March 11, 2015
As seen with third-party solar financing, sometimes the most powerful advancements in renewable energy have nothing to do with new technology and everything to do with new financing.“Yieldcos” are the latest in financial innovations: publicly traded companies that are changing how future renewable energy projects are financed and expanding options available for renewable energy investors.
In 2013, the first yieldco was created as a low-risk renewable energy investment. The financial vehicle acts as a renewable energy equivalent to fossil-fuel-based Master Limited Partnerships (MLPs). Created by parent energy companies, yieldcos are public companies that purchase completed energy projects (mainly renewable) and use the cash flow from plant operations to distribute dividends with low taxation to shareholders. When parent energy companies sell projects into the yieldco, the generated revenue is redirected toward new energy projects.1
Since 2013, yieldcos have been introduced to the market at a rapid pace. Initial public offerings have consisted of NextEra Energy Partners, NRG Yield, Brookfield Renewable Energy Partners, TransAlta Renewables, Pattern Energy Group, Abengoa Yield, Hannon Armstrong Sustainable Infrastructure, and TerraForm Power.2 Just in July, TerraForm Power’s IPO (SunEdison’s respective yieldco) raised $501.6 million.3 In the same month, the NextEra Energy Partners IPO (NextEra Energy’s respective yieldco) raised $442.7 million.4
So why has this financial vehicle become so attractive so quickly? There seems to be no slow in yieldco IPOs; in late February, the two largest solar panel producers, First Solar and Sunpower, announced that they were considering a joint yieldco. On the day of the announcement, First Solar’s stock rose 10.2% while Sunpower’s jumped 18%.5,6 The First Solar and Sunpower yieldco will be named 8point3 Energy Partners, initially consisting of 432 MW of U.S. photovoltaic projects.7 Concurrently, Canadian Solar is planning an IPO for late 2015; its intention is to create a global yieldco with operating assets in North America, Japan, and Europe.8
There are two main reasons that explain the rapid rise in yieldcos. Credit Suisse investment banking director Christopher Radtke has postulated that their attractiveness is due to a lack of yield opportunities in the United States and a beneficial tax structure.9 U.S. treasuries remain at a near-zero interest rate, and corporate and municipal bonds provide little yield compared to the 5.5% yield typically offered by many yieldcos at the IPO stage.10 In addition to the higher yield, a large percentage of yieldco portfolios are composed of projects that historically qualified for the cash grant from the Section 1603 program before its 2012 expiration. The program allowed cash to flow into yieldcos without involving tax equity deals that are usually associated with passive ownership interest in assets and projects.11
Sean Wheeler, partner of the law firm Latham and Wheeler, wrote that yieldcos serve as “vehicles for investors seeking stable and growing dividend income from a diversified portfolio of lower-risk high-quality assets.”12 Yieldcos remove the risk that over the years has been associated with renewable energy investments. Instead of relying on early stage, high-risk investments, yieldcos take regular cash flows from already established projects. Wheeler writes that, in terms of growth, quarterly dividends for yieldcos are expected to increase 20% within the first 18 months, with the yield at the IPO stage being approximately 5.5%.13 Per quarter, dividends are expected to be in the ballpark of 70%–90% of cash available for distribution.14
Dr. Shawn Qu, chairman and CEO of Canadian Solar, has stated that a yieldco will “maximize value creation for our shareholders over the long-term.”15 Other executives are in agreement: SunEdison’s CFO, Brian Weubbles, declared that a yieldco could generate 2.5 times the revenue it would from selling completed projects to an unrelated corporation.16
Are yieldcos really this appealing as an investment vehicle?
The performance and attributes have attracted a number of proponents, energy executives and investors alike. Marley Urdanick of the National Renewable Energy Laboratory wrote this past September that “since 2013, yieldcos have acquired over 8 GW of assets in their portfolios (renewables account for 78%) and have raised a total of $3.8 billion.”17 An estimate drawn from Urdanick’s numbers indicates that each additional GW within a yieldco is worth roughly $500 million. In 2015, many more GWs will be added to that figure with the growth of existing yieldcos, along with the creation of Canadian Solar’s yieldco and 8point3 Energy Partners. How many GWs is unknown—while 8point3 Energy Partners is planning to begin with just 432 MW, the yieldco will have right of first offer on six projects currently under construction and totaling 750 MW.18 More growth may even be expected for 8point3 since First Solar has 1.5 GW worth of projects, currently unsold, and Sunpower has an estimated 4 GW worth of portfolio projects to be finalized by 2019.19 The growth potential is a contributing factor to why yieldcos have become so attractive.
