Lifting the Financial Veil: A Solar Business Case

Friday, July 12, 2013

Making the Solar Business Case

For nearly 60-years, we at Cupertino Electric have focused on thoroughly understanding all of the elements that go into a successful construction project. In the alternative energy world, our analysis determined that renewable power generation systems were forced to compete for funding in the boardroom alongside other facility improvements. Because of this reality, our customers need to present a compelling case to their CFO or vice president of finance for why renewable projects are a sound business investment, aside from the goodwill they create as a symbol of a company's commitment to sustainability.

Since our first solar installation in 2007, our Energy Alternatives Division has treated every project as a stand-alone business case. We are well versed in explaining why a solar project is a good idea—especially in light of other capital projects. At the core of whether solar makes good business sense is our exploration of "doing nothing vs. doing something" as it relates to the rising cost of energy.

Clarifying the Customer's Financial Goals

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We treat every project as a stand-alone business case and are adept at explaining why a solar project is a good idea—especially in light of other capital projects.

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Before embarking on a detailed financial analysis [1], we work with clients to make sure that we intimately understand their financial goals and uncover potential roadblocks. We typically ask:

Is there a maximum allowable payback period?

Is there a target minimum internal rate of return or return on investment?

Do you want to own the PV system, or do you require some form of structured financing (PPA, commercial lease)?

Doing Nothing vs. Doing Something Approach

Once we have the customer's financial goals as context, we establish a client's annual expense and unit costs for electric service by reviewing a year's worth of electric bills. Using well-researched figures from public sources, we then apply a rate escalator (annual rate hike) to derive future estimated unit costs and to project annual expenses. This calculation represents the "do nothing" portion of the equation.

In contrast, the "do something" scenario is iterative from both a design and financial standpoint. For this portion, we prepare a conceptual system layout and electrical single-line diagram. From there, we estimate the delivered cost, and model the anticipated first-year power generated.

Our Approach: Be Transparent and Conservative

Knowing that solar PV projects will only get built if the money spent offers competitive returns, we at Cupertino Electric have adopted two very important principles:

Be transparent— our model, which includes the assumptions we make and the accounting practice we emulate, should always be clear and defendable. (For more on this, read a recent post about the importance of conveying clear pv plant information)

Be conservative—where factors affecting a model's results fall within a range, we use the figure with the most serious consequences that still allows us to remain competitive

The Case for Ownership

Our general approach in working with potential customers is to develop a 25-year pro forma income (profit-loss) statement broken out into three parts:

Income to the project — the sum of the amount of money the client would avoid paying the utility, plus California Solar Initiative [2] incentive payments, plus a Renewable Energy Credit [3].

Direct expense incurred by the project — the sum of maintenance costs of the system, insurance, and replacing an inverter around the ten to 15-year mark.

Depreciation [4] and tax treatment — based on the client's combined tax rate, usually between 35% to 45% to calculate any reduction (added income) or increase (added expense) in corporate taxes stemming from savings derived from the solar system [5].

After running our model, the results are compared to the financial goals outlined by our client. When our designs and estimates yield results that meet or exceed stated goals, we transmit summaries of all inputs and results to our client, and move forward with the engineering and construction processes. More commonly, if one or more of the financial goals aren't met, we review the conceptual design documents with a focus on increasing production and decreasing cost, and revise them accordingly. The iterative process then involves re-running our model to measure progress.

Where our modeling efforts have been successful, we at Cupertino Electric have achieved financial results that fall into the following ranges:

Payback Period

Low = 6.5 years

Average = 8-9 years

High = 10-12 years

25-Year Internal Rate of Return

Low = 8%

Average = 10% - 12%

High = 15+%

25-Year Levelized Cost of Energy

Low = $0.10 / kWh

Average = $0.12 / kWh

High = $0.14 / kWh

When we're able to fully collaborate with our customers to help meet their financial goals and put our extensive design and construction experience to deliver the best solution, we find that the objections to solar systems as investments fall away.

 

Notes

[1] When a financial model is complete, thorough, and conforms to standard accounting practice, it produces information about future equivalent electricity rates and expenses. While the cost of electricity will rise over time based on rate increases of random magnitude, the Cupertino Electric-based model is predictable.

[2] A per kilowatt-hour (kWh) system production incentive offered by the State of California currently valued at $0.025/kWh of PV system production for the first five (5) years of plant operation.

[3] A nominal ($0.01 / kWh) amount that is "banked" with the Western Renewable Energy Generation Information System (WREGIS) that can be bought, sold, or traded as part of the California Environmental Quality Act (CEQA).

[4] The "expense" incurred through reduction in asset value over time.

[5] IRS rules are clear in that only those assets directly associated with the PV system are depreciable. The IRS also requires that 50% of the one-time investment tax credit be deducted from the asset's book valuation.

About Steve Schumer

As senior energy strategist for Cupertino Electric’s Energy Alternatives Division, Steve Schumer draws on more than forty-three years of combined experience in the areas of fossil, nuclear, alternative and renewable power generation/distribution. In his current role at Cupertino Electric, Inc. (CEI), Steve develops financial and engineering models for alternative energy projects, oversees utility and regulatory relations, interfaces with high-level customers and is responsible for project development.

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