Speaker 1 (00:00:03):
Welcome to another episode of The Solar Podcast. Today David is talking with Nathan Jovanelly, head of business development at Enerflo, who also has a long history in renewable energy. They talk about the future of solar sales, debate PPAs and leases for panels, and discuss the recent Inflation Reduction Act of 2022, which entails tax co provisions that will be huge for the solar industry. Let's get right into it on The Solar Podcast.
Dave Anderson (00:00:31):
Well, Nate, want to welcome you to this episode of The Solar Podcast. We're thrilled to have you on today. Today my guest is Nate Jovanelly, and he's coming with us, most recently he's working with Enerflo, but he has a long history of working in the renewable space. And given some of the information that's come down, probably those that watch this episode or watch this podcast have been following some of the ITC. And I guess, what's the new tax code called that they're, what are they calling it? The anti inflation bill? Is that what they're calling it?
Nathan Jovanelly (00:00:59):
The Inflation Reduction Act of 2022.
Dave Anderson (00:01:05):
So formally it's a lot of the same things that would've been in the Build Back Better program, or a few other programs that have existed. We're obviously not going to dive into all of the intricacies of it, but certainly we're going to be talking a lot about that today, but again, thrilled to have you on the podcast today, Nate, and I'd love for our listeners to get a little bit more of a background on you. Not just the time that you've had, short time you've had with Enerflo the software company, but your previous experience working within the renewable space as well.
Nathan Jovanelly (00:01:32):
So my background is, I got started in renewables, it's been a little over nine years ago now. So I don't know if that puts me quite in like the super old school status. I started my career in, actually doing consulting. I was a chemical engineer by trade and always interested in the environmental piece. In fact, I was able to take a few graduate level environmental courses as part of my chemical engineering degree, did a report actually on the use for solar thermal back before really solar PV had any traction at all as a college thesis. And again, it was something I was always interested in. I wanted to do environmental engineering and my brother actually talked me into chemical. So when I graduated, I consulted for companies like Leidos and had clients for everything from NASA to like Harley Davidson, Mott's Applesauce, Utz Potato Chips was an awesome client, Pfizer.
So I did a lot of things in the environmental realm and eventually went and worked and led a team of engineers for water and sewer infrastructure throughout the country. It was a large publicly traded company and it was a great job, but the travel was killer, I had three kids so it was time to move on. And I had an awesome opportunity to come work for IGS Energy, which is the largest privately held energy company in the country. So they're a retailer of gas and electric. It's owned by Scott White in the White family, multi-billion dollar company. I think they're the third largest residential supplier in the country. So a lot like an NRG or Constellation. And what I got hired to do actually was combine heat and power, as a gas supplier that made a lot of sense on a lot of levels. And I think there is a real need for that technology.
For just a super high level for those that don't know, it's basically a boat engine. It literally is a boat engine, in most cases, or a turbine that you would put in somewhere that has a high heat load, like a hospital. And the number one byproduct of making electricity, running natural gas through an engine or a turbine is heat. So if you can capture that heat and recycle it at a high level, you can get super high efficiency and lower your overall cost. And also have the ability to island, if you're, again, if you're a hospital and everyone loses power, you could still have power at your facility. So we got into that. There was four of us that started that group. And I think we were maybe three, four months in and we went to PV America at the time up in Boston. And we had our little combined heat and power booth, you know, talking about natural gas and everyone else is talking about solar.
And they're like, "You guys, are you at the right show? You're in the wrong spot." We quickly realized that there was a huge opportunity, especially for a privately held company to get into solar in a big way. So we started doing that mid-market stuff less than 500 KW and started quick aggregating assets, buying distress assets, working with companies like SunEdison that weren't financing those, doing nonprofits that aren't credit rated. And we would run them through a moody shadow rating to get them so we could actually put them on balance sheet and if we ever wanted to sell those portfolios, we could. And that was a great success. We did that for a long time, taking those projects, getting our foot in the door. And then when SunEdison imploded, we had some opportunities to do some of the first Amazon projects and ended up being the largest client or customer of IGS. So we own over a hundred megawatts or did own over a hundred megawatts of Amazon projects.
I've done projects for Unilever, FedEx, but as we got bigger and bigger, I realized my passion was really more in the residential space. I liked the small stuff. I've been trying to figure out LMI personally for a long time. So ended up pivoting and ultimately running all business development for IGS in the residential space, where we deployed well over a billion dollars. We had worked with many of the largest turnkey installers and turnkey, I mean, we seemed to have more success with those that had their own sales team. So fully integrated, little bit different than your model, Dave, and there's reasons for that we can get into if you're interested, but we had great success there and we just built portfolios over time, ended up deploying about seven funds.
