understanding business decisions to use alternative financing methods for captive solar power...

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Understanding Business Decisions to Use Alternative Financing Methods for CaptiveSolar.

Executive Summary Businesses - perhaps more than others - by design, need to have a longer term planning horizon and constantly endeavor to reduce costs in a good way to be competitive and sustainable. For the purpose of this paper we classify as business; any institution, for-profit or otherwise, paying load and/or slab based, commercial or industrial rate power tariffs. It must be noted that in India these institutions have been paying among the highest power prices in the world, increasing at 7-15% annually. We look at the use-case of businesses installing onsite captive solar photovoltaic (CaptiveSolar) solutions to reduce their electricity bills. For simplicity we only consider a case where the business receives no revenue from the CaptiveSolar system, so its yearly

benefit is calculated as electricity expense savings compared to the utility tariffs multiplied by the expected CaptiveSolar system production. We examine 2 popular financing methods. Through these methods we analyze the considerations that influence their choice and outline the costs and benefits of each method.

Introduction Businesses have large electricity needs, ranging from 30% to up to 90% of their operational expense, which is often an uncontrolled cost, meaning that increase in cost of power directly impacts their bottom-line. They occupy substantial space and idle rooftops can be utilized for CaptiveSolar installation. Finally businesses enter investment agreements to produce long-term


economic benefits. To reduce exposure to electricity prices CaptiveSolar works as a long-term hedge against increasing costs. All these factors allow businesses to extract maximum benefit from CaptiveSolar installations.

One of the early decisions a business must make about CaptiveSolar is how to finance its installation. A business can buy a CaptiveSolar system outright using its own funds, we refer to this as self-financing. Alternatively, it can sign a contract to lease the system. We must point out here that leasing option may not be available to all due to lack of financial data, unavailability of credit-risk assessment models and legal recourse against default.

Corporate Structure and Culture How the business is structured is often the first filter for decision making on CaptiveSolar. Owner(s) run businesses have a smaller decision chain and fewer guidelines channeling their budget. Publicly listed companies with an array of stakeholders may have a myriad of rules and spend allocations that they must follow. Additionally investment in CaptiveSolar is not on any department’s specific agenda and thus may sit slightly behind immediate operational priorities. Decision to self- finance Solar CaptiveSolar systems fits well some business cultures. There may be perception of risk ownership with outright purchasing CaptiveSolar solutions, but diligent process management enables greater benefits of owning long-term, high-quality assets. On the other hand Leasing CaptiveSolar systems may align well with risk- return preferences of others where lower/staggered investments can enable rapid deployment across a large number of locations.

Choosing a Financial Structure The levelized cost of energy (LCOE)- for the

self-financed system by most measurements is lower than the LCOE for the leased system. However, the attractiveness varies based on cost of capital, different perceptions of CaptiveSolar risk, and different perceptions of the risk of using a particular financing method. Some businesses determine early on that they have no interest in leasing method for CaptiveSolar deployment for several reasons.

First, they are convinced of the business benefits of CaptiveSolar and decide that owning the system would provide a better return - If a third party can get a good rate of return and can pass some of the savings onto the business, then often they would like to cut out the middleman and capture all of the benefits themselves, financial and environmental.

Second, they expect to be in the market for a long time, they build their own buildings, purchases land, and own or establish long-term relationships with their suppliers.

Third, they can afford the capital expenditures through their balance sheet. If the expense satisfies their required rate of return the business can self-finance it. For these


businesses CaptiveSolar becomes a part of their default and ubiquitous infrastructure akin to electrical wiring. Others may find self financing CaptiveSolar as a diversion of funds from their core business activities. In case of businesses with large operations spread over various geographical locations funds expected or earmarked for power and other local operational expenses can be used. Perhaps they want to use leasing as a preferred method of project piloting before full scale deployments in all their locations. Often however even the opposite may be true. They may be willing to invest fully in a smaller project but would like to defer on the capital expense when going large scale by opting for the leasing method. Another factor could be the ownership structure of the premises themselves. Due to the nature of some businesses, companies prefer “moving shop” to locations operationally better or more profitable of both. Moving the CaptiveSolar system safely can be the responsibility of the leasing company. Additionally they may also be able to offer flexible lease terms with built in geo-clauses.

