By Philippe Hartley, Managing Director, CleanFinancing.com
Commercial solar installers see battery system design and installation as their present and future, and they’re getting amped up. In California, 31% of the commercial SGIP applications over the last three years are for storage only, according to SGIP data. The segment may increase dramatically this year as California has approved generous incentives for certain key demographics such as vital services and fire zone geographies. In other states, such as New York, resiliency urgency steers policy toward storage first.
But if one considers the inverse of the above SGIP data, it’s evident the vast majority of commercial battery system installations are done in tandem with solar. Of those, about 20 to 30% of projects will require third-party ownership, like a long-term lease or power purchase agreement (PPA). There is, however, a financing-related “problem-du-jour” that makes the combination of solar + storage tricky to wrap into a PPA at the small to mid-sized commercial and industrial distributed generation market: essentially, storage does not benefit from the same operation and maintenance (O&M) guarantees that solar inherently does.
“Then why is utility storage going off the charts?” you might ask, rightly.
Let’s give this some context. The current commercial market financing situation seems to be divided, broadly speaking, between the “over” and “under” $5 million project size. There is financing expertise related to each separately.
Utility and industrial scale
Looking at the larger project category first, there is good news in that sector. I spoke with Thom Byrn, CEO of CleanCapital, one of the burgeoning companies that invests in storage projects north of that $5 million value. That willingness to fund storage-only projects indicates progress from 18 months ago when, per my earlier piece on storage financing, there were really no such options. Large funders are now taking risks. For example, one of the numerous factors of concern was utility rate risk or unpredictability of future tariffs.
”You have to underwrite your deal based on what you know right now,” Byrn said. Translation: There is now enough opportunity here that the rewards outweigh the risks if you package your deals with caution.
“We favor areas where there is a substantial rebate program, like New York, California, Ontario,” Byrn said. “Our financing is 100% equity risk investment. In some states, there’s a single PPA model. But also we have a shared savings model.” Byrn specified that his firm only works with major suppliers it knows and trusts, and have been proven in specific applications.
Generate Capital just locked-up a billion-dollar raise, and it is very bullish on storage. Its willing to underwrite 20-year projects in the large C&I space through major originators and energy storage solutions providers like Stem. No doubt Generate Capital is also lured by the exploding utility storage space, both direct and merchant, which seems to be slicing through all market growth predictions as if the world were about to run out of batteries.
Then we have the recent record-setting Los Angeles Department of Water and Power agreement to buy 6% of its future power from a solar + storage project for 25 years at ~3.3 cents per kWh. Those sorts of razor-margin deals work only with scale, but are not made without solid manufacturer assurances, especially storage.
Small and medium C&I projects
Now let’s look at the smaller project market. Developers working on the small-to-medium C&I sector have multiple challenges that frustrate their efforts. C&I has the smallest growth rate of all sectors currently. Why is it difficult to find lift from the gale force winds propelling the utility markets? Let’s examine two key constraints.
The utility’s need for storage comes from a simple need to deploy power when needed, through the merchant market or from its own facilities. This contrasts with business operators that have a range of scenarios they are addressing: peak shaving, demand management, TOU offset, resiliency and other jockeying strategies that require sophisticated software, themselves based on tariff assumptions that can quickly become obsolete. So the C&I use-case is riskier than utilities’, and requires making difficult choices as to which storage system to use given the software reliability requirements. Add to this a dynamic utility-rate environment. This translates into a need for faster payback by the buyer, and makes many investors nervous when having to back a storage system tied to a 20-year PPA.
Capacity maintenance agreement (CMA)
Here is the crux of the challenge. CMA refers to a battery manufacturer’s commitment to maintain performance levels beyond the warrantied term. For example, the financier would likely own the energy storage solution over a 20-year span. During that period, it has to “operate and maintain” the system so the off-taker (or client) receives the original stated performance. A CMA from a manufacturer covers the financier by supporting a minimum guaranteed performance of the system. At the utility level, this is now common; the terms that battery manufacturers are willing to extend directly to those developers stand apart from what they will offer the segmented commercial market through their distribution channels. The C&I market gets 10 years from leading providers; some value-added storage companies will extend that term to 15 years, for a fee.
