Solar is a Bright Investment

Transcription

1 Solar is a Bright Investment Investing in a solar system seems like a great idea, but what are the financial implications? How much will it cost and what is the payback? These are common questions that are easily answered. This guide walks you through a full understanding of the factors that impact financial feasibility and overall return on investment for a SunPeak PV system. The following topics will be addressed in order: 1. Electrical consumption and rates. How much are you currently paying for electricity? 2. SunPeak PV system production. How much energy will a SunPeak system produce? 3. System price. How much will a SunPeak system cost? 4. Incentives and tax benefits. What assistance are you eligible for to finance the project? 5. Return on investment. Will this system save you money? How much? Let s take these one-by-one using an actual SunPeak project as an example. Electrical Consumption & Rates The first step is digging up your old electric bills. These abstract documents don t typically get a lot of attention, but if you look closely, you will notice a number of key pieces of information that are important considerations to the overall payback model of a solar PV system. It is important to first understand that there are two usage metrics that electric companies measure to bill customers, each with different rate structures: 1. Energy consumption. Energy is measured in kilowatt-hours (kwh) and is what most people think of when they think of what the electric company is selling. It measures a quantity of electricity that is consumed per month. If you were to compare this to a water bill, it would be like measuring gallons of water. Energy is billed in $/kwh, and a ballpark rate of $ /kWh is common today. a. Peak rates. Typically during the time of day when demand is highest, the utility will increase the price per kwh. This makes the value of energy during the day worth a premium, which is one of the reasons solar is attractive. When energy prices are the highest, the solar array is producing the most energy. b. Off-peak rates. Any time of the day that is not considered a peak rate is simply called off-peak. Off-peak rates can easily be ½ the cost per kwh of peak rates, and Solar Financial Model Explained Page 1

2 typically correspond to nights, weekends and holidays when electrical demand is lower. Peak and off-peak rates correspond to a billing scheme that is generally referred to as time of use billing. It is more common for commercial and industrial customers than residential customers. 2. Demand charges. For commercial and industrial customers, there is another charge that is in addition to the energy consumption, which relates to power demand. If energy is gallons of water, power is like gallons of water per hour. It is a measure of energy flow rate. This demand charge is not found on residential bills, but is common for larger consumers. Demand charges are in units of power, which is in kilowatts (kw). This charge puts a premium on consuming a lot of energy in a short period of time and is impacted by how much drain is being put on the electrical grid at a given moment. a. System demand. The utility company keeps track every month of the maximum amount of power that is demanded at any one time. How much electricity are you consuming per unit of time? The highest power demand reached in a given 15- minute window per month is multiplied by the system demand rate to establish the system demand charge. b. Customer demand. This charge is exactly like the system demand, but the maximum value is tracked per year rather than per month. Therefore, the highest power demanded within a 12-month timeframe becomes the high water mark on power demanded. This is effectively like a double charge for the time every year when you are consuming the most power at a given moment. All of the information, both usage and rates, are found on each electric bill. If we look at 12-months of electric bills, we can quickly understand how much energy is being consumed and at what cost. Solar Financial Model Explained Page 2

3 Let s take a look at a portion of a real electric bill from a SunPeak customer: The most important elements are the energy rate (in $/kwh) and the amount of energy consumed (in kwh) as the solar system will directly offset these charges. In the above example, the base energy rate is $0.055 and corresponds to the off-peak rate. This is the cost of all electricity consumed, regardless of the time of day. The on-peak rates and schedule are noted right on the bill, and amount to a $ /kWh premium. This is added to the base (offpeak) rate to calculate the peak rate, which in this case is $ $ = $ /kWh. During the day, the customer is paying 9.2 per kwh, and during the night the rate is 5.5 per kwh. Over a 12-month timeframe, the total energy can be added up and multiplied by these rates to get to an annual energy consumption expense. Both the amount of energy and the rate are important in assessing the financial attractiveness and appropriate system for a given project. It can be seen from the above 12-month total for this customer, that the total energy being consumed per year is ~880,000 kwh. Solar Financial Model Explained Page 3

