Optimism (and Challenges) With New DOE Grant Program

I've blogged on the grants program before here and here, and recently gave a webinar presentation to the Center for Climate Action covering renewable provisions in the Stimulus act (presentation here)

The expectation for the grants program, once it was up and running, was that it would help to overcome a short-term freeze in the tax equity investment market, reduce the cost of project development in the short-term and ensure a fairly good-sized bump in overall renewable deployment through 2011.  Still, even I was surprised by the sudden and enthusiastic embrace of these cash grants.  Among the highlights of a WSJ article yesterday:

"The money is coming back"

"If we have a quick recovery and we're going like gangbusters again, you could easily get to $10 billion in two years"

"I would not be surprised if the program is ridiculously successful and spurs a huge amount of development"

Given the increased project returns now that thirty percent of a project's capital structure is provided essentially for free (minus any bridge financing costs), industry excitement is understood.  Per the article, investors are now expecting 9%-15% IRR on projects, and privately I'd heard even higher figures.

GreentechMedia and Environmental Capital have good wrap-ups on the news today.  Recognizing that these first publicly announced grants aren't necessarily indicative of future projects, a few additional things caught my eye.  

• Allocation: 0.5% of grants went to solar and 99.5% to wind. I would expect to see a similar phenomenon play out moving forward (although perhaps not as extreme) as wind has deployed up to 20 times more capacity annually than solar and other renewables in the past few years, and wind projects are typically going to be larger and more capital intensive than other projects. 
• Timing: Guidelines from DOE announced that funding would be provided within 60 days from receipt of application. In this instance, DOE starting taking applications August 1, and provided funding 30 days later - a good sign for future application turnaround. 
• Cost: This represents one sixth of the total expected $3 billion cost of the program (per previous DOE statements). As the government has received "thousands of applications" (per Greentech story above), I would anticipate this program overshooting $3 billion fairly soon. 

The official launch of the grants program is welcome news for the renewables industry, which has been struggling in a difficult economic environment, with access to a primary source of funding (tax equity financing) absent.  Although wind has installed 4,000 MW in capacity this year, it's 2009 capacity targets have been cut in half.  The solar industry has similarly needed to overcome slackening demand, reduced prices and other difficulties. 

That said, there are still a few concerns that may need to be watched in the coming months.  Again, this is not to downplay the importance or value of the grants program, but only call attention to potential issues that could need to be navigated in future: 

• Oversubscription: according to the WSJ article above, analysts are now predicting significant oversubscription with this program. Instead of the previously announced expectation of $3 billion in expenditures over the life of the program, industry expectations are now much higher - with investors quoting $10 billion as being possible. This would support $30 billion in total investment (or about 15 GW of wind if all grants go to wind), which is positive, but keep in mind that there is no cap in spending on this program.  
• Impact on State Energy Program: The Stimulus Act provided $3.1 billion in funding through the State Energy Program (SEP), to be used by states to invest in renewable energy and energy efficiency programs. Funding varies per state, with California for example receiving about $226 million, and South Dakota receiving $24 million. Per the announcement above, projects in eight states received funding. Comparing the funding from the cash grant program to the SEP, the ultimate amount in cash grants could wind up overshadowing SEP significantly, as demonstrated by the fact that some states more than doubled their SEP funding in this first round of cash grants.

• Overheated Market: Project returns on renewable projects have varied depending upon the economic circumstances. For wind projects before the recession, tax equity investors could typically see around an 7-9% return after 10 years, and project sponsors could expect about a 10-12% return over 20 years. Now, investors and developers are expecting much higher returns on projects (given the lack of need to monetize tax credits at a discount). While this isn't a bad problem to have, potential supply chain issues, and accompanying inflated turbine, components and land costs could be a challenge down the line.  
• Quality Projects: While there are several (justified) criticisms of the production tax credit, one positive was that as a generation-based incentive, it encouraged efficient projects in high wind areas, and a focus on reducing costs upfront and through the life of the project. Unfortunately this new rebate mechanism could open the door to less-than-optimal projects in poor wind resource areas (i.e. more concern with upfront cost and less with long-term generation potential). Additionally, gold plating, or inflating the upfront cost of a project might present a challenge. Transitioning back to a generation-based incentive would be a more socially optimal outcome.

Still, overall, the launch of the grants program is a welcome boost to the renewables industry and vital if we are to reduce the carbon intensity of power generation in the long-term.  It will be extremely interesting to follow the progress of these grants in the coming months.