And I think the key to our success was that we didn't have the front end, that a lot of the other large TPO or third party owner providers have, when I say TPO, I mean a lease or a power purchase agreement. So a lot of the big publicly traded guys kind of have that box that you have to play in. And a lot of the larger mega regional solar installers wanted to use their own proposal. They wanted to use their own design, and we enabled them to do that. But as we grew, we knew we needed a front end, but we also knew if we build it that we weren't going to build the best design tool that no, you're never going to get consensus from everyone on the best CRM, and design tool, and scheduling tool. Go down the line, bring in Enerflo. So I met Enerflo in March of last year and started talking about them to have a really awesome integration for a TPO product, where these installers could bring any tool they wanted and Enerflo is the platform that since underneath.
So if you think about the average installer has eight to 12 pieces of software they use, again, I just named a bunch of them. And a lot of times they don't talk to each other. So Enerflo goes very wide at the bottom. Think of it instead of like one giant Lego or one closed ecosystem, like maybe a Salesforce, it's made up of a bunch of small Legos and you can customize your own configuration. And if you want to change your design tool, you don't have to change your whole process because you can just swap one out for another. So that's what attracted me to Enerflo and why I wanted to use it during my time at IGS. And ultimately after getting to know the two co-founders Pat and Spencer, whom I know you know, I just found that we were very aligned missionally, and that is to lower the cost of solar for everyone on the planet. So I made the very tough decision in December to resign from IGS. I started Jovanelly LLC, and of that I lead business development for Enerflo. So that's what got me here today.
Dave Anderson (00:07:51):
Well, that was a pretty concise nine years of your career summed up there. So that was a nice job. We should jump into a few of those components though. So IGS, truth is you guys have been, or IGS have been players in the PPA market for a long time. Have had some really, I think fantastic partnerships, have deployed a lot of PPAs currently. IGS, their strategy was to own all of those, own all of the paper internally, correct?
Nathan Jovanelly (00:08:20):
Dave Anderson (00:08:21):
And so your funds were a lot simpler, which created some pricing advantages as well. Right? So you were your own tax equity, you were your own equity capital. I mean you could obviously leverage and go out and get debt, but the funds were exclusively IGS funds, correct? Or were you guys raising tax equity as part of those funds as well?
Nathan Jovanelly (00:08:40):
Yeah, so actually all seven were a little different with different tax equity structures, different cash equity structures, but all of them basically had the same debt. So we did get debt against them all. And there were times where we used our own tax, which is a huge advantage in some ways, I don't know how technical you want to get on the finance side, but because if you sell the tax to like a Bank of America or U.S. Bank, big banks and big tax players out there, you can step up the cost of that system. So if I pay Complete $3 to build the system, but my independent auditor says that the system's worth $4.50 because of where it's at and there's a whole bunch of ways to figure that out. And it's different by utility really, mostly state, but also utility.
Then I can sell the tax to one of these big banks at $4.50 and what that enables me to do is then be more competitive and pay a installer more. So it's not like we pocketed that extra money, we used that to be able to pay the installer more. I think in the early days, some of our advantages were in how we treated SREX and we were able to underwrite the whole 15 years of SREX using the tremendous backend of IGS Ventures, the parent company to backstop those, which is obviously a very cash strong company. So that gave us a leg up, because a lot of people were only underwriting SREX for as long as you could sell them. And typically in the auction to buy power, the utilities are buying in three year intervals. So they're only buying SREX in three years.
So that means if you're some of the large publicly traded companies, they would only assume three years of SREX because that's all they could get debt against where we could go out and get debt against 15 years. So it's no surprise that New Jersey was by far our strongest state when we started, with Massachusetts probably as a close second. Eventually we restructured and we're always redoing these funds to try and maintain a competitive edge. But I would say definitively that it's really hard to compete in pricing with both just Sunrun and Sunnova, just to name them so we don't have to keep saying large publicly traded companies, but they don't have a long track record of being profitable. I mean, it's no secret. They each lost over $200 million in 2020. And I don't know the exact numbers from 2021.
So we were trying to, we were profitable from day one and trying to maintain that profitability. So we competed more on the simplicity and that's why I think we appealed mostly to the large turnkey installers. Because when you get into the sales orgs, they don't have to deal with the backend as much. So I think it had less value to them because they want to sell for the highest price to capture the highest spread. And there's nothing wrong with that. That makes total sense to me, and that's probably how I would do it if I was running that business. But the large installers that had their own sales organization under it saw some additional advantages in terms of higher pull through rates with IGS because we were faster, simpler, easier to transact with. And what I always say is we did the 95% really well.
