Over the past few years a new investment vehicle has emerged in the energy sector: the Yieldco.
Yieldcos are similar to Master Limited Partnerships (MLPs) or Real Estate Investment Trusts (REITs) in that they pay out the bulk of their earnings to investors in the form of a dividend.
However, Yieldcos primarily own renewable energy assets, such as solar or wind generation.
Reliable Income
Typically, the future electric generation from these assets has been hedged for a period of about 15 to 20 years via power purchase agreements (PPAs).
These PPAs ensure a steady, reliable income stream that can be paid out to Yieldco investors.
Renewable energy project developers like Yieldcos, because they offer access to a lower cost of capital to finance new projects.
Yield-starved investors, meanwhile, like them because they seek to offer attractive dividends in a low-yield environment.
Public Offerings
One of the very first publicly traded Yieldcos was NRG Yield (NYLD), which went public in the summer of 2013.
Other companies followed, including Terraform Power (TERP) and NextEra Energy Partners (NERP).
Enthusiasm for Yieldcos grew until the first half of this year, when concerns arose that too many Yieldcos were chasing too few renewable energy projects.
That trend, in turn, bid up prices for renewable energy assets to the point that made the underlying economics tenuous.
Valuation Worries
At the same time, there was a general sense that Yieldcos were significantly overvalued, and since then prices have fallen, in some instances by more than 50 percent.
I have multiple concerns about Yieldcos even after the recent decline.
The first is that the true market value of Yieldco assets has been significantly distorted by regulatory incentives, and therefore is hard to determine.
Tax Incentives
The current Investment Tax Credit (ITC) for energy has granted a 30% tax credit for solar development, and encouraged economically marginal projects to get developed.
Much of the output from these Yieldco assets has been sold to California-based utilities trying to meet state mandates for procuring electricity generated by renewable energy assets.
Many Yieldco assets are not viable without taxes, mandates, and regulations.
Once existing purchasing price agreements (PPAs) expire, the value of intermittent, unreliable solar and wind generation assets might be more closely tied to their market value in the wholesale electricity markets.
Regulatory Risk
In fact, one concern I have is that current regulatory incentives that encourage the development of solar generation projects will lead to over development and excess generation during the hours when solar power generation is most viable.
With enough solar generation, the value of power in the wholesale electricity markets might peak during the night, or when the sun is not strong, and then fall precipitously during the afternoon.
In the future, I believe that the residual value of Yieldco assets after their current PPAs expire might be significantly lower than today.
Death Spiral
I also have some concerns that future payments made to the Yieldcos via PPAs may not be as safe as perceived.
A couple of years ago the phrase “utility death spiral” came into vogue.
It described the feedback loop that occurs when electricity customers, encouraged by net metering schemes, decide it makes economic sense to install solar panels on their roofs.
The utility responds by increasing rates for the remaining customers without solar panels, which only encourages more defections.
Utilities are forced to cover the costs of maintaining their infrastructure, which customers with solar panels continue to rely on, across a dwindling number of customers without solar panels.
Uncertain Future
The future financial well-being of utilities that signed PPAs to purchase electricity from Yieldcos, particularly in California where the rollback of net metering is a political nonstarter, is far from certain.
I believe some Yieldcos are better than others, particularly those holding assets based on several different generation technologies, not concentrated in one geographical area, and whose output is hedged with long term PPAs.
In general, however, I feel that Yieldcos don’t offer a compelling investment opportunity right now.
Photo Credit: Chuck Corker via Flickr Creative Commons
