Best Practices in Managing the Investment Tax Credit Expiration

Transcription

1 Best Practices in Managing the Investment Tax Credit Expiration White Paper April, 2015 MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM

2 The ITC Handbook: Managing the Investment Tax Credit Expiration Executive Summary A rapid spike in investment opportunities until the anticipated step down of the ITC, followed by an abrupt project development decline, emphasizes the need for solar investors to, first, gain market-share by accelerating project acquisitions and development through 2016 and, second, emerge with the most effective business processes and cost structure to thrive in a declining market in Most executives understand the need for growth before the deadline, yet insufficient attention is given to building business processes that can effectively boost growth today AND pave the way for a smooth transition in the context of new market dynamics. An investor s growth and preparedness should address: Productivity gains in corporate costs and financing costs Reporting tools that are necessary to leverage low cost capital financing innovations ITC Basics Investment Tax Credit (ITC) is a 30% tax credit afforded to solar systems in the US. Since implementation in 2006, solar installations have grown by over 1,600% - or an annual CAGR of 76%. At the end of 2016 the incentive is set to step down, meaning solar projects with a Commercial Online Date (COD) after December 31, 2016 will no longer qualify for a 30% credit but instead receive a 10% credit. Emerge with the leanest and most effective cost structure to thrive in a drastically reduced market size in 2017 US solar developers are racing to get projects in the ground before the step down of the Investment Tax Credit (ITC). A dramatic spike in projects reaching a COD between , followed by an abrupt decline in projects, demonstrates that the US solar industry is not banking on extension of the incentive, and many aim to capitalize on as much of the credit as possible. The most successful solar investors will have two key characteristics. 1. Gain market-share by accelerating project acquisitions and development through Emerge with the most effective business processes to thrive in a market that is substantially diminished in The key to achieving both is to invest in processes that address productivity and implementing processes that deliver accurate and relevant information to financing partners and secondary market investors. MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 2

3 MW DC by COD is generated by projects processed in Mercatus. Gaining Market Share A dramatic decrease of investment opportunities in 2017 makes the remaining ITC window critical. Maximizing market share by capturing as much of the solar development forecasted for COD in 2015 and 2016 as possible should be the priority for every solar investor. However, optimizing this opportunity is urgent. The executives that invest in tools and business processes to boost organizational productivity will dominate project acquisitions. The Time Crunch The 2011 expiration of the 1603 Treasury Grant illustrated that the real cutoff for financing solar projects actually came when banks will stop looking at deals, which is about six months before the incentive expires. Therefore investors need all the critical elements of projects lined up by June 30, 2016 in order to syndicate financing, as banks want a sufficient buffer to mitigate risk that a project will slip. The real deadline for solar investors comes before December 31, Gaining as much market share of the development forecasted prior to June 2016 should be a top priority for every energy investor MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 3

4 Performing diligence on the bare minimum aspects a project before it can be brought to a bank conditional use permits, the off-take and interconnection agreements etc. can take a month alone. Investors that need to bring in construction lenders or tax equity investors need even more time. This pushes back the time investors have to fill a deal pipeline even further, by a minimum of 1-2 months (April-May 30, 2016). Second, the 2011 Treasury Grant expiration demonstrated that one should anticipate severe financing bottlenecks as June 30, 2016 approaches. Banks will be inundated with so many potential projects, it will give them the opportunity to pick and choose with discretion. Projects submitted later will face stiff competition; therefore investors are well served to line up as many projects as soon as possible. This brief window emphasizes the need to maximize productivity. Investors need to invest in tools and processes that allow them to enhance origination and close deals quickly. Hiring alone is insufficient Solar investors that want to scale deal-flow, in time, solely by hiring more bodies should have done so yesterday. According to a study on hiring processes conducted by University of Chicago economists, filling vacancies in today s economy takes between 5-12 weeks on average, depending on the size of the company. In the solar industry the available resource pool of high quality talent is small and competition is high. The next best option is to hire from outside the industry and train new employees, which adds another 6 months before they make a real impact. Meaning that onboarding a new group that is capable of boosting deal flow of a significant magnitude is not going to impact business until sometime between July-October 2015, at the earliest. Putting it all together, a new team essentially has 7-10 months to fill a deal pipeline with more viable projects. MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 4

