In 2009, the Ontario government enacted the Green Energy Act (Act). Within the Act, The Feed-In Tariff (FIT) Program was established to develop, encourage and promote a greater use of renewable energy sources including on-shore wind, waterpower, renewable biomass, biogas, landfill gas and solar photovoltaic for electricity-generating projects in Ontario. The prime objective of the FIT Program is to increase the development of renewable energy generating facilities sourced from various technologies.
The FIT program provides a participant with a fixed price of electricity over a 20 year period for every kWh generated, depending on the type of electricity. Specifically for solar developers, the initial fixed rated was up to 80.2 cents per kWh. Since the initial implementation the fixed rate has been reviewed a number of times, with the most recent fixed rates being up to 29.4 cents / kWh for new projects effective January 1, 2016.
Recently, there has been a change from the development of such projects to the commercial realization and operation of such projects. As a result, there has been a marked increase in the need for valuation determinations. The increase in valuation requirements are also driven by a number of other factors, including: consolidation in the marketplace, industry maturation, the sale of projects from developers to operators, third party financing requirements and the restructuring of portfolios to increase operational efficiencies. Given the relative infancy of the Act and of the FIT Program, we have identified a number of unique factors to consider, particularly as they relate to any value subsequent to the expiry of the FIT Agreement.
Typically in determining a value for an operating (“going concern”) business, the assumption is that the business will continue indefinitely. However, the FIT Program guarantees revenues for a finite period of time, typically 20 years. There has been some debate as to whether the value of the project should include some time period beyond the initial FIT period (i.e. a residual period). One argument suggests that the pricing and the cashflows beyond the 20 year FIT period are too speculative, and that any value beyond the FIT Agreement is too remote to calculate.
Others however, argue that there is still some on-going economic value, as the panels are still usable and the cashflows from the project can be determined with some consideration to the underlying assumptions.
As an example, in its most recent annual filing, SolarCity Corporation, a publicly traded company, estimated that its residual value was approximately 30% of its overall value. Given the relative size of the residual value to the overall valuation, there have been numerous analyst commentaries regarding the assumptions used by SolarCity in calculating the residual value.
The determination of any residual value requires consideration of the following factors:
• The options embedded within the lease agreement – lease agreements whereby the lessor acquires the equipment for a nominal amount have limited residual value to the lessee. Depending on the obligations of the lessee, there may be costs related to removing the equipment, remediating the land / roof to a pre-use condition that will need to be considered as an offset to any value determination. Where the lease agreement can be extended at the option of the lessee there may be some ongoing value, depending on the length of the extension and the ongoing economics of the project.
• The future price of electricity – currently the price of electricity is approximately 16 cents per kWh (on peak). The future price of electricity at the expiration of the FIT Agreement ultimately drives the economics of the project. Some have suggested that the future price of electricity will increase in line with the rate of inflation over time. Others have suggested that the most conservative approach would be to use the current rate as a proxy for the future rate to determine the financial viability of the project. In any case, the underlying assumptions regarding the future price of electricity should be clearly stated.
• Lease costs – often the lease costs are tied directly with the term of the FIT Agreement. Leasing costs are often one of the largest expenses in a solar project. There are many alternatives to determining the lease’s costs; from a fixed rate throughout the FIT Agreement to a percentage of the revenue. Upon the expiration of the FIT Agreement, it is important to understand how the lease costs may change: to a market rate, a percentage of revenues, or a fixed cost. The changes in lease costs along with the change in the rate of electricity have the greatest impact on the future financial viability of the project.
• Value of the residual equipment – at a minimum, any residual value should consider the market value of the equipment. There should be consistency between the depreciation period used for accounting purposes and the economic life of the equipment so that one can calculate the book value of the equipment at the end of the Agreement. Currently, there are available black books or trade lists with market values of used equipment. It remains to be seen whether the expiration of the FIT Agreements causes excess supply in the marketplace, whereby the market prices are significantly different than expected.
• Discount rate – the discount rate reflects the risks of achieving the cash flows of the project over time. Over the period of the FIT Agreement, the cash flows are not expected to change significantly as the rate per kWh, any interest costs on debt financing, the lease costs and operational costs are fixed. However, once the FIT Agreement expires, the project cash flows are susceptible to increasing variability and should be reflected in the appropriate discount rate.
It’s important to remember that each project is unique and understanding the specific characteristics of each is necessary in determining its value; only time will tell if the light at the end of the tunnel brings with it an increase in value.