An emerging model for green power.
Stephen B. Pearlman and Ryan J. Scerbo are partners with the law firm of DeCotiis, FitzPatrick & Cole, LLP.
Certain New Jersey counties have undertaken a regional, public-private partnership approach to developing renewable energy projects for local government buildings. Local governments generally include municipalities, school districts, counties, and municipal or county or other regional sewerage or water utilities, depending on applicable state law. The regional renewable energy pilot program for Morris County, New Jersey is nearing its implementation phase, with proposals having been submitted by the end of November 2009, while several other New Jersey counties are actively pursuing similar endeavors (e.g., Passaic, Somerset and Union), and it is possible that the program could expand state-wide. It is also conceivable that, under certain circumstances, the program could be modeled in other states. This form of county regional hybrid program presents significant opportunities for the electric utility industry.
Local governments desiring to finance renewable energy projects, for example the installation of a roof-mounted solar array and inverter system to supply a portion of the electricity for a government building, have in the past in New Jersey utilized one of two primary transaction structures, the local government-owned option and the turnkey solar developer-owned option. These financing structures are utilized in other parts of the United States.
In the local government-owned approach, governments that want to own the system, and to retain all the benefits of ownership other than the federal tax benefits outlined below, have issued debt, typically repaid over the useful life of the project. This adds to the debt burden of local government, and usually requires some sort of procurement process to design, acquire or install the solar project. Financing, under this approach, can be obtained at tax-exempt rates, and the local government can earn solar renewable energy certificates (SRECs). These credits in turn can be sold to utilities for their use in satisfying renewable energy portfolio standard (RPS) requirements imposed by the New Jersey Board of Public Utilities.The sale of SRECs lowers the overall cost of the solar system project.
In the turnkey solar developer-owned approach, local governments lacking knowledge or experience with developing a solar project, may engage a turnkey, private developer to build and own the project. Under this scenario, the solar developer gains access to the roof of the local government building through a license and access agreement. The solar developer further agrees to design, finance, install, operate and maintain a solar system on the roof, and then sells the renewable energy back to the local government through a power purchase agreement (PPA) at an agreed-upon price, or set of prices, including an escalator for pricing over time, to the extent local law permits the private solar developer to enter into a multi-year contract with the local government.
Using this approach, the local government incurs no added debt burden, and would enter into this transaction only to the extent the PPA price is lower than that otherwise paid under the tariff charged by the local utility. The solar developer can afford to design, finance, install, operate and maintain the solar system because it would receive the SRECs generated by the project, along with a 30-percent federal investment tax credit, accelerated depreciation, and the PPA price paid by the applicable local government.
New Jersey counties are finding that the turnkey approach tends to favor the party providing the financing, and therefore the savings off the retail tariff rate accrued to their local government constituents have been modest, notwithstanding the potentially high internal rate of return for the private developer.
County Regional Hybrid
In light of the possible downside of the first two options, Morris County has taken the lead—and other New Jersey counties are following—in developing a hybrid approach where the county would provide the financing through a bond issuance. A conduit county agency would issue bonds supported by the full faith and credit of the county, thereby significantly lowering the cost of capital for these projects. The solar project then would be using a turnkey approach, with one material difference: The financing being provided at the lower cost of capital would be obtained by government. Not only does this provide cheaper financing for the solar development community, increasingly including utilities, but it preserves their capacity to borrow from their private capital lending sources for other projects. While some electric utilities in New Jersey have developed their own solar program for local governments, there’s no reason why a parent or subsidiary entity couldn’t participate, as solar developer, in this hybrid program in order to both take advantage of the federal tax benefits, plus garner the SRECs required in order to meet New Jersey’s RPS requirements.
This hybrid approach requires each participating local government to provide roof access through a license and access agreement with the county improvement authority implementing the program. Improvement authorities are a creature of New Jersey law created by roughly half of the counties in the state with conduit bond-issuing authority, for among other purposes, to provide solar systems for local governments. Any other improvement authority can create the same hybrid program in the remaining counties, so the hybrid program has applicability state-wide. In the case of Morris County’s pilot program, the Morris County Improvement Authority (MCIA) will be entering into seven such license and access agreements, one with each participating local government. Under these agreements, the MCIA, or its assignee (e.g., the solar developer), shall be allowed roof access to implement a solar program on the roofs of the participating local governments.
Under what is known as a competitive contracting process under state procurement law, the MCIA solicits proposals from the solar development community to design, acquire, construct, install, operate, and maintain solar systems for the designated local government buildings. Among other things, the proposals set forth the PPA price that would be charged by the prospective solar developer to the MCIA, which in turn passes on such cost directly to the participating local governments through the license and access agreements. MCIA then selects the solar developer under a number of evaluation criteria, including lowest PPA price charged to the local governments, ability to perform, financial strength, and the degree of security offered back to the MCIA and the county under the program.
