Solyandra was a Loan Not a Venture Capital Investment

Thursday, Energy Secretary Steven Chu sat through more than five hours of questioning by the oversight panel of the House Energy and Commerce Committee about the failure of Solyndra. He deftly danced around charges of incompetence discussing Solyndra using such phrases such as “cash burn rate”, “start up” and “build up sales,” and said the White House has not lost faith in him. The committee and Secretary Chu seemed to have missed the point. This was a loan guarantee program. This was not a venture capital fund. This was not supposed to be a government investment in Solyndra or any other company (Beacon Power for example), but a loan guarantee program to aid viable projects in obtaining loans to build commercial scale projects.

The federal stimulus bill signed by President Obama expanded Title XVII of the Energy Policy Act of 2005 by adding Section 1705. DOE describes Title XVII Section 1705 as “ Provides loan guarantees to commercial-scale renewable energy projects, that begin construction prior to September 30, 2011 in Biomass, Hydrogen, Solar, Wind/Hydropower, Geothermal, Transmission, or any other renewable energy systems.” This was clearly a loan guarantee.

All loans typically have a primary and secondary source of repayment. The primary source of repayment is demonstrated or reliably projected cash flow. This is cash generated from the business or project. The secondary source of repayment is “conversion of the collateral,” that would be selling the assets of the company. Loan guarantees are necessary when either the primary or secondary source of repayment is impaired. Loans are made with borrowed funds, banks or other lenders borrow money in the financial markets and lend it to businesses at between 0.5% and 2.5% above their cost of funds.

The less risky the loan the less the lender’s spread. A government guarantee would essentially make a loan almost riskless and provide the secondary source of repayment, the U.S. taxpayer. A loan guarantee program provides a guarantee to reduce the interest rate charged and thus the borrowing costs. In order to protect the U.S. taxpayer from excessive losses in the DOE Title XVII Section 1705 loan program, it was essential to make sure the projects had a primary source of repayment, a sound source of cash flow.

The DOE program provided the loan guarantees for free. However, Secretary Chu, the entire administration, the House Energy and Commerce Committee and the press seem to have forgotten that the DOE Title XVII Section 1705 was a loan guarantee program not a venture capital fund. The Solyndra loan appears to have not primary source of repayment, was subject to regulatory and incentive risk and had limited secondary source or repayment. This was not a loan, yet $535 million of taxpayer money was at risk.

Venture capital is equity provided to early-stage, high-potential, high risk, start-up companies. The target return on Venture capital funds is typically 20%-35% and the venture capital investor is buying portions of companies. Venture capital is used to grow and develop companies with limited operating history that have not yet reached the point where they are able to obtain a bank or other type of loan by demonstrating the ability to make a profit. In exchange for the high risks that venture capitalists assume by investing in riskier companies, venture capitalists usually get significant control over company decisions, and a significant portion of the company's ownership (and consequently value). A venture capital fund makes money by selling the equity in the successful companies it invests in.

A Title XVII Section 1705 loan guarantee for $535 million loan guarantee given to Solyndra was not a venture capital investment by the DOE. The DOE took no ownership of the Solyndra, they simply guaranteed the company’s debt. Solyndra had no cash flow from their existing facility and were not profitable. Building a bigger and highly automated manufacturing facility was a wildly speculative attempt to build a market for a more expensive product. Title XVII Section 1705 was clearly a loan guarantee program being misused, not venture capital fund.

SREC Values in Pennsylvania

The decline in Pennsylvania solar REC prices over the past year can be explained very simply by supply and demand. The demand for SRECs is dictated by Pennsylvania’s Alternative Energy Portfolio Standards Act which requires 44 MW of solar capacity in order to meet the solar-carve out for 2012 Compliance Year. (The Pennsylvania Compliance Year is between June 1, 2011 and May 31, 2012). However, there are estimated to be 105 megawatts of solar photovoltaic systems currently registered and certified in Pennsylvania of which only about 36 are actually located in Pennsylvania, which is one of the last states within the PMJ to allow “foreign” SRECS to fulfill their Solar renewable energy portfolio standard.

Solar Renewable Energy Certificates, SRECs, are not real, but merely a credit for having made one megawatt hour of solar electricity that was used elsewhere. SRECS have no intrinsic value. In other words, if there is no buyer for the solar REC, it is worthless. Like most consumer solar arrays I use all the power produced by the panels in my own home, nonetheless, my system generates 10 SRECs a year. Because SRECs are not physical items their value depends entirely on regulation which can change over time and that is the inherent risk in making financial decisions based on regulations. There was always a risk that some (or all) SRECs could become worthless at any time if regulations change.

