Are Solar Developer Fees Declining?

19 january 2013

 

“Treasury has consistently been racheting fees down” said John Marciano, Chadbourne Parke transactional attorney regarding U.S. Treasury evaluation of developer fees as part of solar energy system costs under its 1603 Grant Program.

The venue was the Novogradac  Financing Renewable Energy Conference held in Washington, D.C. on November 8^th and 9^th. Sponsored by Novogradac, the San Francisco-based boutique tax credit accountancy and Grateful Dead of RE Finance conferences, brought together CPAs, tax attorneys, investors, lenders and developers in its tax credit and finance road show.

Developer fees are profit margin and part of soft costs as reported recently in REW citing a soon-to-be-released NREL report. According to the report, soft costs make up between 41 and 44 percent of a commercial system and “Reducing soft costs is a major goal for the solar industry because it ultimately wants solar energy to price comparably with electricity from fossil fuel power plants.”

And while solar modules have declined in price by over 70 percent between 2005 and 2012, solar developers are sometimes left in the dark, trying to determine whether their profits should be reduced proportionately.

“An appropriate level of development fees  from what we’ve seen might be 15 percent with a range of 10 to 20 percent” commented Tony Grappone, Novogradac CPA partner in the Boston office referencing solar transactions he had advised on.

Treasury Benchmarks – A Clue

Despite dramatic reductions in hard costs, principally solar modules, solar energy remains in a pre-commercialization stage of its life cycle – not yet able to reach grid parity with traditional energy fossil fuels – and dependent on the federal 30 percent Investment Tax Credit and the 1603 Treasury Grant.

The 1603 Treasury Grant expired at the end of 2011, but projects that met Treasury’s ‘Beginning Construction’ test prior to year-end, have until January 1, 2017, the credit termination date, to be placed in service.

Because solar developers remain reliant on those federal subsidies, they are looking for rules of thumb on how to price in their profit  margins. In July 2011, the U.S. Treasury released 1603 grant cost basis benchmarks, included more broadly in its Treasury guidance,  explaining evaluation of cost basis in determining grant awards.

	Residential/Small Commercial	Commercial	Large Commercial/Utility
Size Range	10 – 100 kW	100 – 1000 kW	>  1 MW
Turnkey Price per Watt	+/- $6	+/- $5	+/- $4

Although the 1603 has expired, hundreds of U.S. solar projects that safe-harbored solar equipment, are under Treasury scrutiny during evaluation of project cost basis and developer fees that are baked in. Given the choice, most developers opted for the 1603 Grant over the ITC to increase project cash flow for investors rather than seek out those with tax appetite for a diminishing number of tax equity investors.

Because the 1603 is a grant, rather than a tax credit, panelists felt that developer fees may be under more scrutiny on the front end through Treasury evaluations, rather than what would be a potential future audit under the IRS evaluation of the tax credit.

Avoiding Developer Brain Damage

Treasury benchmarks were issued as of Q1 2011, and while solar installation cost per watt, the industry metric, has declined over the last eighteen months, those benchmarks have not been updated.

Solar developers are pulling their hair out – known in the finance world as ‘brain damage’ – over how to appropriately price in their fees.

During the closing conference session titled “Moving Forward – Leveraging Lessons,” one developer asked about how market pricing should determine his fees, giving an example of a typical 1 MW project that had declined in price from $4.00/W in 2011 to $2.00W in 2012.

	2011	2012
System Size	1MW	1MW
Cost/Watt	$4.00	$2.00
Total System Cost	$4,000,000	$2,000,000
Developer Fee %	10%	10%
Developer Fee	$400,000	$200,000

As the table above shows,  if priced on a percentage basis, developer fees would be halved.  Reductions in developer soft costs – installation labor, customer acquisition, marketing costs, permitting fees, design – along with a project mark-up – have not declined as rapidly as hard costs, reducing developer profits on what were already “skinny deals.”

“Developers might consider a fixed dollar amount, rather than a percentage fee, to bake in, to get around this problem and avoid brain damage,” Grappone added in his closing remarks.