Uncovering the Challenges Threatening the Future of Residential Solar Energy

 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.