There is general agreement that, below a certain size, the transaction costs of a renewable energy project become prohibitive relative to the scale of the benefits. Typical transaction costs include the time and cost involved in:
- The many legal documents and agreements – land leases, power purchase agreements, financing, agreements among partners and owners, construction documents
- The due diligence for financing the project
- Permitting and zoning
The problem is the cost and time required for these steps do not scale with the size of the project. There is a huge fixed component to each of them. They are substantial enough that even mid-scale projects – 500 kW to 2 MW wind or solar – suffer from the effect of these costs. So although there may be a huge potential volume of distributed generation projects at this level and below, funding them is proving very difficult.
This phenomenon is not new with renewable energy finance. It has happened repeatedly in funding capital investments involving new technologies or new business models. The problem is fundamentally one of reducing risk for those who will approve, fund and ultimately be responsible for a long-lived, income-producing asset. So each project carefully goes through the same series of steps, consuming significant amounts of time and money.
There are two basic ways out of this dilemma – commoditization or aggregation.
Commoditization reduces the cost and complexity of a transaction, making it replicable over a wide variety of circumstances. It identifies the critical elements common to most projects, creating a single set of transactions that can be repeatedly executed successfully at much lower cost. It works when a large enough volume of projects fit those criteria.
Aggregation combines a large number of projects into a single larger project. It too employs a simpler set of transactions to reduce the costs, but accepts more variability in the individual transactions. It spreads the cost of individual failures that might have been caught with the more expensive process over a large number of successful transactions. It works when that incremental cost is less than the savings each project realizes from the simpler process.
Both commoditization and aggregation have been successfully used over the last several hundred years to drive economic growth by enabling widespread adoption of new technologies and business models. There have always been barriers of complexity and uncertainty to overcome, and the case of clean energy projects is no different.
Aggregation is usually the simpler path, at least initially. It requires less detailed and certain knowledge than commoditization. Unfortunately, the pigs’ breakfast the financial services industry made of the economy by pursuing that strategy beyond any rational bounds with mortgage financing has all but closed that avenue for now. Reopening it by rebuilding confidence is a necessary step.
Commoditization is often the path to greater long-term growth. For clean energy projects, it must overcome two significant obstacles:
- Inertia – the intermediaries, largely service providers, that benefit from the transaction costs have little motivation to implement a lower-cost system. Even though the overall business volume could be much greater, the professionals who do this work are not generally well-positioned for high-volume low-cost service delivery. Overcoming this barrier requires that some entrepreneurial service providers step up.
- Experience-based knowledge – the process of commoditization, whether of a product or a process, requires an understanding how the product works in different conditions that is only available through real-world experience. The volume of clean energy projects is growing, but still limited, and much of the useful experiential information is proprietary. Public funding that is helping establish the market should be coupled with public policy that ensures the necessary information is gathered and made available.
Clean energy projects may never become as commoditized as personal computers and car leases nor as aggregated as home mortgages, but the opportunity for significant market growth lies in pursuing those alternatives as far as they can reasonably go.