Factors Beyond Typically, CaptiveSolar system costs remain the same regardless of financing structure. Depending on the businesses availability and costs of capital self-financing may be more attractive than a lease over the long term. This depends on the lease rates available, which might vary for several reasons. For example, if the lease providers can lower their cost of capital through securitizing project portfolios, they may be able to offer leases for larger incremental solutions at better rates that could fund future CaptiveSolar deployments. Additional factors might make self-financing more attractive than a lease. CaptiveSolar systems have an economic life of 20 while the average CaptiveSolar system is expected to last for at least 30 years. A business that purchases a system owns it from the beginning. At the end of a lease, however, the business must purchase the system, sign a new lease, or allow the system to be removed from its property. At this stage the business, having confidence in the system’s capacity to save money would typically opt to buy out the solution at a really cheaper price. The lease provider may be able to do this since they already build in their required IRR into the lease payments. Benefits are also dependent on the business remaining on site for 30 years (or being able to sell the system at some point in the future to the next building occupant/owner based on the remaining value of the system’s expected 30-year life). If a business has a shorter time horizon (and/or believes there will be no resale value), a lease may be more attractive. However, while a CaptiveSolar system owner may have a lower cost of capital, the high upfront costs may be unattractive. This is

particularly true for agents with time horizons


shorter than the system’s lifetime for example, a business’s facilities manager, who is unlikely to remain in the same job for the economic life of the CaptiveSolar, might choose immediate energy savings over potential long-term economic value.

Risks Perception and Mitigation

Every business, big or small evaluates some overlapping combination of these three risks when considering investing in a CaptiveSolar solution.

Balance Sheet Risk:

Businesses must also consider how various financing options impact their financial statements. While both are long-term commitments, leases are considered off-balance sheet transactions; similar to an operating expenses, and the long-term liability does not appear on a business’s balance sheet. Financial statements are used to measure the financial health of a business by internal and external parties, and an asset heavy balance sheet may affect the amount debt it can borrow. Of course much of this depends on the size of the business relative to the amount of CaptiveSolar it aims to deploy. As per the New Appendix I of the Income Tax Department (Table of Rates at which depreciation is admissible) section III.(8).(xiii)

CaptiveSolar solutions qualify for 80% accelerated depreciation (AD) leading to a total tax-benefit of about 24% of the cost solution within the first year itself. If the business has sufficient tax liability to take advantage of the deduction self-financing makes good business sense. Leasing companies on the other hand, because of their structures are often unable to take advantage of the tax credits and hence unable to transfer them to the end user. But leasing does offer potential advantages.

Unlike purchase of a CaptiveSolar system, lease payments are off-balance sheet transactions, which might suit businesses unwilling or unable to add the liability of a CaptiveSolar capital expenditure (CapEx) onto their balance sheets. In addition, a business

can get the full benefits of a lease with a lesser amount of tax liability. Lease payments- as any operating expense- can be deducted from total revenue to reduce taxable incomes,

Technology Risk:

Businesses that own CaptiveSolar and those that lease it also face different risk and reward considerations. To a business with a lease, the only risk to unexpectedly low CaptiveSolar generation is the cost of additional electricity that must be sourced from the utility. In contrast, a self financed CaptiveSolar owner must do their due diligence in sourcing the solution from a quality tech-provider to ensure system performance. This risk of CaptiveSolar however is increasingly is small and easily manageable by following basic system design protocols, for example, by requiring certified solar panels that provide a production warranty. As the Indian CaptiveSolar industry matures, and minimum expected generation is transparent, this risk perception will dissolve.


Payback Period:

The timeline for customer payback is another consideration. Self-financing provides better return over the project lifetime. Assuming average solar insolation based power generation for quality CaptiveSolar solution, and the current (non-escalating) power tariffs for businesses, the entire cost of the installation could be recovered in as little as 2-4 years in most cases. So while may be net-cash-flow negative for over this period, once the investment is recovered the subsequently generated power is free. Leasing, on the other hand, could produce savings depending on the rates applied and the power tariffs. However these comparative savings could be smaller yet spread over the term of the lease contract. Self-financing is more attractive if power generated over the project lifetime is considered along with the fact that leases involves more parties in the transaction.

Conclusion In evaluating the decision to install CaptiveSolar, businesses must perform various economic analyses to determine the economic attractiveness of each proposal. The inputs for these analyses are private, and each project and business may have its own unique circumstances. However, analyzing the economic attractiveness of CaptiveSolar ownership versus leasing based on specific circumstances will help a business’s decision. We do not suggest a single option that is most efficient for every circumstance; but highlight key factors businesses may consider in choosing a financing method for a great investment. The most appropriate CaptiveSolar financing option for a particular business depends on the characteristics and circumstances of that business itself.

Abhishek Gupta, President - Sunipod is a Solar Energy Patriot, leading awareness programs to help institutional adoption of solar power as a cost appropriate means to achieve business excellence and social cognizance in India. Sunipod India, manufactures key components used in solar power generation and provides turnkey project deployment solutions. Copyright © Sunipod. All rights reserve. For related articles go to blog.sunipod.com or simply scan the code below with your smart phone.

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