This issue of warranty term becomes critical when attempting to fit a C&I project into a tax structure, like a capacity purchase agreement (CPA) tied to a solar PPA. For those projects where the off-taker is not able to absorb the tax benefits of these energy infrastructure investments, third-party investors will own and operate the system over a period of, say, 20 years or more, while the host commits to buying the energy yield. But, just as in the large industrial and utility scale, those investment structures depend on reliable manufacturer warranties to back the product for the duration of the purchase agreement. A 10-year warranty on a battery bank that is subject to a 20-year purchase agreement will not be popular with investor groups. The extended warranties from value-added vendors and packagers generally do not satisfy third-party financiers because they do not trust the reliability and/or long-term viability of those brands in a still dynamic market.
Energy storage system providers themselves are struggling with this. For the most part, they are software companies that package a battery manufacturer into their solution. They are betting on technologies in a hotbed of evolution. One storage company sales executive told me, “We don’t know what technology we will be using in 10 years … but we are going to need to solve this issue of financing for 20-year PPAs.” Indeed, one of the complicating factors is the wide diversity of chemistries and technologies evolving and competing simultaneously.
This warranty “mis-alignment” problem is less disruptive where the buyer is assuming the financing, or simply paying cash. Our firm consistently arranges for 20-year solar + storage financing via our PACE financing solutions, and we expect brisk business going forward using that structure. There are other sources of funding where this issue is not a hurdle. The right solution for financing storage depends on the specific circumstances of the installation and the property owner.
There are beefy tax benefits associated with the powerful “solar + storage” strategy. Numerous entities cannot take advantage of them, such as non-profits and many closely-held companies. For them, the best cash-flow scenario comes from only one solution: third-party ownership via tax structures such as PPAs and operating leases. This is where warranty mis-alignment derails many projects.
Tax investors seem happy to provide a 20-year PPA program that covers both the PV installation and the storage components, but the O&M obligations will typically specify that the storage performance guaranty will stop at the same time as the solution provider’s own warranty. So, in practical terms, the solar will be covered for all 20 years of the term, while the storage will only be covered for as long as the battery manufacturer’s warranty is valid, typically 10 years. Thereafter, the off-taker is responsible for performance, while continuing to pay the PPA rate. Most off-takers shrug at such a proposition. They want a package that includes O&M for the duration of the term.
This issue is contextually reminiscent of PPA problems in the early days of solar, when warranties were much shorter than is standard today and the technology was expensive. The greater complexity of battery solutions amplifies the challenge, but a couple of indicators point to hope.
There is a vocal segment of the market that believes that battery prices are going down, and most large funds have experts whose models support that. They are “baking in” the replacement cost of batteries based on the price trends and getting strong support from manufacturers. Neither is currently available to the lower end of the C&I market, where funders do not trust the technology yet. In time we will see predictability in performance, reliability and price trends will allow the smaller investors to feel more confident about risk.
The emerging “green bank” movement provides one of the interesting new influences in the storage financing world. States with aggressive clean energy and resiliency programs seem to be creating them as part of their arsenal of initiatives to reach green goals. The point of these independent, non-profit institutions is to help solve financing-related stumbling blocks to reach increasingly mandated targets; green banks aim to do so by developing and kick-starting new financing models.
Alfred Griffin, CEO of the New York Green Bank, could be a source of such boost that perhaps would address the issue covered here. “In New York, there is a very big opportunity for storage, but we need to think through the structuring,” Griffin said. They have plenty of funds to do so. This is an exciting area, and I look forward to doing a separate article on their progress.
If solar and storage together are to become the hoped-for solution to transforming U.S. energy, we must not leave one of them waiting at the altar. Insurers, storage system and battery manufacturers tell me without commitment that they are considering this issue and, in some cases, offering solutions that still do not cash flow. The C&I market is critical to the larger U.S. objective of upgrading energy infrastructure, so this is problem in search of a solution. Yes, technology evolution will probably eventually solve the issue. But increasing state goals and mandates demand short term solutions.
Property owners, developers and financiers await, as does the marketplace.
Philippe Hartley is the Managing Director of CleanFinancing.com, a commercial funding agency.