nevada: 20% by 2015 New York: 24% by 2013 North Carolina: 12.5% by 2021 North Dakota: 10% by 2015 Oregon: 25% by 2025 Pennsylvania: 8% by 2020 Rhode Island: 16% by 2019 South Dakota: 10% by 2015 Texas: 5,880 MW by 2015 Utah: 20% by 2025 Vermont: 10% by 2013 Virginia: 12% by 2022 Washington: 15% by 2020 Wisconsin: 10% by 2015 Leading Commercial PPA Utilities 47 Pacific Gas & Electric Xcel Energy San Diego Gas & Electric Duke Energy Corp. NextEra Energy Resources Power Purchase Agreements – The Good News 48 The installed cost of solar P.V. has plunged Many states are offering solar incentives Projects that didn’t pencil out two years ago may have totally different results today Power Purchase Agreements – The Bad News 49 The solar industry is rapidly consolidating Some large players have gone bankrupt or withdrawn from the U.S. market There have been warranty issues in the past Solutions: – Deal with major players that have staying power – Warranties are only as good as your ability to reach the warrantor Energy Service Agreements Special Purpose Entity (SPE) established for each project – Capitalized by 3rd party investors to finance the costs of the efficiency improvement Host agrees to pay either a fixed or floating rate for energy savings received – Fixed: based on a cost per avoided energy basis 50 – E.g., dollars per kWh avoided or dollar per therm of natural gas avoided Floating: equal to a percentage of actual utility rate Energy Service Agreements 51 SPE retains ownership of installed equipment and returns cash flows to investors The fund owns all environmental attributes, grants & rebates, and tax incentives Energy Service Agreements 52 This structure enables energy efficiency to be treated as a service and an off-balance sheet transaction Investors commonly obtain multiple tax incentives including: – Typical losses during the first year – Accelerated depreciation – Any federal, state, or utility incentives Energy Service Agreements 53 Since many projects yield equity rates of return, the opportunity exists for private equity to provide upfront financing if there were sufficient ability to aggregate contracts, monitoring, and services CPE Questions 54 What are the three leading types of Power Purchase Agreements? Who retains the environmental attributes, grants & rebates, and tax incentives when there is an Energy Service Agreement? Finding the Right Energy Efficiency Finance Strategy 55 Scale efficiency financing to bring down capital and/or transaction costs and increase the deployment of funding to efficiency projects About the Speakers 56 Charles Goulding is an Attorney/CPA and President of Energy Tax Savers, Inc. ETSI specializes in advising building owners, architects, engineers and designers on tax benefits related to energy saving building investments. David Ingram is the Director of Program Management in the Clean Technology Business Unit at De Lage Landen Financial Services. De Lage is a global provider of leasing and business financing solutions.