RE-energizing the US

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Expiring tax credits, cheap shale gas, and congressional gridlock have painted the picture of a US renewable energy market in crisis. Yet with a flourishing solar market, changing energy dynamics and signs of a reinvigorated capital market, it may still be the land of opportunity.

Dash for gas: friend or foe?

The US renewable energy market’s fate has become closely intertwined with shale gas, with increased extraction activity and low prices weakening the appetite for renewables, and its relative cost-competitiveness.

However, the pending retirement of 45GW of coal-based capacity could change this, not only increasing demand for renewables but also pushing gas prices up as demand increases to fill the gap left by coal. The potential to increase gas exports to Europe in the wake of the Russia-Ukraine conflict could also increase the need for domestic renewable energy, though more speculative and long-term. Credit Suisse forecasts that 85% of future demand growth for power through to 2025, including the impact of coal retirements, could be met by renewable energy, representing over 100GW of additional capacity.

Also, the US gas boom does not necessarily conflict with the green agenda. Gas-fired generators’ ability to scale output hourly provides the flexibility to integrate more variable supplies from wind and solar projects into the grid. Increased gas price volatility should also create greater diversity, given that stable renewable energy prices can be visible through 25-year contracts compared to typical gas price hedges of just 5 years.

Blown off course, but back on track

The US wind market is currently recovering. The late renewal of the production tax credit (PTC) in early 2013 had stalled investment decisions in 2012 and reduced build-out activity in early 2013. However, last year’s changes to eligibility criteria have extended the PTC’s benefits to 2015, prompting a significant construction pickup in late 2013. According to MAKE, more than 19GW of new capacity was under development by March 2014, for installation by 2016.

Efforts are now focused on renewing the PTC, which many see as critical to sustaining medium-term growth. Positively, both the PTC and investment tax credit (ITC) have been included, with bipartisan support, in a broader tax extenders package that would see the construction threshold pushed out to 2015, though there is some skepticism as to whether the bill will be passed ahead of the November 2014 midterm elections. However, with the unsubsidized levelized cost of electricity (LCOE) for wind projects expected to reach grid parity in key US markets in 2016 and most of the country by 2023, wind deployment’s long-term prospects are still good after a potential slowdown in 2017 to 2018. Looking further ahead, the IEA forecasts 154GW of wind capacity in the US by 2035, up from 59GW at the end of 2013.

Solar to let: downsizing triggers growth

While the long-term prospects for wind indicate recovery and then growth, the US solar market’s buoyancy is more obvious. It hosts some of the world’s largest projects, and the IEA forecasts 99GW of solar power by 2035, compared to just 13GW at the end of 2013.

However, the market is also accelerating toward residential and commercial rooftop applications, with demand for utility-scale projects slowing as an increasing number of states meet renewable portfolio standard (RPS) obligations. Goldman Sachs expects the rooftop market to grow 45% a year between 2013 and 2016, compared to just 8% for large-scale solar installations.

This shift has also been driven by the US’ solar leasing business model, which eliminates up-front panel installation costs and provides rental cash flows for the leasing company. SolarCity and Sunrun have pioneered this model to date, though it is rapidly gaining traction across the country. At least 22 solar lease funds, totaling about US$3.34b, were raised in 2013, according to Mercom Capital, and in April this year, SunPower and Google unveiled a US$250m solar leasing program.

50 shades of green

 

Country-wide capacity projects and high-profile federal level political wrangling make it easy to forget the US is not one market but 50, many of which are larger than entire European countries.

In addition to varying levels of natural resources, each state has different targets, incentive programs, electricity pricing, infrastructure quality and fossil fuel exposure. While this makes it more difficult to immediately identify the most attractive sites, it also significantly expands the range of deployment and investment opportunities.

Mandatory and voluntary RPS targets are in place for 30 and 8 states respectively, and although many have already met near-term obligations, some are now pulling in renewable energy-supported demand from later in the decade.

Texas surpassed its RPS long ago but is still expected to install more than 8GW of wind power in the next three years, largely driven by a power capacity reserve margin forecast to be negative as early as this year. A 2GW deficit by 2016 is also projected for the MISO network serving the northern Plains states. While most other markets currently have sufficient capacity, several states will start to breach the reference margin levels by 2023 according to MAKE Consulting, triggering a need for new capacity.

Political push in the right direction

Bipartisan politics’ adverse impact on the creation of a stable, long-term US renewable energy policy is well known and unlikely to change soon. However, a renewed focus on President Barack Obama’s “all of the above” approach to energy and an apparent push on climate change mitigation measures are sending encouraging signals that should boost deployment and confidence.

Climbing capital hill

No to policy uncertainty, yes to capital

Policy uncertainty over issues such as the PTC and ITC incentive regimes are, however, continuing to drive unhealthy boom-bust cycles, and clarity is needed to help stakeholders make long-term energy project and offtake decisions.

Yet, with uncertainty over the phasing out or expiry of tax credits still prevalent — having already technically occurred for wind, and scheduled for the end of 2016 for solar, when the ITC is expected to drop from 30% of project value to 10% — the sector will need to drive down costs and take advantage of changing energy mix dynamics to prosper in a post-subsidy environment. The expiry of tax credits will also likely prompt the withdrawal of tax equity financing, creating a need, and opportunity, for new sources of capital. And lots of it.

Goodbye tax equity, hello silver lining

To be clear, tax equity is still likely to fund the vast majority of US’ renewable energy activity in the short to medium term. However, given the time and expense associated with structuring projects to attract tax equity investors and the complex requirements that have resulted in fewer than 20 active investors, the market is eager to explore innovative vehicles and capital sources for original financing and refinancing.

The National Renewable Energy Laboratory (NREL) estimates that by 2017, 20GW of wind and solar projects will be past their recapture period (the minimum time tax equity investors must hold onto their asset to avoid a clawback of benefits) and could be suitable for refinancing. It forecasts that wind projects in 2013 alone could represent US$10b in freed up capital for reinvestment.

Read our full article for an overview of the latest financing trends in the US and the opportunities these are creating for developers and investors both in and outside the US.

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US energy market at a crossroads

Boom–bust cycles triggered by the expiry of key tax credits and reactive policy-making, the realization of RPS obligations and the impact of cheap shale gas on renewable energy’s march toward grid parity threaten to dampen deployment and depress investor appetite.

But there is another path. Characterized by greater policy certainty, innovative business models that leverage the scale and diversity of deployment opportunities at a state level, and attractive funding models for a broad range of investors, this path must be actively chosen by stakeholders across the sector.

In return, the renewable energy value chain will profit from increased demand and cheaper capital, investors will secure long-term, stable returns, and the US economy as a whole will benefit from a more secure and resilient energy market — particularly critical in light of the increasingly devastating impact of natural disasters such as Hurricane Sandy on infrastructure and business continuity.

But this path should also be open to the international community. It’s food for thought that only 20% of foreign direct investment into the US currently goes toward greenfield investments, compared to 50%–60% in China. Given that renewable energy represents only 8% of US electricity generation (excluding hydro), there are significant opportunities for foreign businesses, large and small, to participate in the US energy revolution.

The path is set; the choice must now be made.