Senator Jeff Sessions of Alabama has opened up an investigation into the financing practices of solar developers like SolarCity SCTY -2.03%.
The concern: that solar companies may have been inflating the value of
their solar installations. Why? In order to siphon more cash out of
taxpayers’ pockets via federal grants and tax credits.
The most generous subsidy program, managed by the Treasury Department
reimburses solar investors a remarkable 30% of their purchase price —
in cash. Alternatively, solar investors can elect to receive tax credits equal to 30% of that price. The Treasury Department has dished out more than $18 billion in cash grants to renewable energy
developers under Section 1603 of the American Recovery and Reinvestment
Act of 2009. More than $4.3 billion of that has gone to solar projects.
This is an invitation to aggressive accounting, if not outright
fraud. The higher the prices that solar developers report to Treasury,
the more cash they can rake in.
The cash doesn’t just flow to solar installers. Those companies,
especially SolarCity, are unprofitable and rely on the likes of U.S.
Bancorp and Google GOOG -0.83%
to fund their solar buildouts. If those partners are putting up the
capital, you can be sure they are the ones enjoying the profits — at
taxpayer expense.
It’s not enough to just get free money from the government. By
systematically inflating the prices of their solar systems (by what
several solar industry executives insist is more than 15% on average),
the installers and their backers could be generating hundreds of
millions of dollars in unjustified cash payouts and tax credits.
Considering that the Treasury’s Section 1603 program
still has some $10 billion in grants available to dole out in the years
to come, this is an issue that needs to be examined and resolved.
***
SolarCity has long been suspected of inflating the “fair market
value” of its solar installations significantly above actual
installation costs. Even before its IPO late last year, SolarCity
disclosed that it was being investigated by the Treasury department for
the practice. Sungevity and SunRun were also subpoenaed by the Treasury
last year.
But SolarCity has been the focal point of investigation so far
because of its skyrocketing market valuation (up 350% in the past year),
leading market share, and its connection to high profile billionaire Elon Musk,
who owns 21 million SolarCity shares, worth about $1 billion. Musk is
even starting to supply SolarCity with battery backup systems designed
at his Tesla electric automaker.
There have been numerous reports on suspect practices over the past two years, but the issue began to snowball this summer. In July the Arizona Republic showed
how SolarCity’s average costs per watt in Arizona were perennially
about 19% higher than its competitors. In August, Barrons published the
expose “Dark Clouds Over SolarCity.”
That prompted Sen. Sessions to launch an investigation, and send a
letter to Treasury Sec. Jack Lew demanding answers to a laundry list of
questions. Wrote Sessions: “In simple terms, there is concern that
SolarCity might become the next Solyndra — a company propped on the back
of the taxpayers, not the product produced.”
SolarCity, in November, published this rebuttal
to the Barrons article, which is well worth reading. Entitled “Burying A
Dead Horse,” it seeks to put the issue to rest, explaining that its
independent appraisers use the same valuation methods as everyone else
in the industry:
The issue in the inquiry is the fair market value of solar assets. We are absolutely certain that we have followed the 1603 Program’s rules and guidance. As we explained above, in applying for Section 1603 grants, we have relied on independent appraisers using well established IRS guidelines, and all of our projects were valued at or below the guidance that Treasury itself had published for the industry beginning in June 2011.
And yet the company and its investors have been at loggerheads with
officials in the Treasury Department over what this fair market value
should be. SolarCity has said in its filings that Treasury has balked at
forking over millions of dollars in grant money that the company thinks
it and its investors are entitled to.
SolarCity explains that to the extent its prices are notably higher
than its competitors, this is simply a function of its different
corporate structure.
“SolarCity is unusual in that it finances, develops and installs the majority of its solar projects. Most of SolarCity’s competitors in the lease and power purchase agreement category don’t build the systems themselves, but rather acquire them from third-party contractors. When SolarCity’s competitors report for the project database, they report the amount they paid the third-party contractor. That is a lower number than the price they sell the system for, but the price is the value the grant or tax credit is based on. In short, Barron’s mistakenly assumed that the system costs reported in published databases like CSI are the same as the fair market values that Section 1603 applicants are allowed to claim. They are not. This misinterpretation contributed to a flawed analysis that appeared to show a much greater difference in price (and by implication, grant or tax credit) than actually exists.”