So when they would come and ask us like, "Why don't you do trusts, or LLCs, or ground arrays?" Which now they do all those things. But at the time they didn't, it was like, because we want to be the best at the majority of the jobs. And if you need to go sell some of those others to other players and they can have them, we don't want to distract from our mission. The other thing I think that we end up doing really well was, and I don't know if this has evolved with some of the other players in the space, but we did a soft credit pull, never a hard pull. And it was, we ran it through all three bureaus so we gave the customer the best chance of passing. And as you know, I mean, especially in the last five years, the default rate for solar even through COVID was very low.
I mean, you can see there's a lot of data out there from different publications, but it's less than half a percent in a lot of the newer portfolios. So I don't think that default, I think they're really correlated to the quality of the install. And a lot of times, like if someone's not paying you, it's a result of they're angry at the installer or they felt misled in part of the sales process. So we're constantly refining that to get that down. And this is a topic we can rabbit trail on forever, but I think one of my missions is to continue to bring solar access to everyone and should be, it shouldn't matter what your income level is or what your FICO score is, because I don't think that's indicative of whether you're going to pay your electric bill or not.
Dave Anderson (00:13:27):
Well, there's some things as part of this new bill that maybe address some of that actually. And we should talk about that a little bit too, but unpacking a few things, I might actually, going back to just the structure of a PPA, or a power purchase agreement, or any third party owned product. So sometimes they're called power purchase agreements and they operate by selling a cost per kilowatt hour to a end consumer or to a purchaser of the power. And sometimes they operate as an operator, as an operating lease where the, where you're leasing the use of the equipment, ergo you get the benefits of the production of the system that's on your roof. And technically there are, there is a difference, but to the end consumer, they essentially perform the same. You're paying a monthly fee that's generally reduced or almost always reduced as a fund requirement relative to what they would pay to the utility company.
So the question here is, and I'll ask you and put you on the spot a little bit, but why is it that solar, these PPAs and these leases have a history of being, of having such a big percentage of the market? And I'll precursor that by stating typically a homeowner, if you're looking at a 20 year or a 25 year cash flow model, does better by owning it with a, with either using their own money, just paying for the system upfront, or using either an unsecured or a secured line of credit. Most of those are provided pretty liberally from solar companies at this point. Why is it that PPAs and leases have continued to exist in the marketplace? And I'm not saying that they're bad or they're good, but they do and have had a huge percentage of the market share for a very long time.
Nathan Jovanelly (00:15:08):
Yeah, I think so this might be my favorite question I've ever had on a podcast, because I always want to debate this point, is that I still believe that a PPA is the best product for most customers. And I know we could talk, we could do four episodes on this.
Dave Anderson (00:15:25):
I'll say that's a little bit of a controversial take for most people that would come on the podcast.
Nathan Jovanelly (00:15:30):
Oh, for sure it is. If you look at what the high for, I'm just going to call it generically TPO again, it's third party ownership, meaning the homeowner doesn't own the array, whether it's a lease, an operating lease, it's a PPA and there's advantages even more, I think a PPO over a lease. And we can talk about that too, if you want. But at the height, and I think this was like the solar city heydays, it was like it was 72% in 2014 of solar finance projects was TPO. And now in 2021, which is the most recent data I have, it's 23%. So why is that? I think there's a few reasons and not all of them are good. So first of all, I think what you're doing with a lease is that you have historically low interest rates, right? But also like when IGS got in the market for TPO, a lot of leases were 15 years, now they're 25 years.
It's really hard to compete with a 25 year loan because the customer can save a lot of money. And the other, I think advantage of a loan is that you can roll in other products and services. You can put a roof on, right and attach that, or insulation or whatever, energy efficiency measures. There's lots of different things you can do. So I do think that loans have advantages. For TPO, generally because of that capital stack we just talked about, you have to give the customer savings, and it goes back to perception of default rates. So you might be able to sell, what we would call a bill swap in the industry, so in other words, I'm going to put solar on your roof and you're not going to, you're going to break even.
You're not going to save any money year one, but your power that you're paying for the solar is not going to increase, it's going to stay it's 0% for 25 years. So that's, you can do that, but generally a PPA, and I would say what people would say against it is, well, they have a 2.9% escalator, which again is no different than the interest rate of loan, but it has a 2.9% escalator so if you do the math, if you start at a 10 cent rate today and pick it just, it could be all over the place depending on your market. But if you're at a 10 cent PPA today, in 25 years, it's roughly going to double, you're going to be at 20 cents. And to sell that product and to be able to get debt on that product and have funds, you generally have to offer the customer savings.