5 Accelerating Past the ITC The good news is that the same productivity gains that are necessary to optimize the remaining ITC window are necessary to survive a step down. A transformed solar market in 2017 will require a lean cost structure and leveraging financial innovations that unlock lower cost capital to get projects across the finish line. The Importance of Productivity Gains Without productivity gains, solar will lose a significant portion of market share. Examining the Levelized Cost of Energy (LCOE) today underscores the importance of the ITC in the context of competing forms of energy. Ultimately, a lowered tax incentive without continuing to address the costs of developing solar projects will decrease the portion of electricity markets where solar can maintain grid parity with conventional sources of energy. Where Productivity Gains Can Be Made While there have been significant reductions in the costs associated with solar, a great deal of opportunity still remains in addressing soft costs which constitute roughly 52%-64% of the costs of associated with solar projects in the C&I and residential segments in the US. MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 5

6 At the financing level there are gains to be made to increase process efficiency. According to the National Renewable Energy Laboratory, solar developer s and investor s corporate costs which constitute up to 18% of solar s costs depending on project size - support an average of roughly 7-8 employees per MW installed at the residential and commercial scale. There is significant room for productivity gains in the following areas: Project screening and project diligence Project origination Project management Internal Process Management Portfolio management and optimization Advantages of ITC Step-down Reduces impact of Tax Equity bottlenecks Reduces the transaction costs associated with tax equity arrangements. Estimated to add $.05-$.06/W according to NREL estimates Encourages long-term sustainable business models in solar industry Addressing these key areas can boost employee productivity by roughly 20% on a Per-Watt basis while reducing the overall cost of developing solar projects by as much as $.21/W. Accelerating Past the ITC This example presents a baseline of 70 MW of solar development without addressing internal productivity. With productivity gains the same resources can generate significant growth. *Assumes 1 MW of developed solar corresponds $2 million in net capital employed MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 6

7 Cost of Capital Financing innovations in the solar industry are unlocking access to new sources of low-cost capital. New mechanisms like Yieldcos, securitizations, green bonds, pooled investment vehicles, SolarREIT s and MLP s will provide opportunities to bring in a bigger pool of investors to financing solar projects at a low cost. Learn More About Low Cost Capital: Low Cost Capital Handbook Leveraging these new financing opportunities will be necessary to compensate for a reduction in the ITC but they require robust reporting and compliance. Secondary markets will simply not participate in projects or tranches with unknown risks. Low-cost capital will only be available to companies that can: Consistently and accurately report on acquisitions and projects in development Consistently and accurately report on cash flows from operating assets Consistently and accurately forecast cash-flows Data-Rooms Cost $3000/hr in top line growth Without the proper processes, reporting can add significant costs. Not only in the form of employees whose focus is to collect data for reports, but also as a time-tax on high cost resources. In the Commercial & Industrial space, an hour in the data room, inboxes, and excel for information gathering roughly translates to $3000 of top line growth. Additionally, reporting errors can result in steep fees, emphasizing the need to invest in systems that can reduce the risk of being non-compliant to regulations or contracts with financing partners. The power of an investment management solution An investment management solution drives productivity throughout the life of an investment by integrating all the key elements of the entire financing process. The important factors of an investment management solution are consistent project screening, automation, insight, and accurate reporting. MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 7

8 A consistent screening process drives efficient origination because it allows the front end of a project pipeline to process more deal flow by eliminating bad projects quickly, and efficiently moving good projects through diligence across a variety of business units. This drives productivity by opening up time and resources to originate more deals and grow revenue. Automation eliminates redundant work, creates audit trails, and produces elegant and impactful reporting to drive swift and accurate investment decisions. A best-in-class automation solution enhances financial model controls across multiple business units in order to empower an efficient diligence process. An investment management solution should be built around driving insights that optimize investment returns A comprehensive investment process should deliver insights that drive portfolios optimization, market insights, and personnel management. An effective process should not leave the c-suite uncertain about when and where to execute. Strengthened Reporting and Compliance A great investment process should leverage reporting tools that help 3rd party investors gain the insights necessary for confidence deployment of capital and help sponsors avoid costly fees associated with non-compliance. An investment management solution provides both productivity gains and improved reporting and compliance. By focusing on the investment processes solar investors can make tremendous gains positioning themselves to grow rapidly through 2016 while preparing for new market dynamics in About Mercatus Mercatus provides renewable energy investors on-demand software solutions and professional services to automate, standardize and simplify workflow from origination to syndication. Mercatus helps leading investors grow their business faster and accelerate the deployment of capital with a focus on increasing profitability, improving productivity and enabling operational transparency. Companies that use Mercatus can better position themselves to meet investor demand and keep the capital flowing. MERCATUS, INC TECHNOLOGY DRIVE, SUITE 250 SAN JOSE, CA GOMERCATUS.COM 8