BY Brad Bauer

When it comes to supporting solar energy, there is a critical difference between the U.S. and its European counterparts.  In Spain, Germany and other vibrant PV markets, policies are homogenous across an entire country--making it straightforward to value the potential of investments and determine the optimal size of a project. But in the U.S., there are federal policies, and each state--and even each county or utility service area in a state--has its own incentive programs, policies, regulations and other factors that can impact the desire to invest in PV projects in a certain region.

Encouraging PV Investment

No matter where a commercial PV project is planned in the U.S., it can qualify for two primary federal incentives: investment tax credits or a cash grant in lieu of the tax credit and depreciation. While these federal incentives are necessary, they alone are not sufficient to encourage deployment of facilities for distributed generation PV. States, as a result, have developed their own incentive plans designed to attract investment in renewable energy within their borders.

Over the course of time, state incentives have begun shifting away from simple rebate programs, according to the “2009 Updates and Trends“ report from the Interstate Renewable Energy Council. Instead, as the U.S. solar market matures, states are introducing Performance-Based Incentive (PBIs). “Over the last year, 15 PBIs were created, and the caps or rates for seven PBIs changed,“ the report noted. “There are 39 production-based incentives in 28 states, with 14 production incentives for solar (excluding feed-in tariffs), 11 feed-in tariffs (FiTs), and 14 renewable energy credit (REC)-purchase programs (through which RECs are purchased separately from electricity). The emerging trend of implementing FiTs is a more recent expression of the shift towards PBIs.“ Investors like MP2 Capital weigh these various state incentives before determining where to invest in a PV system deployment. Having installed systems in California, Connecticut, Colorado, and Massachusetts, MP2 Capital has experience financing projects in a variety of incentive regimes. Below we examine the various types of incentives now in use, as well as how we perceive their value in driving growth of PV infrastructure.

Performance-based Incentives

There are three primary types of incentives that are based on the amount of electricity that a PV system produces: PBIs, REC purchases and FiTs. 

PBIs, for instance, provide cash payments based on the kilowatt hour (kWh) production of a PV system. The cash payments can last from five years, as is the case with the California program, to 20 years, as in Arizona, Colorado and New Mexico. When set at an appropriate rate over an extended period of time, PBIs play a crucial role in attracting financing for distributed generation PV projects.

REC purchase agreements are another type of PBI. Approximately 27 states have established Renewable Portfolio Standards (RPS), which are regulations that require the increased production of energy from renewable sources, such as solar. But no two RPSs are the same, as each has been designed to foster state-specific policy objectives, including economic growth, diversity of energy supply, environmental impact, as well as local resource endowments and the capacity to expand renewable energy production. Those renewable energy projects certified under these programs earn certificates--RECs--or each unit of electricity they produce. The REC serves as the currency of the RPS, and typically represents 1 megawatt hour (MWh) of production. Because RECs track compliance with the RPS, they have value to commercial-scale PV development in select states--such as Colorado, New Jersey, and to some extent, Arizona and New Mexico--which allow load serving entities to meet their RPS obligations with RECs purchased from distributed generation PV projects.

FiTs expand on RECs by enabling the power producer to sell both the electricity and the environmental attributes to the buyer. While FiTs have been popular in Europe, they are only beginning to catch on in the U.S., but to a much lesser extent. FiTs provide PV companies with guaranteed, long-term contracts for the purchase of the power produced, ensuring that providers have a market for what they generate. States offering FiTs are few and far between, and the ability to participate in these programs is limited. For example, Vermont‘s FiT program is now closed to new applicants, while Oregon has a pilot program that is capped at 25 MW statewide and Hawaii is just in the process of finalizing rates and terms. California, too, has a FiT program, but it limits systems to 3 MW. And with a price based on Market Price Referent (MPR), California’s FiT is generally too low to support PV development. Other FiT programs in the U.S. are localized, being offered by an individual city, county, or utility service district. For example, in Florida, Gainesville Regional Utilities introduced a small program that quickly received enough applications to meet the program caps through 2016. 

Rebates and Grants

While the PBIs discussed above focus on the amount of electricity produced, other state programs offer incentives based on the size of the installed system--most commonly in the form of rebates and grants. Rebates are typically determined by the installed capacity, such as in Colorado, where the rebate is US$2 per watt. Cash rebates are extremely attractive to PV project developers because the money is received upfront. However, in many states, the rebates are capped at a specific dollar amount, which effectively limit the system size and often mean that a system is too small for Power Purchase Agreement (PPA) financing. For example, in Colorado, the maximum rebate is US$200,000, which effectively limits system size to 100 kW. State rebate programs, too, can be a victim of their own success. Many, such as those in Massachusetts and Connecticut, closed quickly because they were oversubscribed and allocated funds were depleted.

State Tax Incentives

A number of states also offer PV system developers sales or property tax exemptions. However, the most useful tax incentives for spurring solar investment are credits that may be applied against state income tax liability or gross insurance premiums tax. While many of these tax incentives are generous, they are only valuable if a project developer can locate an investor with adequate tax liability in that state. If the state tax credits were made refundable--as they are in Hawaii--states would likely see far greater PV development.