4 Demand charges are also important, and can be offset by the solar system; however, since their value is dependent on when the maximum power is demanded, calculating a payback based on these is more challenging. If the demand charge is based on a daytime maximum, the solar system will most likely help reduce this charge in the future. If your heaviest usage of power is at night, the solar system clearly will not benefit this portion of the bill. Once all these factors are considered, a total snapshot of annual electricity expense can be generated. By the way, don t be intimidated by this level of detail SunPeak will do all of this work for you with no obligation. We analyze energy bills every day. SunPeak PV System Production With an annual demand of ~880,000 kwh per year, a sizable system can be installed. Typically, it is best to undersize the system relative to annual consumption so the solar energy is all consumed on site. This avoids the customer from becoming a net producer of energy, where more energy is produced on-site than is consumed. Since utilities will not pay retail rates for annual net production, payback is diminished for excess energy that cannot be used, thus lowering the payback on that portion of energy generated. In this example, the limiting factor was available roof space. The building was 45,000 sf in total footprint, but some rooftop obstacles prevented the entire roof from being usable. The local utility also had a practical cap at 100 kwac size for standard net metering tariffs on self-generation, so this was the size that was chosen. Solar Financial Model Explained Page 4

5 The 100 kwac project was simulated for the location s climate and available sunlight, and for the configuration chosen. Using software, the projected SunPeak system production was 150,000 kwh/year, or about 17% of their total energy need. All photovoltaic (PV) systems lose some efficiency each year, which is assumed to be 0.5% per year. Over the course of a 25-year life, the system will produce approximately 89% of what it did at installation. This is expected and factored into all financial models. System Price SunPeak offers some of the most competitive pricing available in the industry, and this project was installed for a total cost of $282,000. Variations in system price can be influenced by the project complexity, size and other factors. For this size system, $282,000 is a reasonable ballpark figure for illustrating the payback model. Incentives and Tax Benefits The federal and state government can play a vital role in the financial attractiveness of a project. Additionally, utilities and other grant sources can factor in. Each project needs to be assessed individually. The following incentives will be discussed using our example: Federal Investment Tax Credit (ITC) The federal government currently offers an Investment Tax Credit, known as the ITC, on all new solar projects. From now through December 31, 2016, this tax credit is equal to 30% of the total system cost. (Beginning January 1, 2017 the ITC drops to 10%). For our $282,000 system example, the tax credit would be $84,600. This is a tax credit, meaning $84,600 can be directly subtracted from the calculated taxes due (unlike a tax deduction, where the value is subtracted from income). The credit can be applied to last year s taxes (one year retroactive), or up to twenty years into the future until it is consumed. For the taxpayer, it effectively equals $84,600 of the system being paid for directly by the federal government. This is the single most important financial incentive available in the solar industry today, and has fueled the industry s significant growth in recent years. There is no tax credit dollar limit, and it is awarded by simply claiming it at the end of the year. Solar Financial Model Explained Page 5

6 Accelerated Depreciation (5-Year MACRS) In addition to the ITC (tax credit), the government allows the system to be depreciated to zero (full write off) using the 5-year Modified Accelerated Capital Recovery System (MACRS). The tax basis for depreciation can be up to the full cost of the system, less 50% of the tax credit (ITC) taken. In our $282,000 project example, the tax basis would be 85% and it could be deducted from pretax income per the following schedule: This means that $239,700 can be deducted from income in the first six years of the system s life. With an assumed 35% effective (state + federal) tax rate, the after tax benefit is $83,895 (29.8% of total system cost). Additional Incentives Incentives beyond the federal program often exist, but their structures vary greatly from one region to another. Most incentives are either performance-based (pay per kwh the system produces) or investment-based (% of the installation investment). The website DSIRE (dsireusa.org) is the best resource to evaluate incentives. In our example, a grant was applied for in Wisconsin through its Focus on Energy program. SunPeak wrote a grant application on behalf of our client, and submitted it through a competitive process. The application was successful, and the customer received a $75,000 award, which corresponded to $0.50/kWh of energy projected in the first year (150,000 kwh). This was a cash incentive, payable upon system completion. Once the system was commissioned, the customer received a $75,000 check Simple and effective. Solar Financial Model Explained Page 6

