Google, KKR Deal on Fringe of Solar's Future (Update 1)

(Google, KKR solar story updated for comments from Recurrent Energy CEO Arno Harris)

NEW YORK ( TheStreet) -- It seems lately that every investment in solar has to be the proof that solar is economic without government help and a part of the long-term energy future.

Maybe it's the long tail of Solyndra at work. If so -- and it shouldn't be so, because Solyndra was an example of failed manufacturing and not failed energy generation, one of Solyndra's private equity investors, KKR ( KKR), is doing its part to undo some of the damage inflicted on solar's reputation as an economic energy source.

KKR announced on Tuesday that it has teamed with Google ( GOOG) to invest in 88 megawatts of solar power plants being built for the Sacramento Municipal Utility District (SMUD). The solar power plants are being constructed with the help of Sacramento's feed-in tariff (FIT) scheme, under which a government body can authorize the "feeding in" of renewable energy to the grid at a pre-determined rate.

The solar power plants are being developed by Sharp's U.S. renewable energy company, Recurrent Energy.

"The investment is a clear demonstration of solar's ability to attract private capital from well-established investors like Google and KKR," said Arno Harris, CEO of Recurrent Energy in a release. "This transaction provides an example of the direction solar is headed as a viable, mainstream part of our energy economy."

If the deal is an example of the direction solar is headed in, it's likely to be an isolated example. And that's because it relies on the FIT structure that has been a niche approach to solar from a select group of local municipalities in Texas and in Florida, as well as Vermont, as opposed to a main source of solar deployment throughout the U.S.

Every example of major investors like Google and KKR stepping up to invest in solar is an example, but it needs to be framed within the reality of the long road to being a major part of the U.S. energy landscape, and it's difficult to see FITs being a key large-scale mover.

In an interview with TheStreet, Harris said that the FIT program probably does not represent the future for solar in the U.S., however, a viable industry has to have "pillars of support." He added that more important to solar than the deal's structure is that it is representative of mainstream investors finally investing in a significant way in what had been a "backwater of the capital markets."

In the past month, there have been two investments by Warren Buffett's Berkshire Hathaway ( BRK.B) energy subsidiary, MidAmerican Energy, in solar projects created by First Solar ( FSLR), and in each case, there has been fanfare about Buffett endorsing solar. What's needed -- in both the Buffett case and the Google/KKR case -- is some balllparking of the investments relative to the larger energy landscape. For renewable energy stock investors, there is also risk of equating attractive deals for institutional investors with a general endorsement of renewable energy.

Take the acquisition by Buffett's MidAmerican Energy of First Solar's Topaz project and a 49% stake in the First Solar constructed Agua Caliente project owned by NRG Energy ( NRG), Buffett's first major foray in solar.

The key issue to watch going forward is whether MidAmerican remains active in solar where economic incentives for investors are disappearing. In a way, Buffett's Berkshire was running out of opportunities to get into solar on the most attractive economic basis, with a Treasury cash grant program that both of these First Solar projects qualified for ending at the end of 2011, and in the case of Agua Caliente, an expiring type of federal loan offering cheap debt financing.

With the end of the Department of Energy loan guarantee program -- though Buffett's energy company did buy the Topaz project without a federal loan supporting it - and with the cash grant program that covers 30% of a project's cost expiring, how solar is financed once these programs are gone is the key, not the last "solar land grab" of those type of legacy projects.

Berkshire Hathaway, and any other buyer of solar projects, will also be scouting solar projects that offer less attractive equity returns in the future, as the value of power purchase agreements (the contract with a utility to buy the power from the project) decline.

Reservations can also be voiced of the Google/KKR deal with Sacramento. It's a step, but a small one, considering the relative footprint of FIT programs in the U.S. A national feed-in tariff program has always been viewed as a non-starter in the U.S. given the utility structure state by state and city by city and with local rate payer boards representing utility customers, and those boards by and large balking at schemes that could force higher electricity rates on consumers.

The FIT program was the main financing mechanism for solar in Europe, and it worked well because it generated a generous rate of return for the equity investor selling the electricity to the grid.

Yet now at a time of austerity budgets in Europe, the rug has been pulled out from under many FIT schemes. In some cases, the returns of equity investors (like KKR is in this case) has created a political firestorm. The high rates of return to the equity investors can mean higher electricity expenses being passed on to electricity consumers. Spain retroactively rescinded "good as gold" FIT program incentives last year. With municipalities across the U.S. also facing a budget crunch and the European example a problematic one, it makes a widespread rollout of FIT schemes seem like a tough sell in the U.S.

Recurrent Energy's Harris said that it is KKR's infrastructure group investing in the solar power plants, and their goal is a low-risk, low-return portfolio, as opposed to the other end of the private equity spectrum. The Sacramento utility lists the price to be paid for electricity per kilowatt hour during "summer on peak" period ranging from 7.8 cents to 9.1 cents/KWh for FIT contracts. By contrast, the price per kilowatt hour for conventional natural gas-powered energy would be 5.6 cents to 5.8 cents during peak periods, according to data from the Sacramento utility.

Harris said there will continue to be questions around the issues of natural gas pricing and what price we as a nation are willing to pay for renewables and the "clean portion" of energy, including the avoidance of carbon costs.

"We struggle to answer these questions, and the path is driving costs down so renewables are increasingly at parity and that makes the questions begin to fade and the difficulty disappear," Harris said.

Early attempts to create FIT programs in the U.S. also posed legal questions related to the role of the federal government and Federal Energy Regulatory Commission (FERC) in regulating power rates under interstate commerce law.

"Municipalities are in general risk-averse now," said Stifel analyst Jeff Osborne, who added that several of the public companies in the renewable energy market that he covers, and who sell to municipalities, have seen a softening of business in 2011.

The primary example of the local FIT scheme in the U.S. is the Gainesville, Fla., municipality, but it's one of only a few FIT programs. Osborne says the future of solar financing in the U.S. is likely to reflect this limited role for FIT programs. "What normally drives demand is tax equity or a cash grant," Osborne said.

There are additional reasons to expect the FIT will have a limited role in the deployment of solar in the U.S. beyond the austerity budget concerns and the role of rate payer boards in the utility business across the U.S. and on a local basis.

For example, the major deployment of solar has come through renewable portfolio standards in states, including California, where investor-owned utilities had been required to increase electricity generated from renewables up to 20%. "Municipal utilities is a tougher market to sell into compared with investor-owned utilities," Osborne said. Though municipal utilities are now included in the new renewable portfolio standard in California which mandates 33% renewable generation by 2020.

Harris added that for the time being, "The only way we get the kind of money needed to transform the grid and develop billions of dollars in solar projects in the U.S. is to provide a rate of return that is attractive, and that's a good thing."

The investment from Google and KKR is a positive for solar, but as Osborne remarked, "It's a sign we are moving forward but FITs won't be a mainstream market in the U.S. FITs will be on the fringe."

-- Written by Eric Rosenbaum from New York.

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