Uncovering the Challenges
Threatening the Future of Residential Solar Energy
As a multi-billion dollar industry, Solar Energy business
relies on unstable foundations of easily accessible funds, questionable
financial practices, and aggressive claims for government tax incentives. With
the cost of money on the rise, political uncertainties surrounding subsidies,
and allegations of fraud circulating, a collapse may be imminent.Seated at a sparsely occupied conference table with only 20
chairs in his Houston headquarters, William "John" Berger, the CEO of
Sunnova Energy International, appears calm and self-assured. His pristine white
shirt is partially unbuttoned, and his black hair remains untouched by gray. At
50 years old, this Texas-born engineer, who also holds an MBA from Harvard, has
transformed Sunnova into the second-largest developer of residential solar
power in the country. Their installations, which generate a total of 2,000
megawatts of electricity, grace the rooftops of 390,000 homes. However, Berger
jokingly warns that if you enjoy suspenseful situations, "you've come to
the right place."
Sunnova has experienced a loss of $330 million despite
generating $722 million in revenue over the past year. Its shares are currently
trading at around $10, marking an 80% decline from their peak in 2021. Wall
Street is expressing concern about the company's bonds, particularly its $400
million senior unsecured debt issue set to mature in 2026. Initially offering
an interest rate of 5.75%, the bonds now yield 14%, which is unusually high
even for high-risk investments. Nevertheless, Berger believes that the true
test will come in the event of an economic recession or difficulty in securing
funds (which he fears more than high interest rates). In the worst-case
scenario, he contemplates reducing costs by 50%, ceasing to pursue new business
opportunities, and even stepping down from his position.
Not long ago, the United States experienced a golden age for
residential solar power. In 2022, a record-breaking six gigawatts of peak
generating capacity were installed on 700,000 rooftops, resulting in a
cumulative residential solar power capacity of 40 gigawatts – almost enough to
power the cities of Los Angeles and Philadelphia combined. This boom was fueled
in part by the declining prices of solar panels and inverters, as more
countries, including the U.S., entered the market to compete against China.
Adding to the momentum, President Biden signed the Inflation Reduction Act in
August 2022, which provided a surge of subsidies for renewable energy. This act
increased the solar tax credit from 26% to 30% and extended its duration until
2032, meaning that the U.S. government may be obligated to provide
approximately $8 billion annually for renewable energy incentives for at least
the next decade.Despite these circumstances, the residential solar industry
is facing significant challenges. The sharp increase in interest rates has
dampened both the demand for new residential solar systems, which are typically
financed, and the value of $21 billion in debt issued to install existing
systems. Sunlight Financial, a residential solar financier, attributed its
October bankruptcy filing to the high interest rates. Two days after Sunlight
sought Chapter 11 protection, Sunrun, the largest player in the residential
solar market with annual revenue of $2.3 billion, announced a write-off of $1.2
billion in goodwill, primarily related to its acquisition of Vivint Solar in
2020.
The surge in interest rates has shed light on other issues
within the industry. It has revealed that the industry relies not only on cheap
financing but also on questionable accounting practices and a tax credit system
established in 2005 that has encouraged aggressive and, in some cases,
fraudulent claims. Sunrun, whose stock has plummeted 90% from its peak in 2021,
continues to face pressure from short sellers who accuse the company of
inflating tax credits. As Warren Buffett famously noted, "you don't find
out who's been swimming naked until the tide goes out." In response to
inquiries from Forbes, Sunrun has defended all of its practices as appropriate.The short sellers are not alone in their concerns. A
whistleblower within the industry has reported to the IRS that inflated tax
credit claims are widespread across the residential solar sector. While the IRS
has not made any public statements, the whistleblower's attorney believes that
the agency is investigating the claims, which could potentially result in a
substantial reward of 15% to 30% of any recovered funds.
Gordon Johnson, an analyst at a New York equity research
firm that primarily serves short
sellers, goes so far as to compare the current
predicament of the residential solar industry to the subprime mortgage crisis
of 15 years ago, describing it as a debt Ponzi scheme. According to Johnson,
these companies continually issue more debt to fund projects that do not
generate the expected cash flow.This is not merely a case of short sellers promoting their
own interests. John Berlau, the director of finance policy at the Competitive
Enterprise Institute, a libertarian think tank in Washington, D.C., predicts
that there will be a reckoning in the industry. He believes that due to the
perceived positive nature of the industry, it has not received the same level
of scrutiny as other sectors.
The residential solar industry has always faced a
significant challenge: the high upfront costs associated with installing solar
systems on rooftops. A typical residential solar system with a capacity of 7.5
kilowatts can cost anywhere between $20,000 and $45,000. While the tax code
provides some relief, claiming federal subsidies is not a straightforward
process. Homeowners are eligible for a federal tax credit that can eventually
refund them 30% of the installation cost. However, this credit is
nonrefundable, meaning it can only be used to offset income taxes paid or owed
in the year of installation. Homeowners do not receive a direct subsidy check
from the government, although any unused credits can be carried forward to
offset future taxes. As a result, most families are unable or unwilling to pay
the upfront installation costs out of pocket.
The industry has developed two main solutions, both of which
rely on accessing cheap financing. One approach is to offer creditworthy
homeowners the full installation price as a loan, which they can repay over a
period of 20 or 25 years using the savings from lower electric bills and the
eventual tax credits they receive. Installers sometimes provide these loans at
below-market rates, incorporating the additional interest expense into the
upfront charge. These consumer loans are then bundled and sold as securities.
This was the business model used by now-bankrupt Sunlight and by GoodLeap, the
leading solar loan provider. When interest rates are low, this can be an
extremely profitable business. GoodLeap's CEO, Hayes Barnard, has amassed a net
worth of $3.7 billion, earning him a place on the Forbes list of the 400
richest Americans.
The other approach is an older one. In this model, the solar
installer, such as Sunnova or Sunrun, retains ownership of the solar panels on
the homeowner's roof, and the homeowner enters into a power purchase agreement
(PPA) to buy the electricity generated by the panels over a typically 20-year
period. This allows the solar companies or their investors to claim a 30%
investment tax credit for solar energy. This financing method was losing market
share, but the Inflation Reduction Act provided a boost by enabling the direct
sale of renewable energy tax credits.
Even before the Inflation Reduction Act, solar companies
like Sunrun and Sunnova were able to raise billions by indirectly selling tax
credits to profitable corporations with substantial tax liabilities. These
"tax equity" investors would contribute 30% of the installation cost
and then recoup almost all of their investment within two years through tax
credits. They also benefit from the positive image associated with investing in
green energy and receive additional returns. Major players in this market
include Alphabet, Meta, Bank of America, JPMorgan Chase, U.S. Bank, and Wells
Fargo.
In this financing model, the remaining 70% of the
installation cost is typically covered by debt financing in the form of
asset-backed securities. When interest rates were at record lows, fixed-income
investors eagerly purchased solar bonds that were priced similarly to
high-grade corporate debt. Sunnova has issued $4.5 billion in asset-backed securities,
while Sunrun has issued $3.5 billion over the past decade. However, now that
investors can earn a riskless 5% return on money market funds, they are
demanding much higher yields. The rising interest rates have increased the cost
structure for solar companies, and they are feeling the impact.
