The financing gap in C&I solar is leaving a lot of value on the table

C&I solar market starting to attract some attention from investors

Commercial and industrial (C&I) solar has, to a certain degree, fallen between the cracks in the landscape of solar financing. Utility-scale solar, given its high capital requirements and relatively straightforward risk profile, has been an easy sell for debt providers, tax equity investors, and well-capitalized equity investors. Small-scale rooftop solar has found success in third-party financing and leasing models that have unlocked a wave of deployment, especially in states with favorable net metering policies. Compared to these two markets, C&I has been a more difficult market to serve. The smaller scale of the projects is often unattractive to many investors, and can create a bottleneck when it comes to finding tax equity investors. Moreover, the higher transactions costs and more opaque risk profile compared to utility-scale solar have handicapped this sector in the eyes of many underwriters and investors.

The challenges faced by the C&I market are not evidence of any underlying weakness in the value proposition, but rather that different approaches are needed to serve this highly untapped market space. Increasingly, investors are recognizing this need, and entering the C&I market with the intent to reduce transaction costs, standardize the due diligence and underwriting process, and bundle projects to achieve the scale necessary to access more efficient capital markets. There are excellent prospects of higher risk-adjusted returns and comparatively less competition for those successful in mitigating the risks inherent to the C&I market.

Lucrative opportunities increasingly concentrated in states with healthy SREC markets

As solar deployment has accelerated and installation costs continue their downward trend, it would be reasonable to conclude that there should be no shortage of lucrative solar project investment opportunities. But then, you would be overlooking the countervailing impact of progressively lower and shorter term PPAs, particularly in markets dominated by a small number of incumbent utilities with concentrated negotiating power to determine the terms. PPA rates are now consistently falling below the $60/MWh threshold, sometimes with no escalators, and for periods as short as 10 years. Returns to solar project investors are being squeezed to the point where traditional investors in the space may be starting to look elsewhere to meet their hurdle rates.

Solar project investment activity is increasingly focusing on the handful of states with healthy SREC markets. Massachusetts and New Jersey are the most prominent in the mix. Massachusetts SREC I bid prices are trading above $450/MWh and SREC II bid prices are around $270/MWh, though these markets are on hold due to pending legislation. New Jersey SREC bid prices are all hovering around $280/MWh. Washington D.C. and Maryland both have SREC programs with bid prices above $100/MWh, which rounds out the most impactful programs from a price standpoint. These additional revenue streams can help to offset the lower PPA rates, and increase risk-adjusted returns to a level that is attractive to many investors.  

You may ask - what is driving these SREC bid prices? To which I would respond - the oldest economic story in the book is playing out in these markets The supply of solar (solar project installations) and the demand for solar (driven largely by RPS and solar carve-out policies) govern SREC prices. The extension of the solar ITC is projected to increase the solar pipeline over the next five years, thereby increasing the supply. On the other hand, there is concern about dwindling demand for SRECs, as program caps and other RPS targets are met. Already in Massachusetts, we are seeing developers faced with increased risks due to caps being hit for the SREC II program. When you combine the increasing supply with decreasing demand, you quickly get the picture that SREC prices may not be able to exist at their current levels for many years to come. This eventuality has motivated solar developers and investors to quickly take advantage of the current market conditions in these target markets.