What residential solar teaches us about commercial energy projects

Image courtesy of Flickr user WayneNF

Third-party financing changed the solar market. Will it change your next energy project?

For many facility professionals, solar energy is an intriguing, but distant possibility. Not many commercial organizations have the combination of roof space and fiscal patience at today’s prices, which explains why 95% of applications to California’s Solar Initiative program are residential. However, even if you are not considering solar, get ready for a key financing innovation related to solar energy to make its way into your project proposals.

One of the sales barriers for solar systems has always been the high upfront cost of the equipment. A key innovation solar has brought to the market is third-party financing and contract structures such as Power Purchase Agreement (PPAs) and solar leases. These allow solar projects to show savings from day one by parceling out fixed payments monthly alongside electricity savings.

Now these same financing mechanisms are starting to creep into the commercial energy efficiency markets. Today you can lease LED lights, buy electrons from a Bloom box, arrange for no-cost commissioning or finance an entire commercial energy project.

Financing often takes the fantastic return from an energy project and sends the bulk of that return back to the financing organization

This all sounds like a great technique to get more projects done and save more energy, right? For some cash-strapped organizations, creative financing can indeed boost projects that would otherwise never get off the ground. Nevertheless, we urge caution, as financing often takes the fantastic return from an energy project and sends the bulk of that return back to the financing organization.

Here is where solar is illustrative. In a recent filing, SolarCity indicated that its gross margin on a sold solar array is approximately 15%. On a leased one? 68%! In moving to a financing model, SolarCity has boosted its margins over four times and, extracting most of the value from the project.

Again, this might still be a good deal for all parties. A homeowner who really wants solar panels on the roof no doubt appreciates the arrangement. Likewise, if your team is tight on cash, this is a nice tool to get a project done while you are in budget lockdown. But make sure to consider what you’re giving up. In a down economy, with low public market returns, why forgo the fantastic returns from an energy project?

Government customers have long dealt with this quandary as they evaluate ESCO proposals. If this is new for your commercial team, think about what it means for you. If you examine energy projects purely on a payback basis, how will you evaluate projects with financing?

Some simple tips to help:

  • Refine metrics: in addition to payback, make sure your organization is developing net present value (NPV) and internal rate of return (IRR) tools metrics for your projects. This will allow you to cleanly compare financed and non-financed projects.
  • Separate financing and product costs: as a policy, get proposal costs both with and without financing. This allows you to determine financing costs and compare them to internal benchmarks.
  • Watch the accounting: the accounting treatment for leases is currently a hot topic. Make sure your organization undertands the risks of taking new project leases.
About Tom Arnold

Tom Arnold is co-founder and CEO of Gridium. Prior to Gridium, Tom Arnold was the Vice President of Energy Efficiency at EnerNOC, and cofounder at TerraPass. Tom has an MBA from the Wharton School of Business at the University of Pennsylvania and a BA in Economics from Dartmouth College. When he isn't thinking about the future of buildings, he enjoys riding his bike and chasing after his two daughters.

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