MEET THE PLAYERS

Sarath Srinivasan is the Vice President, Head of Product at kWh Analytics. With more than 15 years of experience, Sarath has spent the last 10 in energy finance focused on renewable energy with extensive experience across asset acquisitions, capital markets and project finance, closing over $3 billion in transactions. Prior to joining kWh Analytics, Sarath worked at Gardner Capital, SunEdison, and Barclays. Sarath received a B. Tech degree from the Indian Institute of Technology – Madras and an MBA from the MIT Sloan School of Management. He is from Chennai, India.

Michael Eyman brings more than 20 years of leadership and operations experience to Origis Services and as Managing Director is responsible for its rapidly growing solar and energy storage portfolio.

Better P50 Estimates Will Protect Equity Cash Flows

Using data from kWh Analytics’ proprietary database, consisting of performance data from over 30% of the solar assets in the US, the Solar Risk Assessment Report revealed the median performance of solar assets in recent years has been at 92% of P50 predictions. After financing, the consequence is a 30-40% reduction in equity cash flows, which has surprised and alarmed many asset owners eagerly awaiting their returns. How can 8% underperformance cause 40% profit loss? Sarath explains:

For every $100 of cash flow, some of it goes to the tax equity, some of it goes to the debt. Let’s say out of the $100, $80 goes to those two stakeholders over the first couple of years, or the first few years, especially when the tax equity is still in the deal. . . And out of that $100 now, the equity investors are getting $20, right? When you’re performing at 92%, because your (sponsor equity investor) payout] is the lowest in the waterfall, you only participate in the remaining cash flow after both debt and tax equity have taken their share. So, if you were expecting $20 before . . . if you’re at 92% production, now you just made $8 less, so that’s 40% of your cash flows roughly.

Because of this financing structure, solar assets are especially vulnerable to underperformance in the first few years after construction when there’s no operating history to rely on. While some of this underperformance can be tied to weather volatility, equipment failure, construction quality, and other risks from starting a brand-new facility, much of this underperformance stems from P50 overvaluation in project design.

The issue, Sarath says, stems from analysts being incentivized to win bids instead of to predict performance. “If you’re competing, and you’re the one that’s going to take a conservative view on the P50 estimate, it means you probably lose out on the bid. We’ve had large asset owners and utilities who’ve been in the power business for over 10 years complain to us about that.” It will be these same asset owners who can reverse this trend. As the industry continues to grow and learn, long-term asset owners can and should develop better P50 estimates, based on their own data or on the insights from third parties such as kWh Analytics.

Insurance Products Are Replacing Blanket Performance Guarantees

kWh Analytics has already developed their own P50 model that is validated by the industry’s largest independent database of in-field production data, which has become increasingly useful in evaluating insurance products to secure cash flows. In years past, O&M operators offered performance guarantees, but those days are over, as Michael shares: “At the time that performance guarantees were being provided, O&M contracts were $16-20 a kilowatt. Today, they’re like, $4, right? So, a lot of the reason why you don’t see those performance guarantees is because asset owners are not willing to pay for those. And the risks like weather, quality, supply chain issues—which you can’t control—are expensive from an operator’s perspective. Our contracts are so slim they can’t absorb those risks.” As more asset owners get burned by underperformance, insurance risk mitigation is becoming a more prudent option.

“It goes back to project finance 101,” says Sarath. “In any project finance transaction, you want to take risk away so the participants can get stable, predictable cash flows. That’s really the goal of all project finance. When you reallocate risk to a counterparty that’s best suited to take the risk on, everybody is better off in the transaction.” As developers and insurance companies collaborate more closely to mitigate risk from the beginning, P50 predictions will be more widely socialized across the industry and will be better founded on realistic data.

Production Tax Credits Can Better Align the Industry

Accurate P50 estimates become even more important under the new options available through the Inflation Reduction Act. Many facilities, such as those in the Northeast, may choose to stick with the ITC (Investment Tax Credit) options currently available. Assets in high solar irradiance regions, however, will likely choose the new PTC (Production Tax Credits) going forward. For owners who choose the new PTCs, accurate P50 estimation becomes even more crucial. Sarath explains: “So now, suddenly, if your asset underperforms, there’s a double impact. Not only are you getting less energy revenues and less equity cash flows as a result, but you’re also getting fewer tax credits. And so, that just exacerbates the impact of underperformance on the entire capital stack.” Sarath believes, however, this will be a good motivation for the industry to course correct and learn from its recent growth and experiences.

CONCLUSION

Sarath closed the discussion with some optimistic thoughts: “I look back at the growth of solar over the last decade from 2012 to now.  It’s just staggering. But I think we all have to remember we’re still a pretty young industry scaling quickly. And so, a lot of these are growth pains we just have to work through on the path to becoming a more mature player in the energy market. Because if everything goes according to plan, solar is going to be a big part of the energy system. And making sure we’re prudent stewards of being in that position is critical. Ensuring solar assets produce and perform the way we say they’re going to is key.” The path to a clean energy future includes many learnings along the way.

In conclusion, the three takeaways on Solar Asset Underperformance are:

1. Better P50 Estimates Will Protect Equity Cash Flows
2. Insurance Products Are Replacing Blanket Performance Guarantees
3. Production Tax Credits Can Better Align the Industry

We’re so grateful for our expert guest Sarath Srinivasan and Power Players host Michael Eyman for bringing their experience and data to this critical industry topic.

RESOURCE LINKS

kWh Analytics 2022 Solar Risk Assessment

RE+ 2022 Poster Presentation: Addressing Solar Underperformance with data from kWh Analytics

Addressing Solar Asset Underperformance, Power Players Episode 3