helping clients improve economic return with energy project financing

Helping Clients Improve Economic Return with

Energy Project Financing

Energy Tax Savers, Inc.Charles [email protected]

Why Finance an Energy Project?

Rapid economic payback

– 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Outdated building equipment can be retrofitted immediately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

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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

– 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

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Financing Options

Vendor Provided Financing

Bank Financing On Bill Utility

Financing State/Municipal

Loan Programs Municipal Lease-

Purchases4

Property Assessed Clean Energy Bonds (PACE)

Preferential Treatment for Green/EE Buildings

Performance Contracting

Power Purchase Agreements

Energy Service Agreements

Vendor Financing

Capital Lease:

– 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

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Vendor Financing

The energy efficiency savings realized from new equipment can offset the lease payment

– 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

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Vendor Financing

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 payments7

Vendor Financing

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.

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Bank Financing: Mortgage-Backed Energy Efficiency Financing

Energy Efficient Mortgage (EEM):

– Provides additional borrowing capacity

– Better terms to borrowers buying new energy-efficient 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)

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Either for purchase or refinancing

EEM assumes that energy savings exceed amortized cost of improvements

– Results in NOI positive investment that improves the borrower’s ability to pay, hence lowering risk of default

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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

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CPE Questions

Should clients with tax capacity structure vendor financing as an operating lease or capital lease?

– What are the ramifications of each?

What is the major benefit to using vendor financing over traditional bank financing?

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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

Leverages existing billing relationship utilities have with customers and builds on access utilities have to energy use information

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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

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Utility Examples:– 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&E15

– 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:

– $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

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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

– Made critical advancements to unlocking financing for energy efficiency and green building

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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

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CPE Questions

What are the two types of on-bill utility financing?

– What are the differences between them?

What is the major benefit to using vendor financing over traditional bank financing?

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Municipal Lease-Purchases

A conditional sales or installment sales agreement

– Market alternative to a cash purchase or municipal bond issue

Lessee’s payment obligation usually terminates if lessee fails to appropriate funds to make lease payments

– So lease may be kept off balance sheet

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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:

– Security interest is removed and the municipality has clear title to the equipment.

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Interest is tax free to the investor

– If rate is lower than commercial rates

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

– Eg. Municipality prohibited from engaging in further similar project transactions if in default on this one

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Two key ancillary forms– 838G

Confirms tax exempt municipal instrument

– Opinion of Counsel Signed by municipality’s counsel

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Municipal bankruptcies

1. Central Falls, RI

2. Birmingham, AL

3. Vallejo, CA

4. Stockton, CA

5. 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

– Typically by selling bonds secured solely by payments made from participating property owners

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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:

– Objections by the Federal Housing Finance Agency have largely closed this PACE options for residential energy efficiency financing

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PACE - Commercial

Program funds energy improvements on:– Multifamily (>4 units)– Commercial– Industrial

Long-term loans Secured by a lien on owner’s property

– Paid back via a charge on property tax bill

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PACE - Commercial

Municipal loan pools funded by: – Issuing bonds– State/federal grant funding

Mortgage-holder’s consent required DOE:

– Reduced monthly energy bills should more than offset the additional charge on property tax bill

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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

Works with third party to underwrite insurance policy to back guarantee

– Capital provider offers low-interest short-term loan Loans bundles into long-term bonds and sold to institutional

investors

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CPE Questions

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?

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So far mortgage lenders and insurance providers largely do not recognize the lower risk/higher return attributes of investments in energy efficient buildings

– Despite documented findings about the innumerable benefits to a “green” building,

These parties need to be convinced with robust data to give preferential treatment

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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.

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A method for developing and implementing comprehensive energy efficiency or clean energy projects

Typically provided by an Energy Service Company (ESCO)

– Typically used for projects in federal government buildings and in public institutions such as municipalities, universities, schools and hospitals (MUSH)

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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

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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:

– Customer shares in a portion of the savings

After contract term:

– Customer ceases payments and enjoys all of the residual energy savings

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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

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These projects take several months to develop, involve complex contracts, and blend several sources of funds:

Utility incentives and rebates Public revolving loan funds State/federal government grants Bonds Tax equity Loans Leases

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Performance Contracting Advantages and Disadvantages

Advantages– 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

Disadvantages– Substantial negotiation and documentation– Increased transaction costs– Difficult to finance smaller projects

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CPE Questions

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?

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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

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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.

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All sales of electricity are metered to provide both seller and buyer with information about the amount of electricity generated and bought

– 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

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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

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Solar Power Purchase Agreements (SPPA)

From EPA’s website:– “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.”

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Solar Power Purchase Agreements (SPPA)

From EPA’s website:– “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.”

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States with Renewable Energy Portfolio Standards

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

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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

Pacific Gas & Electric Xcel Energy San Diego Gas & Electric Duke Energy Corp. NextEra Energy Resources

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Power Purchase Agreements – The Good News

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

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Power Purchase Agreements – The Bad News

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

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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

E.g., dollars per kWh avoided or dollar per therm of natural gas avoided

– Floating: equal to a percentage of actual utility rate

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SPE retains ownership of installed equipment and returns cash flows to investors

The fund owns all environmental attributes, grants & rebates, and tax incentives

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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

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Since many projects yield equity rates of return, the opportunity exists for private equity to provide up-front financing if there were sufficient ability to aggregate contracts, monitoring, and services

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CPE Questions

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?

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Finding the Right Energy Efficiency Finance Strategy

Scale efficiency financing to bring down capital and/or transaction costs and increase the deployment of funding to efficiency projects

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About the Speakers

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.

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helping clients improve economic return with energy project financing

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