Arizona Public Service (APS) and Tucson Power have recently come under a lot of scrutiny for their proposed rate-based solar programs. The complaint from private sector companies is that rate-basing (i.e., the utility practice of raising funds for capital investments by increasing electricity rates) would create an uneven playing field in the solar industry, because rate-basing a capital expenditure gives utilities a guaranteed rate of return. As SolarCity’s VP Jonathan Bass put it, “If there were ever a reason for a regulatory body to exist, it would be to stop a state-sponsored monopoly from unfairly competing against the free market in an entirely new industry.”
That’s hard to argue with. However, I would add that another reason for a regulatory body to exist is to stop the free market from abusing the subsidies that are so crucial to an entirely new industry. In the spirit of fair-minded analysis, let’s take a closer look at the solar industry and at how level the playing field actually is.
Pump and Dump
First, let’s examine the solar developers (SolarCity, Vivint, SunRun, Clean Power Finance, etc.) whose solar lease and solar loan programs are responsible for catapulting the industry into the period of rapid growth we’re seeing today. Critics argue that solar developers base their business models around building solar arrays on the cheap and claiming an inflated fair market value (FMV) of the systems. The FMV is supposed to reflect the fair price of a system, and it’s ultimately used by the government to determine the monetary value of the 30% income tax credit (ITC) that goes back to the owner of the system. Ironically, the FMV is becoming increasingly difficult to determine as more solar companies are vertically integrating, which has made the true system costs less transparent.
For systems that are being leased (which are most systems), the owners and thus recipients of the ITC are actually third parties. These third-party owners tend to be financial institutions, such as Morgan Stanley, Goldman Sachs, Credit Suisse, Google, and Blackstone, that are constantly looking for tax credits, and they have found a slam dunk as financiers of residential and commercial solar arrays. Typically, the developers bundle a group of solar customers together into a tranche (essentially a bucket of leases), which is then backed by the third-party ownership groups. The financial firms own the leased systems for 5 years and then dump them, but not before taking advantage of the Modified Accelerated Cost Recovery System (MACRS), which is a method of depreciation that allows third-party owners to recoup part of their investment in the solar equipment over a specified time period (5 years) through annual deductions. Basically, MACRS represents an additional subsidy, with a net present value of 25% of the initial investment.
The Treasury Steps In
So between the 30% ITC and the 25% MACRS, the owners should be getting a 55% subsidized investment; but with the inflation of the FMV, it turns into a much larger subsidy, on the order of 80%. Then consider the high rate of return (up to 15%) that investing in solar offers on top of all these subsidies, and it starts to sound pretty good to be a solar financier. Solar developers readily admit that their business models are dependent on government subsidies, but this sounds like manipulation of those subsidies. Indeed, this practice is currently under investigation by the Department of the Treasury. While the developers claim they haven’t done anything wrong, if the government tightens the rules around the ITC or tries to recoup the inflated subsidies, it could be a major blow to the solar industry.
What’s more, the developers themselves don’t seem to be reaping the rewards of their innovative business models that have brought solar to the masses. If anything, they seem to be bearing all the risk while the third-party owners reap most of the profits. Is there some merit to rate basing solar? In my next blog, I’ll examine this question.
Tags: Finance & Investing, Policy & Regulation, Renewable Energy, Smart Energy Program, Solar Power
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