High demand for fixed income has resulted in sustained low yields for investors. Over the past five-years, 10-year treasury yields have ranged from a low of 1.37% in July 2016 to a high of 3.22% in November 2018. Current rates are approximately 2.15%, which is very close to the 52-week low. In spite of a strong U.S. economy, Fed watchers expect rates to fall further before the end of the year. Persistently low rates have encouraged fixed income investors to seek out other sources of returns.
One such source is Distributed Energy Resources (DERs). DERs are electricity producing resources within a local distribution system that are typically connected directly to a host facility. Rather than owned by a utility, a DER may be owned by a business-user, a real estate owner, or an energy / infrastructure investor.
DER examples include solar, wind, cogeneration and biomass, and increasingly include a storage component as well. DERs range in size from several hundred kilowatts up to 10 megawatts or more. As such, DERs are larger than typical residential projects, but smaller than “utility scale.”
Property owners and business operators enjoy several valuable benefits from a DER. First and foremost, a DER reduces the off-taker’s cost of electricity. Typical savings may be 70% or more through improved efficiency and reduced transmission loss. In addition, DER power is more reliable and cleaner than utility-provided power.
Despite the benefits of DERs, hosts may be unable to finance the up-front cost of a DER system. This presents an opportunity for investors to capitalize the cost of a system and generate returns from the electricity cost savings. Such investments are most frequently structured as a secured loan or capital lease.
Typical financing term is seven to ten years, but due to principal amortization the average duration is generally shorter. If the total energy savings is insufficient to provide adequate payment coverage, credit enhancements may be added to reduce investor risk. Such enhancements may include second lien on underlying real estate, cash flow or equity pledge in the business, or personal guarantees.
Yields available for DER financing typically range from 8% to 10% or more, depending on a variety of circumstances, including the “spark spread” (the energy cost savings from the DER), underlying credit, term, and other factors. Given the low risk of repayment, this represents a healthy risk-adjusted return when compared to other fixed income investments.
Though most investors will consider DER financing investments for high risk-adjusted yield, there are a number of additional considerations. Because DERs are sized between residential and utility-scale projects, the investment class is relatively new and underserved. In addition, these investments are Green, and therefore meet investors’ ESG or socially responsible mandates. Finally, DER investments fit energy, infrastructure and renewable strategies.
Distributed energy resources represent a relatively new opportunity for investors. DER investments result in positive social impact and achieve high risk-adjusted returns in a low-yield environment. Windmill Capital Management works with renewable DER developers around the country to source and diligence high quality projects for consideration. Contact us today for more information.