So in other words, SolarCity’s reported prices (averaging around $6
per watt) naturally should be higher than its peers (about $4 per watt)
because what SolarCity is reporting is the price it gets from selling
solar systems to the investment funds that it co-sponsors, not its own
installation costs. Got it?
With that in mind, consider the findings of Molly Podelefsky, a PhD student at the University of Colorado who published a paper
last month looking at reported solar system prices in California, and
comparing SolarCity’s pricing to other companies’. She found that from
2007 to 2011 SolarCity’s prices were regularly about 28%, or $3 per
watt, more than systems from other companies. She also found that over
that period the costs of “third-party” owned systems (like those built
by SolarCity) averaged 10% to 15% higher costs than customer-owned
systems.
Incredibly, when the Treasury Department opened its investigation in
2012 and subpoenaed SolarCity, those price premiums, according to
Podelefsky’s research, suddenly dropped to nothing. “SolarCity appears
to have completely shifted its third party pricing to bring it in line
with customer-owned pricing,” she writes. Podelefsky is convinced that
SolarCity and others have been engaged in “tax evasion” — inflating
prices in order to get more investment tax credits.
”This result coincides with the hypothesis that when making the decision whether or not to evade taxes, firms are responding to the perceived probability of detection and severity of punishment. SolarCity’s swift reversal on pricing of third party systems suggests the threat of punishment encapsulated in the federal subpoena was a sufficient deterrent to completely eliminate cheating.”
Podelefsky figures that in the years leading up to the federal
subpoena solar companies likely inflated their system costs subject to
tax credits by about $80 million and as a result gleaned some $25
million more in tax credits than the $225 million they were otherwise
entitled to.
As for SolarCity’s talk about “Burying A Dead Horse”? Well if
Podelefsky’s findings are right, that horse might not even be dead yet.
***
Since SolarCity has no profits for the government to tax (in the past
three quarters it lost $95 million on sales of $117 million), the
Investment Tax Credit is entirely useless to the company. That’s why it
partners with big investors with low costs of capital and plenty of
taxable profits to shelter.
And who are these investors? The likes of U.S. Bancorp, Google, PG&E PCG +0.55%,
and even Honda. SolarCity says that since its inception in 2006 it has
raised more than $3 billion to finance its more than 500 megawatts of
solar projects. More than $700 million of that capital has come from
investors injecting capital into off-balance-sheet funds that they set
up with SolarCity. All told, SolarCity and its outside investors have
likely generated upwards of $900 million in grants and tax credits.
SolarCity’s biggest such partner appears to be U.S. Bancorp. In 2012
U.S. Bank said it expected to invest $440 million in renewable energy,
80% of it in solar. The biggest chunk of the bank’s solar investment
appears to be with SolarCity. In 2012 the two companies formed a $250
million solar investment fund, the biggest of six such funds they’ve
formed. Google in 2011 created a $280 million fund with SolarCity.
In basic terms, the investors put up money into a fund in which
SolarCity also has a small stake. SolarCity leverages that cash to build
out solar systems. But once packaged up with a long-term lease and
power purchase agreement, the solar assets are then taken onto the books
of the investment funds. The funds then A. own the solar assets, B.
receive regular cash inflows from the customers who have leased the
systems on their roofs C. enjoy a stream of grants and/or tax credits
from Uncle Sam D. get to deduct system depreciation from their taxes.
(For far more than you’d ever want to know about how these kind of deals
get structured, check out this report and this one.)
What kind of returns do these backers anticipate? Brandon Conard, the
CEO of Greenzu, explains adroitly here, that an average return on
investment for these funds (when they simply follow the letter of the
law) is on the order of 16% per year for the required 5-year holding
period.
How would these funds benefit from buying SolarCity’s systems at
higher rather than lower prices? Because the funds tailor the amount
they invest depending on how much government money they can get. They
typically invest about $1.20 in a system for every $1 in tax credits or
grants.