7 Return on Investment The final step is tying all of these factors together to evaluate the total financial impact of adopting a solar system. An analysis period of 25-years is chosen, because that is the minimum expected life of the system. The following example has been truncated to show Year 1-6 (when depreciation is occurring) and Year 25 (final year of the analysis period). These years give us a useful snapshot of the figures occurring through the life of the system. Energy Pro Forma First, let s look at projected future energy rates and production: It is assumed that energy rates will escalate in the future, as they have on average nearly every year. For this analysis, a 3.0% annual rise in energy rates is assumed, which is a conservative assumption and less than typical over the past ten years. As the price of electricity rises, the payback on solar increases, since the investment in solar is fixed and upfront. Therefore, future higher energy rates increase solar investment payback. The System Performance Index (SPI) shows the declining effectiveness of the solar modules over time. Notice the expected rise in energy prices is much more significant than the declining panel effectiveness, loss of energy production each year. On a net basis, the system still gets more valuable every year. As a side note: At the end of Year 25, the system has produced a total of over 3.5 million kwh of energy! This is equivalent to 2,700 tons of CO 2 avoided, 5.8 million automobile miles avoided, or 276,000 gallons of gasoline. However you want to look at it, the positive impact on the environment is significant. Solar Financial Model Explained Page 7

8 Income Pro Forma With energy production known and forecasted for each of the 25 years, the next step is to evaluate the financial implications. Avoided cost is the same as revenue; i.e. if you produce your own electricity on-site it is just like receiving a check for that electricity you would otherwise buy. Therefore, the value of energy produced is treated as revenue in the below model. A conservative assumption has been made that the solar system will offset 40% of potential demand charges, which is reasonable. This allows for days when it may be cloudy out and the facility reaches its maximum power figure. Therefore, there is avoided cost for energy production, avoided demand charges, and avoided sales tax on electricity that was not purchased. (There is no sales tax on solar systems, which is another fringe benefit of going solar). Typically, state rebates and other grants are treated as income. If they are, they do not negatively impact either the depreciation basis, or the available federal tax credit. For this model, it is assumed that income tax is paid on the received grant and the tax credit and depreciation basis remain fully available. Solar Financial Model Explained Page 8

9 Some budget is included to keep the system operational over the course of its life, which is primarily an Operations & Maintenance (O&M) contract with SunPeak and an insurance premium. The figures shown are reasonable, but can vary from project to project. Cash Flow Pro Forma To calculate the return on investment, we use a discounted cash flow model. In this example the customer chose to pay 50% of the system cost with cash (after the Focus on Energy rebate), and finance the remaining 50%. Using a 10-year loan and an interest rate of 6.0% APR (annual percentage rate), the following cash flows result: In the start-up year (Year 0), $50,220 in after-tax cash is received from the Focus on Energy grant, the depreciation tax shelter provides a $15,839 after-tax benefit, and the Federal Investment Tax Credit contributes $84,600 after-tax. $282,000 is paid out for the system cost and $103,500 is borrowed from a financial partner. The net result is a net $27,841 negative cash flow, about 10% of the system cost, which is financed with the customer s cash. Put another way, in the installation year, 10% of the system cost is paid by the customer while over 50% is paid for by the federal government and the state grant. The resulting loan balance, $103,500, is less than 37% of the original system cost, which will be paid off through the resulting energy cost savings from the system. Clearly, this sets up a favorable return on investment. Solar Financial Model Explained Page 9

10 Year 0-5 benefit from tax depreciation Year 11-25, loan is repaid and free energy from sun result in strong positive cash Net out-of-pocket cash flow in Year 0: installation year In Year 1-5, the after-tax benefit from energy cost savings and the accelerated deprecation provides significant positive cash flow benefit even after the loan payments. During Year 6-10, the energy cost savings are slightly greater than the debt service on the loan. From Year 11-25, the system is paid off and positive cash flow becomes substantial and steadily grows as the price of electricity increases at an assumed rate of inflation. The following chart shows the period in which each factor plays a role in net after-tax cash flow on the operations: Solar Financial Model Explained Page 10

