Making Residual Value Real: Where is Solar’s Emilio Estevez?

by Colin Murchie

Seeking Solars’ Emilio Estevez

It is no secret that costs of capital must decrease to make distributed generation a massively scaling resource. And, as costs of capital steadily decrease, the “residual value” – what happens to the asset once the PPA has run out – becomes more and more important. With that in mind, it no longer seems reasonable to fill the years after the PPA’s expiration – with a row of zeros on the pro forma. There is residual value there that is often ignored.

Customers and investors often assume a negative residual value – that the panels will need to be removed at end of term at some significant net cost. In fact, there’s been a recent trend in public RFPs in particular to require a reserve or bond for same. The effect of these requirements is to raise the cost of solar to the customer – they’re buying pricey insurance against the exceedingly unlikely event that the panels will need to be removed.

Clearly, there is not agreement on the ability to monetize an out of term or defaulted asset. It’s in this kind of situation that our thoughts must inevitably turn to Emilio Estevez.

How Emilio Estevez Relates to Solar

In the 1984 classic Repo Man*, Emilio’s character, Otto, works as – we’ll call him a facilitator to lower costs of capital in the secured asset finance market – and “stumbles into a world of wackiness as a result.” Emilio’s work represents something critically missing from the solar industry as a whole – a robust, standard, and low-friction set of secondary industries that permit off-contract or out-of-contract assets to be monetized.

So how do we capture this real value? There’s a few means of approaching it, of radically different levels of sophistication. To illustrate this point, let’s look at an end-of-term 1MW system today and see what cash they’d generate to the hopeful PPA provider (or creditor) in three different scenarios below, presuming an active Emilio working on behalf of the hopeful investor or developer:.

Scenario One: The Renewal – $130,000 / MW / yr

In the first and most simple scenario, the developer may leave the system in place and encourage the customer to renew or extend their PPA contract at the then-prevailing PPA price. Most PPAs explicitly contemplate this one way or another. In fact, Job #1 of SolarCity’s (SCTY) investor relations team is probably convincing the public that their 50,000+ PPA customers will extend or renew their contracts in an exchange for just a 10% discount of their then-applicable contract rate. Presuming a system in the Maryland area might enjoy a 10 – 20% discount to retail rates – from say $.13/kWh to $.10/kWh – a 1MW system so renewed could add $130,000 in annual revenue.

To be clear, the level of assumption in this number makes it much more debatable than the others; it’s more of an equity valuation assumption than a valid underwriting one. Customers at end of term will have some amount of leverage – roughly, the amount of space between the discounted cash flow in the fully loaded “Repo” model and whatever Emilio charges the developer. (This probably contributes to the significant spread between Solar City’s market price and its analyst valuation targets.)

Scenario Two: The Repo- $40,000 / MW / yr

In our second scenario, at the end of the contract term, a customer stops paying their PPA contract, and Emilio comes by to repossess the system, and then plant the modules on the cheap land next to the junkyard and tow lot, selling the resulting electricity is sold at a wholesale price. Solar panels are not perishable items (as a sort of party trick, John Perlin will happily produce from his briefcase and produce a 40+ year old and entirely functional mini-module). Even though a 20-year old panel will have significantly degraded performance, its value is much higher than zero.

Imagine a boneyard of more – or – less matched panels, placed on string inverters and some sort of highly undesirable land. On an 8,760 hour adjusted basis, a brand new 1MW system airdropped into the PJM market would earn something like $56,250 / year in pure wholesale revenue; an end of life system panel operating at perhaps 80% of initial output should still garner north of $40,000– more than $50,000 if PJM doesn’t make its proposed disastrous modifications to the wholesale market. That’s revenue that could be reliably expected to increase in future (and while the ITC would be long gone, the new owner would be able to restart depreciation on their purchase price).

Of course, someone would still need to erect racking and string inverters, plant hedges around the motley array, handle wholesale market scheduling, feed the Doberman, etc. But these are (mostly) fixed startup costs associated with the single facility; the marginal MW still makes a great deal of sense.

In sum, solar still has the potential to generate significant value, even if the modules are removed from the roof after the expiration of the PPA.

Scenario 3: Scrap Cars Hauled for Free? One-time payment of ~$30 – 50,000 / MW

Even if Emilio decides to just take the modules to the scrapyard after removing them from a customer’s roof at the end of the contract, even the scrap steel in a typical ground mount array (roughly 275,000 lb / MW**) would fetch $30 – $50,000 / MW in today’s market. This is enough to pay for three month’s work by four construction laborers, some 15 x 30 yard dumpsters for the (nonhazardous) panels, and a fair amount of grass seed. Customers anxious about removal or restoration of the system should just preserve the right to an abandoned system; escrowing funds for what should be a positive-cash flow removal just increases end user PPAs to insure against an unrealistic risk.

Why You Should Pay Attention to the Residual Value of Solar

Solar is still in the early days of project finance; while some of its supporting and secondary industries are robust and well established, others do not yet exist. But, it is still possible and desirable to make end of life assumptions that are empirical, conservative, defensible, and which make a real impact on project economics – and another horizon of opportunity for solar support businesses.

As the weighted age of end of term assets increases, the opportunity to build a business in the space becomes more concrete. (Consider – some of SunEdison’s first PPAs have already hit their first customer buyout eligibility dates.)

*We will not for the purposes of this metaphor be discussing the inferior 2010 Jude Law vehicle.

** Approximately 2,500 lb. of steel including piles to support a 5 x 6 module array of ~ 7.5 kW; 133 such subassemblies in 1 MW, at conservatively just <$.12 / lb scrap prices for SAE 3xx stainless steel as of April 2015 would be $40,000; purlins and other components would be seperateable, higher quality stainless components – thanks to MJ Shiao of Greentech Media for
some thinking here.

ABOUT THE AUTHOR

Colin Murchie is Director of Project Finance at Sol Systems, a solar energy finance and investment firm. The company has facilitated financing for 180MW of distributed generation solar projects on behalf of Fortune 100 corporations, insurance companies, utilities, banks, family offices, and individuals. Sol Systems provides secure, sustainable investment opportunities to investor clients, and sophisticated project financing solutions to developers. The company’s tailored financial services range from tax structured investments and project acquisition, to debt financing and SREC portfolio management.