But let’s take a look at the risks. Skepticism is not to be ignored, considering that yieldcos—structured to be decades long investments—have been around for less than two years. Tom Konrad, of the JPS Green Economy Fund, has pointed out that some of the excitement surrounding yieldcos has pushed their stock prices up high enough that their “yield” may not be worth the investment; however, it is probable that the market will adjust over time to a stock price reflective of the 5.5% yield cited by Wheeler.20 Gerhard Hinse, a managing director of SunPower Corporation, also acknowledged the risk yieldcos face as interest rates change. Hinse noted that if there were to be access to cheaper forms of capital, yieldcos (even one like 8point3 with multiple rights of first offer) may be outbid in their attempts to acquire new projects.
Another risk Konrad presented is product lifetime, by questioning “will solar panels still be producing power twenty years from now?”21
Konrad poses a valid query, especially considering that in recent years most solar panel production has been outsourced to China, where many companies have begun to cost cut with cheaper materials.22 Defect rates are a reality associated with solar; Solarbuyer of Marlborough, MA, found a defect rate of 5.5%–22% in a 2012–2013 audit of 50 Chinese solar manufacturers. Even First Solar, a parent to the future 8point3 yieldco, set aside $271.2 million in the past to replace defective modules produced in 2008 and 2009. If defect rates are higher than anticipated, it is likely that yieldcos will have to set aside additional capital for infrastructure maintenance, resulting in a decrease of projected dividends.
There is future risk associated with every energy option. A question to challenge Kondrad’s is, What will the state of current energy sources be even ten years from now?
While the probable need to replace solar panels is a risk for solar companies, fossil fuel companies are facing even riskier future scenarios. Currently, fossil fuel companies have the equivalent of 2,795 gigatons of CO2 in reserves; only an additional 565 gigatons worth of CO2 can be burnt before a 2°C increase presents detrimental climatic effects for human survival. The difference between the 2,795 gigatons of CO2 in reserves and the 565 gigaton CO2 buffer is referred to as “unburnable carbon.”23 It is extremely likely that future policies within the next decade will address the issue of unburnable carbon—perhaps in the form of a carbon tax— which will, in turn, be reflected in fossil fuel investments.24 Continuation of fossil fuel investments, such as MLPs, is infinitely riskier over the long term (for both the climate and investors) than the quality of solar panels in yieldcos is today.
Konrad’s suggestion to combat yieldco risks associated with equipment longevity, as well as every other risk associated with yieldcos, is to diversify. Diversification in regards to project technologies, suppliers, and geographic locations of yieldco portfolios will diminish risks. In coordination with this suggestion, Konrad advises avoiding smaller yieldcos (due to their inherently slighter diversification) and investing across multiple yieldcos.
Executives and the market have picked up on these risks. SunEdison acquired First Wind for $2.4 billion this past November to expand its portfolio beyond solar.25 Yieldcos have even moved away from the basic renewables of solar, wind, hydro, and thermal sources and resorted to diversification with fossil fuel sources, as in the case of Abengoa Yield and NRG Yield.26 Dr. Shawn Qu, of Canadian Solar, confirms how essential yieldco composition is, stating that Canadian Solar is currently, “engaged in the process of analyzing the optimal structure for a yieldco, including the optimal asset profile.”27
Sol-Wind has come to know this thinking all too well. The company withdrew its $100 million yieldco IPO registration in early February; those close to the deal cited cash available for distribution as too small to be worthwhile, again confirming the necessity for a large size in yieldcos.28
The connection between size and diversification is likely why First Solar and Sunpower have teamed up to form the future joint-yieldco, 8point3 Energy Partners. In terms of attractiveness to investors, the bigger the yieldco the better. While both companies are of substantial size, and could likely create their own yieldco, there doesn’t appear to be a downside to sharing a yieldco if the desired structures are similar, especially in an environment following a Sol-Wind yieldco IPO withdrawal.
And while yieldcos are inarguably attractive (a conclusion based on executive and investor reactions), perhaps the rapid spread of yieldcos is simply due to their increasing market saturation. Are all the big energy companies forming their respective yieldcos because their competitors are? Is there a mad rush to find projects for a yieldco portfolio before another corporation claims it? Qu of Canadian Solar has said that the company’s future yieldco is considering adding assets from third parties.29 At this point, without a yieldco, an energy company selling a completed project to a third party is likely to be selling to a yieldco.
There are many reasons yieldcos are compelling, and they appear to be here to stay. It is a financial vehicle that is mutually beneficial to investors, companies, and the future of renewable power generation. Taking the risk out of renewable investments is increasing the capital available for future renewable energy projects. Indisputably, it’s time to yield to the yieldco.