So there's some states just right off the bat, just aren't going to work because you can't offer the customer savings. The 0% product is a lower fair market value, which we talked about the implications that has on tax equity. So it is, it's tricky business, right? But the advantages are there's zero out of pocket cost, there's zero maintenance. You don't need tax appetite, going back to serving anyone with a 650 credit score can get it. I think it should be lower, but that's what it is right now for most of the major TPO providers. I think the biggest one that people overlook, and I don't think they even consider, is that it's transferable. So technically if you move within five years, I think that could potentially cause you problems with the ITC. So if you think you might move and the average person only lives in their home for seven years, PPA often can be a better option. Also strictly with a PPA, not a lease, there's no production risk.
And what I like about the product, just what I like about all partnerships, is that the company that is selling you electricity has a vested interest to make sure that solar system is operating. So they're going to operate and maintain it for you, and it's really a no worries system. Now, worst case it breaks and you have a TPO provider that's not paying attention, which I don't think that happens very often with who's left in the market. But if it did, you're only paying for the power generated. So your default is you're paying a little bit more for electricity, just like you didn't have solar at all, but you're not, you're not losing money, you're maybe losing a little bit of savings. So for all those reasons, I think that TPO is an undervalued product in a lot of markets.
I'll also say just that it's artificially capped too based on how all the companies come up with their cost per watt to the sales organization. So you can only sell up to a certain amount, because like I said, you have to have 20% savings. So let's say the rate to compare for your utility is 12 cents, and just to keep the math easy, you get a 10 cent PPA. If that caps out the sales order installer at $3 a lot, they can't sell higher. Now for a loan, you can sell as high as you want and generally you're just trying to beat the utility bill. So in some areas you could sell that same system at $4. So I would say that for customers that go with TPO, they have an artificial cap on what their actual system costs is going to be, even though they're not paying for it, which keeps their rate generally low and guarantees them that at least year one savings.
Dave Anderson (00:20:36):
Yeah. So thinking about the reason, and by the way, those are all valid points and I think those are all the reasons that people should consider a third party owned or a TPO product, either a PPA or a lease. And I, like you, believe that there's a very strong place in the market for the TPO product. And couple things to think about with it though. So the first question that I'd asked you was, why have they risen to such prominence? Right? So typically if you were going to add something to your home, a service, any construction project, you would want to own it. And that's the general mindset of people. And yet the product has been sold, you mentioned that one point probably 70% market penetration, maybe it was as high as 80% or higher actually, depending on the market.
Now it's probably, you hear different numbers, but let's just say half or less than half products are sold currently are the TPO products. And so then the question is, is why do they exist? What is it that makes it, I mean, the businesses like SolarCity, and now Sunrun, and you said Sunnova, and then there are other players, obviously IGS Energy. There are other smaller funds that exist as well that people have heard of, or haven't heard of. And so it's that capital stack. And so just maybe going into it, and the reason that I want to go into it a little bit in the simplest terms that we can, is because so much of what has happened with yesterday's announcement of this new bill is impacted by that. We're in an industry, all industries, we had a guest on last week that talked about how, basically what they do is they're, he's a venture capitalist, they do impact investing, and he says all industries have risk. And that's true, but this is an industry that has some particularly interesting regulatory risk.
If you don't believe me, just take a look at the solar stocks that are all up 30% in the last 24 hours, right? One person goes out and says, "Hey, we're going to renew this ITC, this investment tax credit." And all of a sudden end phases were $10 billion more today than they were two days ago. That's the kind of impact that, regulatory impact that the government has on our industry specifically. But anyway, going back a little bit and talking about the capital stack. So typically in any of these funds, you'll usually have a component, what you call your equity sponsor or your equity partner. And those are the people that are putting up hard money that are saying, "I'm going to buy solar assets and I just want a reasonable or responsible return on my money."
And then usually there'll be some component of debt, so that's your leverage. So some debt component, and then you'll have a tax credit investor, an investment tax credit. And then you also create this structure entity where you might have someone like a complete solar that's selling these products. And then Sunrun might, if I were going through Sunrun, for example, Sunrun would pay me something and then Sunrun would turn around and sell that asset again to another fund. And each time they do that, there's a step up in the basis so that they can take a higher tax credit. So essentially before the system is ever commissioned, the end owner of it is going to be a fund that will be able to take advantage of the tax attributes at a higher basis than what a typical consumer could. And that if whomever it is that's listening to this, didn't follow that, you are in the majority of company that don't understand it as well.
