Municipal Bond: PPA Model Continues to Provide Low-cost Solar Energy

19 january 2013

The municipal bond–power purchase agreement (PPA) model might not have just rolled off the lot, but it still has that new car smell. A former NREL colleague first looked into this unique third-party ownership–public debt hybrid financing model last year. Here, I discuss recent applications and provide new insights based on a conversation with James Mann, co-founder and general counsel of Sunlight General Capital.

The municipal bond–PPA model is also known as the Morris Model after Morris County, New Jersey, where the arrangement was first applied. The gist of the model is that it combines the tax monetization benefits of third-party ownership with low-cost capital in the form of public debt. To make use of federal tax incentives, the county government issues taxable bonds and passes the proceeds on to the developer through a lease-purchase agreement. The lease-purchase agreement transfers ownership of the solar installations to the developer and also requires the developer to make payments to the county that are in turn used to pay principal and interest on the bonds. The county government also enters into a PPA with the developer on behalf of the public schools and other municipal facilities where the solar installations will be located. By onlending the public debt to the developer, the county/state government is in effect buying down the developer’s cost of capital and, in exchange, receives a reduced PPA price.

So far, the model has been used to support projects for schools, colleges, county administrative buildings, and other public buildings. The municipal bond–PPA model appears to have been applied only in New Jersey to date. It is quite possible that localities in other states could replicate this financing; for feasibility analysis of 10 key solar markets, see this fact sheet.

Over the past year, six counties in New Jersey have issued request for proposals (RFP) to support eight solar photovoltaic (PV) project portfolios. For each RFP, the counties allowed the respondents to chose from one of three financing mechanisms: (1) PPA (with the projects being financed by outside investors), (2) partial municipal bond financing (the other part to be financed by outside investors), or (3) full municipal bond financing. Interestingly, all except one of the awarded proposals use full municipal bond financing.

Sunlight General Capital will build, own, and operate four of the project portfolios, all of which are qualified to use the 1603 Treasury cash grant and the 50% bonus depreciation (for those facilities placed in service before the end of 2012). The other successful bidders include Tioga Energy and Vanguard Energy Partners.

Sunlight has yet to determine if they will try to monetize the depreciation to tax equity investors. But, as it stands, the projects will provide PPAs at $0.03–$0.10/kWh—a steal compared to local retail electric rates of $0.16–$0.17/kWh.

The bonds have 15-year terms and roughly 4% interest rates and are all guaranteed by the counties in which the projects are located. The New Jersey bonds used for the municipal bond–PPA model are taxable at the federal level (because they are for private use) but exempt from state taxes, providing some tax shelter to local investors.

According to Mann, there is a potential secondary market for the projects, pending approval from the localities. Utilities are one potential strategic buyer and could be attracted to the projects due to their profitability and need to meet renewable portfolio standard requirements.

Why, then, hasn’t the municipal bond–PPA model become a silver bullet?  Primarily it’s the learning curve: municipalities, developers, and lenders must get comfortable with the model and be able to acquire necessary (and extensive) tax counsel. However, based on the sales of the bonds issued under this model, investors, at least, are more than comfortable with this financing arrangement.

A key aspect of the PPA–municipal debt model is, of course, the low-cost financing that might not be viable for municipalities with a less-than-stellar credit rating. And in many places, voter-based debt restrictions could be in place, thereby limiting the ability of local governments to issue bonds that might result in tax increases.

As is the case with most solar PV projects at current installed costs, incentives are needed to make the cost of electricity economical. New Jersey projects were previously buoyed by strong solar renewable energy certificate (REC) spot prices of around $600/MWh. But, these have now sunk to $140/MWh.

With REC prices so low, does the municipal bond-PPA model still have steam left? It’s unclear, but let’s hope it doesn’t have the same fate as the Studebaker Electric.