As explained on Greenzu.com:
Federal tax incentives pay back 60% of the solar system’s installation costs (explained in Solar Tax Incentives Basics in 2013). The investment is structured so that even though the Tax Equity Investor puts in 36% of the capital, it takes 99% of the tax incentives. In our example, a $334,000 system is entitled to a $100,000 ITC credit plus $90,180 (after-tax) from depreciation deductions. In other words, a $120,000 cash investment now earns $190,180 in tax savings over 5 years.
This should make it clear that the entire objective of investors in
these funds is to unlock as much government money as possible. The
higher the “fair market value” the more they can get.
Senator Sessions said he was concerned that SolarCity might become
the next Solyndra. I’m not sure that’s a fair comparison. Solyndra, as
you’ll recall, was attempting to manufacture solar panels not install
them, and in so doing was competing directly against lower cost Chinese
factories not against domestic rivals. And the nature of the
government’s support to the two companies is very different as well. The
amount that SolarCity has generated in subsidies is far more than the
$500 million the Department of Energy loaned to Solyndra. But at least
Solyndra paid back about $135 million of that before it went belly up.
SolarCity has made the case in this
report that taxpayers will eventually be made whole for our generous
subsidies. When you take into account all the tax revenue generated by
system leasing and power purchase agreements over the 30-year lifespan
of the equipment, the “return” to taxpayers should be on the order of
10% per year. Less compelling: when you factor in depreciation
deductions, that return drops to 1%.
There’s nothing inherently wrong or unfair about solar getting a
handout — God knows that the oil and gas and ethanol industries enjoy
billions a year in subsidies while electric utilities
are regulated monopolies. But a little more scrutiny is in order to at
least reduce the fraud and waste that is inevitable when the government
hands out its $80 billion in free money to renewable energy.
If pro-solar politicians really did care about eliminating not just
the temptation to cheat but the ability, then there’s a straightforward
way in which they could restructure solar subsidies. Get rid of the
grants and tax credits. Replace them with a new set of tax incentives
modeled after the Master Limited Partnership structure.
Senator Christopher Coons (D.-Delaware) has written the MLP Parity Act,
which would expand the range of MLPs beyond oil and gas into renewable
energy sources like geothermal, solar, hydropower, fuel cells and wave
power.
MLPs are used extensively in the oil and gas pipeline industry. Those
are businesses with fixed assets that generate predictable cash flow —
pretty much like solar panels. MLPs operate like corporations but are
taxed as partnerships, with income flowing directly to unitholders. And
the tax advantages are significant. In the early years after a capital
investment, much of the income from an MLP can be enjoyed tax-free,
sheltered by big depreciation deductions. What’s more, because of their
tax advantages MLPs enjoy lower costs of capital than regular
corporations.
And vitally, it would be far more difficult for solar installers and
their investors to play shenanigans with MLPs because the only cash
flowing through the structures would be cash generated by solar system
leases — not from government grants. (For much more on MLPs check out
Forbes’ MLP tax guide.)
The idea of a solar MLP has gained the support of a number of
industry bigs like David Crane, CEO of NRG Energy, which has invested
heavily in solar in recent years and this year launched the IPO of a new
publicly traded vehicle called NRG Yield, which aims to distribute
sizable income streams from NRG’s renewable energy portfolio. As Crane
is quoted on Coons’ website: “The MLP Parity Act is a phenomenal idea.
It’s a fairly arcane part of the tax law, but it’s worked well and has
been extremely beneficial to private investment in the oil and gas
space. The fact that it doesn’t currently apply to renewables is just a
silly inequity in our current law.”
The MLP idea might gain some traction depending on what Sen.
Sessions’ committee uncovers. Sessions ordered the Treasury to deliver
documents on the grant program by December 18.
I don’t pretend to have this all figured out. But we should all
be cynical when it comes to the actions and intentions of companies that
are hoovering up billions in taxpayer cash for nothing in return. Please share your own insights by leaving a comment below or emailing me at chelman@forbes.com
http://www.forbes.com/sites/christopherhelman/2013/12/12/dead-horse-or-real-scandal-making-sense-of-solarcitys-lingering-financial-questions/3/?ss=businessenergy
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