Note that the solar developer isn’t required to finance these solar projects. The MCIA issues bonds in an amount set forth by the solar developer in its winning proposal to finance the renewable energy projects, along with any incidental capital improvements (i.e., cost to maintain or extend roofing warranties and electrical upgrades that might be needed). By issuing the bonds, the MCIA owns the solar panels for New Jersey law purposes, but structures a lease purchase agreement whereby the benefits and burdens of ownership are passed on to the winning solar developer with the intent that the lessee solar developer qualifies as the owner for federal tax purposes. If the lease purchase agreement is structured properly, the solar developer, as lessee of the panels for state law, but as owner of the system for federal tax purposes, is entitled to take the 30-percent investment tax credit and advanced depreciation. The license and access agreement, along with the lease purchase agreement, also provide that the solar developer receives all SRECs generated by the program.
In return, the solar developer will make lease payments under the lease purchase agreement in an amount sufficient to amortize the MCIA’s bond issue. The MCIA bonds carry a low cost of capital because they are guaranteed by the county, which in this case is a AAA rated local government. Along with the lease purchase agreement, the solar developer enters into a PPA with the MCIA, setting forth the PPA price or prices applied to the electricity MCIA sells to the participating local governments under the license and access agreements. Should the solar developer walk away before the end of the transaction—state law permits a 15-year deal—the MCIA, as the direct party to the license and access agreements, receives what the solar developer was previously entitled to (i.e., the PPA price and the SRECs). Note again, that governments can’t receive any federal tax benefits. Consequently, solar developers also are required to put up some sort of security to cover the deficiency between the residual value to the MCIA in such a potential walk-away situation, and the county guaranty, so the county recovers, to the fullest extent possible, any draw on its guaranty.
To the extent all parties perform, the MCIA raises the funds for the solar project, drawn down by the solar developer to design, construct and install the project within the allotted construction period (i.e., approximately one year in the MCIA pilot program, with the queue of projects on the 19 buildings left up to the winning solar developer). Once the solar project is installed and operational, the solar developer is entitled to the federal tax benefits, and to sell the energy produced from the solar panels through the MCIA to the participating local governments at the PPA price, paid monthly. The solar developer also can take the SRECs, and if dealing with an electric utility, apply them to meet RPS requirements, or if not, monetize the SREC flow through a contract with one or more electric utilities looking to meet the RPS requirement.
Whether an electric utility chooses not to participate directly in the hybrid program as a proposal-submitting solar developer, or simply prefers to work with a successful developer after award of a PPA, several significant opportunities and benefits for electric utilities are provided through this public-private partnership approach to renewable energy (although solar was used as an example, the concept, if not the exact values, translate for other forms of renewable energy).
First, the hybrid program makes available a large number of SRECs, in one-stop-shopping fashion, to the electric utility industry. To the extent local governments issue their own debt, or enter into the traditional turnkey PPA contract with individual solar developers, electric utilities would need to enter into contracts to purchase SRECs from each local government or solar developer, as the case may be, for the respective transactions. In the case of the county pilot program, more than 3 MW of renewable energy, and accompanying SRECs, will be generated from 19 local government buildings and parking canopy systems involving seven local governments. An electric utility could submit a proposal in hopes of being the successful proposer or need only enter into a single SREC purchase contract with the winning solar developer to obtain all the SRECs produced from the hybrid program. Although SREC purchase contracts typically have a duration of less than five years—more likely one to three years—under New Jersey law, in theory at least, electric utilities could lock up the SRECs produced by the program for a 15-year period.
In addition, this hybrid regional approach would allow utilities to eliminate certain public procurement processes. To the extent the local government issues its own debt to finance and own the solar project, New Jersey law requires such local government to enter into its own competitive process to sell the SRECs it is entitled to receive as a generator of renewable energy. Under the hybrid program, the competitive procurement process required by New Jersey law already has occurred during the solar developer procurement process. Accordingly, if an electric utility isn’t the selected solar developer, there is no procurement process required for an electric utility to purchase the program SRECs from the solar developer, because the solar developer itself was selected under a competitive procurement process under state law. Therefore, the electric utility can enter into a direct negotiation with the solar developer. In fact, arrangements can be made by the electric utility with one or more solar developers seeking to submit proposals under the hybrid program, prior to such submission, thereby eliminating a risk factor that the solar developers must otherwise build into their pricing models, since their resale of SRECs would, absent any agreements with electric utilities prior to proposal submission, be at assumed rates.
Lessons from New Jersey
Thirty-one states have adopted some form of RPS. If the trend continues, more states, and possibly the federal government, will enter this field. Moreover, states such as New Jersey that have existing RPS requirements, are considering elevating those requirements in order to meet state energy master plan goals for renewable energy production. To date, in New Jersey, most electric utilities contemplate SREC purchases as part of their RPS compliance program. Although market risk plays a significant role in the duration of SREC purchase contracts, the hybrid program can provide a ready source of SREC supply, from a single, non-competitively procured source, for years to come, bringing some measure of potential stability to the SREC market. Although this hybrid program was structured in New Jersey, to the extent other states with RPS requirements have regional bond-issuing entities and mandatory local government procurement laws, some form of this program might be contemplated by other states as a more efficient model for meeting the various goals and needs of local government, state RPS, the solar development community, and the electric utility industry.