20 Nov

Advantages of a Power Purchase Agreement vs. an Operating Lease for Non-profits

All non-profits stand to benefit more from third party financing of their solar arrays than purchasing them to own. The reason is because if a non-profit purchases a solar array it cannot take advantage of the tax incentives. The Federal Investment Tax Credit for solar arrays effectively writes down the cost by 30%. Through third party financing that cost savings is passed on to the non-profit through the sale of lower cost electricity under a Power Purchase Agreement or in a fixed monthly payment for an Operating Lease. Both financing tools enable the customer to avoid the large upfront capital expense associated with purchasing the system while immediately lowering electricity expenses. Under both a Power Purchase Agreement and Operating Lease the long-term operations and maintenance service is also provided by the third party system owner. Through the use of third party financing of solar, non-profits can reduce their expenses and free up revenues that can then be redeployed in support of their mission.

With an Operating Lease the customer makes a fixed monthly payment for the duration of the term of the lease, usually 5 to 15 years. With a Power Purchase Agreement the customer is buying the energy produced by the solar array at a stabilized cost per kilowatt hour for the duration of the term of the agreement, usually 20 to 25 years. So, which of these financing tools provides the greatest benefit to non-profits? The answer is a Power Purchase Agreement for the following reasons:

1. The Power Purchase Agreement provides a lower cost for the customer. This is associated with the length of the term of the agreement. Both the Operating Lease payment and the Power Purchase Agreement payment are determined by the cost of the system. Since Power Purchase Agreements are longer than Operating Leases the total cost of the array can be spread over more payments which reduces the cost of each payment. Think of the difference in monthly payments between a home mortgage amortized over 30 years versus one amortized over 15 years. It is the exact same concept.

2. The purchase option at the end of a Power Purchase Agreement is lower. At the end of the term the non-profit has the option to purchase the system at fair market value. The fair market value of a 10 year old solar array is going to be significantly higher than that of a 25 year old solar array. Think of a used car. At the end of the Power Purchase Agreement the array can be purchased for a lower amount and used for many more years to come.

3. The Power Purchase Agreement is less risk for the non-profit. Operating Lease payments are fixed each month for the entire term of the agreement. Since solar electricity production varies depending on the weather, the effective cost per kilowatt hour of electricity also fluctuates with an Operating Lease. This places all of the downside risk of the system’s performance on the non-profit. If the solar array produces less than expected for a given month, the non-profit will have to purchase more electricity from the utility provider to meet its needs while still paying the fixed monthly lease payment. This can inadvertently cause a higher total cost of electricity. Granted, the reverse is true if the system produces more electricity than expected which benefits the non-profit. However, since the lessor of the system will only receive the fixed monthly payment under either scenario, there is no added incentive for the lessor to ensure a high level of maintenance leading to greater production levels. In fact, purely from a profit motive, the lessor is incentivized to reduce costs by spending less on maintenance thereby increasing profits at the expense of the system’s production efficiency. In the end, the customer bears the risk of production whether that is associated with maintenance issues or atmospheric conditions.

On the other hand, the Power Purchase Agreement aligns incentives between the system owner and the non-profit. The non-profit wants to reduce its energy costs by purchasing more solar electricity which is priced below the utility’s cost of electricity. The system owner wants to ensure the system is producing optimally so that it can sell that electricity to the non-profit. If the system under produces the non-profit only pays for the electricity that was produced and the system owner loses out on that additional revenue. For that reason, the system owner is financially motivated to ensure a high level of production efficiency and provide the level of savings the non-profit expects to receive.

Clean Footprint is an Independent Power Producer supplying solar electricity to customers through the use of Power Purchase Agreements. We do not use Operating Leases for project financing. The vast majority of third party owned solar arrays are financed using a Power Purchase Agreement because it aligns the interests of the system owner and the non-profit.

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Kurt Easton

Kurt Easton

As a Managing Partner of Clean Footprint and professional Urban Planner with over 25 years of consulting experience, Kurt has an extensive background in both public and private sector initiatives. His experience provides valuable insight into public/private negotiations for renewable energy development. His network of municipal contacts through the Florida Redevelopment Association and Florida League of Cities enables direct access to decision makers for the successful development of solar PV projects throughout the State.Contact Kurt at kurt.easton@clean-footprint.com.