11 Financial Metrics The above work lays the foundation to calculate a few simple figures that give us an idea for the relative attractiveness of an investment. These concepts are common for any investment decision, and relate well to investments in renewable energy. Cumulative Cash Flow Payback Period (CCFP) Cumulative Cash Flow Payback Period looks at the net cash flow leaving the business (negative cash flow) versus the cash flow entering the business (positive cash flow) as it relates to a specific investment. Time is the unit measure: How long will it take to recover my out-of-pocket cash? In this case, since money was borrowed to finance the system, we are mainly interested in the timeframe needed to recover the initial net down payment in the installation year. The balance of the system was financed by borrowed money. In Year 0, $27,800 of net after tax cash was invested in the system. In Year 1 (the first year the system is producing energy in this model), $25,300 of net after tax cash is returned to the business. In Year 2, another $15,300 is returned. Therefore, the system breaks even on a net cumulative cash flow basis in Year 2 and generates positive cash flow from there after for 25+ years. The following shows net cumulative after-tax cash flow over the life span of the system. Solar Financial Model Explained Page 11

12 Simple Payback Period (SPB) The Simple Payback Period is a quick, simple way to evaluate how long the project pays for itself. The total cost of the project is compared to how long it takes for the costs to be recovered. It is commonly used and easy to calculate, though has some significant drawbacks. For one, it neglects the time-value-of-money because there is no premium placed on current dollars. Secondly, it neglects the power of leverage. And last, it neglects the return on investment after the initial payback period. Therefore, it can be an interesting metric to calculate, but provides an incomplete picture of the financial return. In this example, the impact of borrowed money is removed from the cumulative net cash flow to show a larger upfront cash need (since no money was contributed by a bank), a higher net after tax cash flow impact (since a loan does not need to be serviced) and a longer break-even timeframe. By Year 6, all costs have been recovered on this project and the project contributes positive cash flow every year after until the end of its useful life. Net Present Value (NPV) The Net Present Value (NPV) of an investment takes into account the time-value-of-money, known as the discount rate. It allows for a present-year valuation of a series of future cash flows, based on an assumed discount rate. The discount rate can be thought of as an annual return on investment your business would be satisfied with for a given investment. The risk profile often influences the chosen discount rate. Solar Financial Model Explained Page 12

13 Solar is a low risk investment. If the sun comes up, the system will produce valuable electricity. Therefore, it can be argued that a relatively low discount rate is appropriate when calculating the NPV for solar. For this example, a nominal discount rate of 7.5% was chosen. The system is projected to generate $663,600 worth of electricity over its 25-year life cycle and a net after tax cash flow of $310,500 once the system cost, tax benefits and operating expenses are factored in. Discounting the annual cash flows back to the present day, the system delivers $104,000 in net present value using the example solar loan (levered NPV). Had money not been borrowed, the NPV would have been $86,500 (unlevered NPV). Borrowing money for this investment magnifies the NPV because the internal rate of return is greater than the bank s interest rate (6%). Solar Financial Model Explained Page 13

14 Internal Rate of Return (IRR) The Internal Rate of Return (IRR) for a series of cash flows is defined as the rate that sets the Net Present Value (NPV) to zero. It can be loosely thought of as an effective interest rate that would return a series of cash flows. Its advantage is its simplicity. If the IRR is greater than the businesses cost of capital, the investment may be attractive. Since finding IRR is an iterative calculation, it is best done with computer software. In this example, the after-tax net cash flows are used to calculate an IRR of 55.3%. The degree of leverage in the project has a large impact on IRR. Had this project been cash financed with no borrowed money, the IRR would have been 15.7%. Solar Financial Model Explained Page 14

15 Levelized Cost of Energy (LCOE) The Levelized Cost of Energy boils all of the above analysis and calculation down into one that is directly comparable to your current electric bill, which is in units of $/kwh. LCOE is a widely used metric to compare alternative energy technologies such as solar (high in upfront costs and low in operating costs) with conventional fossil fuels (lower in upfront costs, but much higher in operating costs). To calculate the LCOE, both the value of the energy (in dollars) and the quantity of energy produced (in kwh) are discounted back to the present with an assumed discount rate. For this example, the same 7.5% discount rate was used as in the NPV calculation. The project returns a Levelized Cost of Energy of $0.048/kWh. In contrast, the blended price of electricity (which does not include any demand charges) from the customer s utility is $0.0703/kWh. These two figures can be directly compared to one another, showing that the LCOE of SunPeak solar is 32% less than conventional energy from the utility. This savings is what drives the positive return on investment conclusions already covered above. It is also important to note that over time, as utility prices continue to rise, the savings between the cost of energy from the utility and the SunPeak LCOE will continue to increase. Solar Financial Model Explained Page 15