Guest blog by Jim Jenal, founder and CEO of Run On Sun
In Part 1 of this series on financing commercial solar power systems we explored the basics—cash purchases and commercial loans. Now in Part 2, we move on to examine the pros and cons of solar leasing arrangements and Power Purchase Agreements (PPAs).
An option that has gained significant traction in the past few years are leases. (Indeed, it is the explosion of solar leasing in the residential market that has fueled the growth of major players like SolarCity and Verengo.) But leases can come with unexpected traps for the unwary and a commercial customer needs to look closely at the details before signing on to a lease agreement for a commercial solar power system.
In a solar lease arrangement the right to use the solar power system is transferred from the owner, referred to as the lessor, to the lessee. From an accounting perspective, all leases are either considered a capital lease (or finance lease) or an operating lease. Generally speaking, “capital leases are considered equivalent to a purchase, while operating leases cover the use of an asset for a period of time.”
When leases are applied to solar power systems, other important considerations apply.
Under accounting standards, a capital lease is defined as “a lease that transfers substantially all the benefits and risks of ownership to the lessee.”
Therefore, with a capital lease, as with a cash purchase or loan, the solar client is treated as the owner of the system and receives the benefits of ownership: utility rebates and tax incentives (if applicable). The capital lease is often for a longer term—the basic criteria is that the lease must run for at least 75 percent of the estimated economic life of the system—that is, between 15 and 19 years or longer.
The longer term can keep payments lower, but because the solar client lessee receives the rebate and tax incentives, the capital lease might carry a higher interest rate than does an operating lease. At the end of the term, the lessee can typically purchase the system at below market cost, perhaps for as little as a nominal one dollar.
In contrast, with an operating lease the solar client lessee does not effectively own the system and the lessor retains the utility rebate and the tax incentives. Rather, the lessee is simply acquiring the right to use the system for a limited time in exchange for periodic rental payments. Typically an operating lease will be for a shorter period of time, and potentially at a lower interest rate. However, at the end of the lease term the lessee either has the system removed by the lessor, enters into a new lease arrangement, or must purchase the system for fair market value.
Power Purchase Agreements
A related, but different vehicle for making use of a solar power system is a Power Purchase Agreement or PPA. As with an operating lease, the solar client under a PPA does not own the system. Rather, they purchase the electricity that the system produces from the system owner. (Presumably at a price lower than what they would be paying their utility for the same quantity of energy.)
Since the solar client under a PPA only pays for the energy actually produced by the system, the system owner has a greater incentive to maintain the system at peak efficiency and the solar client may receive more of the “benefit of their bargain” under a PPA than they would under an operating lease.
PPAs typically contain “escalator clauses” by which the price paid per kilowatt hour generated may increase over time. As long as PPA costs increase more slowly than do utility rate increases, the solar client’s savings will grow over time. However, it is possible under a PPA to actually end up paying more for energy to the system owner than the client would have to the local utility. (Indeed, this possibility is what gave rise to a class action lawsuit against Sunrun.)
Federal Trade Commission Concerns
The Federal Trade Commission (FTC) is the federal agency charged with regulating false or deceptive marketing claims, and solar leasing options can surprisingly lead to unwanted scrutiny from the FTC. The FTC’s concern is “double counting”—multiple entities taking credit for the same environmental benefit. This sort of double counting can occur when a company hosts a solar power system, but does not own it.
The FTC provides this as an illustrative example:
A toy manufacturer places solar panels on the roof of its plant to generate power, and advertises that its plant is “100% solar-powered.” The manufacturer, however, sells renewable energy certificates based on the renewable attributes of all the power it generates. Even if the manufacturer uses the electricity generated by the solar panels, it has, by selling renewable energy certificates, transferred the right to characterize that electricity as renewable. The manufacturer’s claim is therefore deceptive. It also would be deceptive for this manufacturer to advertise that it “hosts” a renewable power facility because reasonable consumers likely interpret this claim to mean that the manufacturer uses renewable energy. It would not be deceptive, however, for the manufacturer to advertise, “We generate renewable energy, but sell all of it to others.”
Deceptive claims are actionable under the FTC’s mandate and offending companies could be subject to enforcement actions and fines. Under either an operating lease or a PPA (though likely not under a capital lease unless the Renewable Energy Credits (RECs) associated with the system are assigned to the utility), the solar client does not own the solar power system and any claim to be “solar-powered” or “using green energy” would be deceptive under the FTC’s guidance.
The original article was posted on the Run on Sun blog.