How Incentives Work--Focus on Three Key States

California, New Jersey and Colorado each take a different approach to the incentives they offer for PV projects. This section will examine the incentives that make certain states leaders in PV investment.

California

California is the largest PV market in the United States, thanks to abundant sun and commitment to renewable energy resources. There has been tremendous growth in the market as a result of the US$3 billion California Solar Initiative (CSI) that began in 2007, which offers PBIs to customers in territories of the states investor-owned utilities: Pacific Gas & Electric (PG&E), Southern California Edison (SCE) and San Diego Gas & Electric (SDG&E). Of these three utilities, the highest PBI as of April 2010 is 22 cents per kWh from SCE, making this the most attractive region for distributed generation PV development in the state.

To receive the PBI under California’s solar plan, systems are limited to 1 MW AC. In addition, the return on a PV investment can be impacted by a number of factors, including the installation cost and the PPA rate that is negotiated with the host, which is true no matter the geographic area in which a project will be built. Given the combination of these factors, we have found that in order to maximize project economics for the California PBI, it is often prudent to design a ground-mounted system to use a tracker, which can increase production by approximately 30%.

New Jersey

Electric suppliers in New Jersey are required to meet some of the most aggressive RPS standards in the country, and they can do so by purchasing solar RECs traded in a competitive market. This approach has been extremely successful, making the state the second largest solar market in the U.S., behind California. The driving forces for PV investment in New Jersey include the price, term and quality of the off-taker in the REC contract. In New Jersey, PPA providers seek out long-term REC purchase contracts, which typically last no longer than five years.  In addition, there is no optimal minimum or maximum size of a project. But, from a practical perspective, PV developers base their decisions on the requirement that system output should not exceed 100% of the historical or expected consumption.

Colorado

In Colorado, investor-owned utilities offer a hybrid incentive that combines rebates and REC purchases, making the state an extremely attractive market. The rebate is generous--at US$2 per Watt DC of installed capacity. However, it is capped at US$200,000, which effectively limits system size to 100 kW DC. The success of the program has altered the REC purchase contract regime. Recently the state moved to tiered rates--based on system size--which decline as the total installed capacity in the state increases. The current REC purchase rates are less than half the rate offered under the preceding program. Because of the structure of Colorado’s incentive program, the sweet spot for PV system size is around 100 kW. With projects of this size, we believe it is important to find hosts--such as municipal governments or school districts--that can offer multiple installation sites for a single project in order to minimize transaction costs.

Emerging Markets

A number of other states--namely Arizona, Massachusetts and New Mexico--may potentially see increased investment in the PV market as a result of pending regulatory and legislative changes. In Arizona, for instance, the Corporation Commission is approaching a decision that would allow third-party ownership of PV assets, which sell power to public and non-profit hosts. At present, there is a risk that the Arizona constitution could be interpreted to characterize these third-party owners as utilities, which would then subject them to significant regulation. Until these regulatory and legal issues are sorted out few PV investors will be interested in taking a risk on the Arizona market. But at the most basic level, the changes being considered by state regulators will make investment possible for larger projects.

Some may consider Massachusetts a “re-emerging“ market. The state instituted a limited rebate program for PV projects up to 200 kW, with funding from the American Recovery and Reinvestment Act of 2009 (ARRA). The first US$4 million block of this funding was claimed the day the program opened for applications, and the second US$4 million block was claimed just as quickly in early April. More critical, though, to the long-term development of the market, Massachusetts is putting in place a competitive solar REC program, modeled after New Jersey’s successful one. The main difference is that through the Massachusetts program, power producers will be able to access a solar credit clearinghouse auction, which will provide a floor price of 28.5 cents per kWh for 10 years. This floor price will provide an important minimum assumption in the pricing equation for PV developers. The maximum size of PV projects covered by this program is 2 MW, with support of 400 MW of PV in aggregate.

New Mexico is exploring changes to REC purchase contract terms, which have allowed the utility off-taker and/or site host to terminate the contract under certain circumstances, with no recourse for the owner of the PV assets. The changes under consideration would remove the termination language, reducing some of the risk to the most crucial revenue stream in the transaction. In addition, new legislation has been enacted clarifying that owners of renewable energy distributed generation facilities will not be subject to the same regulations as public utilities. This law removes ambiguity surrounding the status of PPAs in the state.

The success of programs, such as those in California, New Jersey and Colorado--as well as the changes taking place in emerging markets are clear evidence that the right incentives can encourage greater PV investment in any state, and make the promise of renewable energy alternatives a reality.

Brad Bauer is Co-founder and Managing Director at MP2 Capital. Bauer graduated from Boston University School of Law with an LL.M. in Taxation, and holds a J.D. cum laude from Michigan State University College of Law and a B.A. from Michigan State University (http://www.mp2capital.com/).

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