It may make financial sense for your organization assume ownership of the systems after 7 years. What should you know before you move forward?
A Power Purchase Agreement (PPA) is common form of financing for solar projects. In a PPA, a customer enters into a 20 or 25-year agreement with a solar developer, typically an EPC (Engineering, Procurement & Construction company). The customer leases a portion of their property – roofs, parking lots or open space—where the developer designs, builds and operates the system. The developer then sells the electricity generated by the solar facility back to the customer at what should be a lower rate than they would have paid the utility for that energy.
Most PPA agreements have buyout provisions: the ability to terminate or buy out the contract before the full term. Although buyout provisions are common in PPA agreements, buyout terms – years available and associated costs/system valuation – vary widely. PPA agreement buyouts are typically not offered before Year 7 of the contract due to restrictions on the federal tax incentives utilized by the PPA financing entities.
Why Buy Out a PPA?
The primary reason to buyout a PPA is to save money. Some PPA contracts have buyout provisions specifically set up to provide a relatively low-cost buyout option early in the contract (Years 7-10) to facilitate transfer of ownership to the customer once federal tax incentives have been harvested by the financing parties.
Another common example are California customers that entered into PPA agreements between 2007 and 2013 to access the California Solar Initiative (CSI) program’s cash incentives during the first five years of operation. Some of these earlier PPAs had relatively high base energy rates and large annual rate escalators of 4%-6%. During this same period, utility energy costs have been relatively flat due to both the 2008 economic downturn and the advent of “fracking,” which dramatically reduced the cost of natural gas—a key fuel for electrical power plants.
Once CSI incentives for the projects are exhausted after Year 5, and because utility energy costs have not risen as much as expected, many of these customers have found that they are paying as much or more for power from the PPA provider than they would if they purchased all of their electricity from the local utility.
How to Determine if a PPA Buyout is Right for You
If you suspect that you can save money by buying out your PPA agreement, a thorough evaluation of the agreement and financial performance of the project is in order. To determine if a buyout is right for your project, Sage recommends the following:
- Evaluate your PPA agreement and identify the buyout and termination provisions, including the schedule of values for each
- Identify and understand the various financing mechanisms available to you to finance the buyout
- Identify and understand the various costs and risks associated with owning and operating the solar facility, including operations and maintenance, insurance, decommissioning and financial management
- Most PPA agreements require that the buyout price be at least Fair Market Value (FMV), which may require a FMV assessment according to IRS guidelines
- Evaluate the current all-in cost of electrical energy, the sum of both PPA and residual utility energy costs
- Careful financial and performance modeling that accounts for potential utility tariff restructuring, long-term energy market trends, system performance degradation and the various costs of ownership.
PPA Contract Renegotiation
As an alternative to, or part of, a PPA buyout, it may be possible to renegotiate some of the terms of the PPA agreement after Year 7, though there is little incentive for a PPA owner to renegotiate.
If you’re a commercial customer considering a solar PPA buyout, Sage can provide independent oversight and expertise to help manage project risk and maximize the lifetime savings of your project. Call us today.