What’s the best way of encouraging solar power?

Third-party ownership (TPO) has spurred record distributed generation installations across America as homes and businesses lock in cheaper power costs without a large upfront expenditure – but that paradigm is about to change.

Distributed solar photovoltaics (PV) have spread fast across the U.S., topping 12.1 gigawatts total capacity through 2013, with TPO systems representing 66% of the residential market and a considerable portion of the commercial market in 2013. But as solar goes mainstream, new capital investments are spreading fast. Given the typical 20-year lifespan of a solar PV system, picking the right financing option could mean thousands in savings, so which is best?

According to the National Renewable Energy Laboratory, financing PV systems with solar loans are a significantly better financial choice than third-party power purchase agreements (PPA) for both residential and commercial buyers – up to 29 percent cheaper for homeowners and up to 47 percent cheaper for businesses!

Financing Options Spread With Solar’s Surge

High upfront costs traditionally made the TPO decision a no-brainer for homeowners and businesses. After all, if another entity will pay to install your system in exchange for below-average electricity costs through a long-term PPA, everyone wins (except utilities, sometimes).

But even with rapid solar cost declines, owning a rooftop array doesn’t always create economic benefits. Self-financing requires a large capital investment, the ability to navigate state and local incentives and permitting, and sufficient taxable income to fully utilize tax benefits, among others.

Before 2013, few solar-specific financial products existed and self-financing for distributed solar was limited to home equity loans/lines of credit or commercial loans. But this equation has shifted as lenders became more comfortable with solar as an asset class and solar loan products have sprouted among banks, credit unions, and solar companies directly funding projects.

NREL cites at least nine new solar-specific loan programs launched between October 2013 and October 2014, an 85 percent annual increase of invested funds since 2010, and between $10-20 billion potential investment within several years as evidence of the increasing funds available to distributed solar.

Electricity Through Solar Loans Significantly Cheaper Than PPAs

So given this investment influx, how can solar consumers be sure they’re getting the best deal? NREL created three financial models to estimate the levelized cost of energy (LCOE) for residential/commercial PPAs, residential solar loans, and commercial solar loans.

NREL assumed 20-year PPAs, and a 30 percent principal pay down in year one of the solar loans. NREL also built their models assuming solar systems located in California, as declining usage of theCalifornia Solar Initiative fund shows economic feasibility without state incentives, removes variables like lack of incentives or declining funds as state-level solar targets are met, and relies on the federalInvestment Tax Credit (ITC).

A PPA and solar loan both delivered energy savings compared to utility retail rates, but the LCOE of power for a customer owning their own project via solar loan was between 19-29 percent lower than the LCOE through a PPA. This difference is due to a higher cost of capital through PPAs and lower interest rates for 5- and 10-year loans compared to a 20-year loan or PPA.

While these shorter-term loans boost first-year payments to 50 percent more than the cost of retail power from a utility, they also cut annual costs to just operations and maintenance (O&M) by year ten, meaning a solar owner pays nearly nothing for power in the second half of the array’s lifespan.

This outcome is even more significant for commercial customers. LCOE for commercial solar projects financed via solar loans was 43-47 percent lower than through a third-party PPA, and the 10-year loan returned five percent cheaper energy due to interest deductions as well as commercial tax and discount rates compared to residential customers.

NREL also notes while PPAs and retail power rates increase over time with inflation or an escalator, loan payments are fixed meaning customers potentially pay less than even PPA costs during the first few years of loan payments.

Individual Factors Complicate The Loan v. PPA Debate

But even with these rosy projections, several factors complicate the solar loan equation in specific situations, and NREL cautions residential and commercial customers to carefully consider how to fund solar projects. “The most appropriate PV financing option for a particular business depends on the characteristics and circumstances of that business,” said David Feldman, NREL senior financial analyst.

For instance, can the borrower secure an interest rate with annual payments cheaper than a PPA? Is a PPA, considered an off-balance sheet transaction and treated as an operating expense, better for a company’s financial statement than long-term loan debt? Will renewable energy credit (REC) market volatility or unforeseen O&M costs impact long-term solar project returns?

Tax liability may be the biggest wildcard. Homeowners and businesses can both take advantage of the 30 percent ITC, but NREL notes roughly 40 percent of American households don’t meet federal tax liability requirements to claim the ITC benefit, and only a company can expense the cost of a solar project through depreciation.

Will The Solar Industry Adapt To Financial Change?

NREL’s analysis underlines the change solar power is creating across America’s energy system, but it also raises questions about the industry’s future. Where solar customers once wondered rooftop system cost more than it was worth, we’re now debating which financing approach saves the most money.

Borrowing costs fall as consumer lending options increase, meaning distributed generation should keep growing as an option across the U.S. “Lower cost rates provided by the loans could help to make solar power more affordable to more consumers, and more competitive with utility rates in more states,” said Travis Lowder, NREL energy analyst. This factor’s especially important with an expected ITC decrease from 30 to 10 percent in 2017.

But the loan versus PPA debate also shows developers must continually adapt to changing market conditions to stay relevant. GTM Research forecasts solar loans are already supplanting TPO models, and some residential developers like SolarCity are rolling out solar loans, but the larger question remains for developers – can they develop new products to serve an evolving market?

This article is published in collaboration with The Energy Collective. Publication does not imply endorsement of views by the World Economic Forum.

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Author: Silvio Marcacci is the Principal at Marcacci Communications, and author of the Green Growth column at TheEnergyCollective.com.