Solar projects are sold based on state rebates, tax credits and SRECs to make financial sense. Electricity costs would have to be much higher to make solar photovoltaic panels a rational choice without incentives. Many solar projects built within the PMJ service area were sold based on selling the SRECs for the power they produce to make the cost versus return of the projects work as well as the state and federal tax incentives/rebates. The costs of the SREC are ultimately paid by electricity consumers rather than taxpayers. There are estimated to be about 105 megawatts of solar capacity now in place in Pennsylvania, while the 2004 law requiring utilities to buy a steadily increasing portion of renewable power envisions a demand of only 44 megawatts for the current year. The result: SREC prices have crashed within Pennsylvania. The solar industry says the market may remain oversupplied for several years unless the legislature steps in. The solar industry lobbied Harrisburg to accelerate the annual increases for solar-power mandates for the next three years.

Legislation amending the 2004 law has been introduced annually for the past few years. Two bills were introduced this year one in the state senate this past spring and one in the house this month. The senate bill would have increased the solar requirement and banned out-of-state projects from selling their credits to Pennsylvania utilities. This would effectively raise the price and value of in-state SRECs and make the out of state SRECs worthless in Pennsylvania. The legislation was introduced in the State Senate on June 14, 2011 and referred to the Environmental Resource and Energy Committee on that day. It has not emerged from committee and in the current legislative session appears to have no traction. The house bill, HB 1580, introduced in October of this year modifies the solar carve-out requirements for energy years 2013, 2014, and 2015 increasing them from approximately 71 MW, 118 MW and 205 MW to 207 MW, 238 MW, and 290 MW, respectively. This bill also proposes to close the Pennsylvania market so that only in-state systems registered after January 1, 2012 would be able to sell SRECs in the PA market. It appears under this amendment that out of state systems registered before January 1 2012 would be grandfathered. This bill is currently with the Consumer Affairs Committee of the house and has wide sponsorship and support.

The future of SRECs as always is dependent on political and economic environment. For three years Pennsylvania’s lawmakers have debated legislation to increase the state’s Alternative Energy Portfolio Standard (AEPS). Each effort ultimately sank under the weight of amendments- too many, too complicated, too confusing, and too messy. In the 2010 legislative session Pennsylvania lawmakers introduced HB 1128 to increase the solar requirements under PA’s Alternative Energy Portfolio Standards (AEPS). In addition to increasing the solar requirements, HB 1128 was written to amend the program by introducing a fixed alternative compliance payment (ACP) for the Solar PV portion of the AEPS as was done in the Massachusetts program. That bill failed on a roll call vote. It remains to be seen if the current simpler amendment can move forward and what regulatory interpretation of the amendment is if it passes both houses.

The regulatory interpretation of the 2004 legislation ACP was surprising to the solar industry. The regulators assumed that since Pennsylvania accepted SRECs from throughout the PJM region, it was a fair indication of the average price in the region. Therefore, Pennsylvania uses an ACP of 200% of the average price paid for SRECs in Pennsylvania. This was a different interpretation than the SREC market participants expected; that the utilities would be fined based on neighboring state closed market SREC values as well as the reciprocal Ohio market. So as long as there are some market participants willing to accept a low price and the market remains well supplied by allowing out of state participants, there is no price support for SRECs.

However, ACP mandates for 2011-2012 are increasing in other states some of which still have reciprocity with Pennsylvania. So if there are no legislative changes to offer relief the Utilities, and the state rebate monies are all spent there might be an improvement in the Pennsylvania market in the 2013 compliance year without the current bill passing. SRECs are valid for RPS compliance for the year generated and the following 2 years. Remember, though, that DOE recently approved a $1.4 billion loan guarantee to Bank of America Merrill Lynch to support Project Amp; the installation of 752 MW of photovoltaic solar panels on 750 existing rooftop owned by Prologis. This represents more than 80% of the total amount of PV installed in the U.S. last year when the renewable energy solar photovoltaic rebates were widely available. Depending on where these solar photovoltaic panels are installed they could significantly impact pricing and economics in the solar market and the cost of electricity across the nation and could change the SREC economics in all states.