But the point is, is that there's a fairly complex fund structure that allows businesses to optimize or maximize the amount of tax, or of tax benefit that they can take by doing these PPAs and these leases. And it should be stated as well, that because it's a business entity, throughout the period of time over the last 12 years. So I've been in renewables for 12 years, you've been in for nine, and you can go back even further, probably 2007 when SolarCity and Sunrun started writing these PPAs and leases, and SunEdison even before that, on the commercial side. The reason that these PPAs and leases really rose prominence was because there were other tax attributes that don't exist today that were even better.
And these were relating to the depreciation of an asset that typically homeowners can't take. Although there are lots of CPAs out there right now that are teaching homeowners how they can own the asset in a way that they can actually take the tax attributes outside of just the ITC, the investment tax rate. They can also take the appreciation. Now, I don't want to unpack all of that stuff. There's a lot going on there. But the point is, is that there's a complicated fund structure that exists because of some specific tax code, and that might be changing a little bit. So you said you'd taken some notes. I'd love to get your take on some of the recent announcements that have come down regarding this, and what did we call? It's the, I keep want to say anti inflation, but that's not what it is.
Nathan Jovanelly (00:25:34):
It's the Inflation Reduction Act of 2022. I believe that's what it's called.
Dave Anderson (00:25:39):
And as with every bill that goes through the government, they pack a bunch of stuff that's probably not related to do it to anything about inflation.
Nathan Jovanelly (00:25:46):
Dave Anderson (00:25:47):
So it's a lot of provisions that existed in Build Back Better that are making it into this bill that has a more palatable and friendlier name that's probably going to be able to get through the Senate.
Nathan Jovanelly (00:25:57):
Yeah. So just to close that last conversation, so you're right, there's a lot of advantages of a TPO product that homeowners don't even know, but even more importantly, it's just simple, right? You don't have, they don't have to understand the tax credit because they're not taking it. They don't have to understand what a solar renewable energy credit is, which we don't have to get into. But it's just, it's very easy. It's no money out of pocket, saving money from day one, and you have no maintenance obligation. So it is, some people want to, I always liken it to owning a car versus leasing a car. Some people like to own cars and they don't like leasing cars, some people want to lease cars. So it's, do you want to own your solar or do you want to lease it? Have somebody else own it for you.
And I think there's always going to be a need for both of those, but so the anti or the, I just, the Inflation Reduction Act of 2022, I haven't read the whole thing yet because it just came out. I just got a copy of it this morning. But for those that want to follow along, on page 344 is the provision for the federal investment tax credit. And how I read it is, is that it extends the federal investment tax credit at 30% starting January 1st for 10 years, through 2033. So right now the tax credit's at 26%, it was scheduled on January 1st to go to 22%, and then the following year effectively zero for residential. But now this new provision would extend, would raise it back to the 30% for 10 years and then phase it out at 26% in 2024 and 22% in 2025.
Dave Anderson (00:27:36):
Nathan Jovanelly (00:27:38):
Sorry, yes, 2034 and... Thank you. But yeah, I think that the interesting thing is, is this good for the industry? And I know everyone's excited about it. I could debate on both sides, honestly. I think that I'm happy it got extended obviously, but I also think that it, until solar breaks free of anything that would be considered widely as a subsidy, I think there's always going to be this stigma around it. I do like some of the provisions they put in, although I didn't see the direct pay in there and maybe I'm wrong because I didn't read the whole thing yet. So you still need to have a tax appetite. There is, I think, a carve out for storage only, which is nice. So your solar, your battery doesn't have to be attached to your solar to get the ITC and that's a whole nother conversation.
But there is some margin obviously in that customer acquisition cost. I listened to your episode recently with Brian Lynch, who I know and really like, and he was talking about all this in the customer acquisition cost. And I think the last number I saw from SEIA is that like 64% of the residential solar installs soft costs. And again, that's one of the reasons why I came to Enerflo. We're trying to reduce that soft cost, and there's a lot of ways to do that, but I don't know if going back to 30% forces discipline that I think we definitely need in the solar industry.
Dave Anderson (00:29:10):
Yeah. I would, I tend to agree with that. So as a general statement, I usually say I don't like it when the government's choosing the winners and losers, and you obviously saw there was a big swing in the stocks as a result of this new policy. And you certainly could make the argument, and there's a lot of validity to it, that these subsidies sort of prop up bad companies and maybe don't force us to be as inventive as we need to be as an industry. We're competing on a world scale to purchase modules. We talk about supply shortages all the time. Well, right now in Australia, people are buying modules for significant, or not not buying modules, excuse me, getting systems installed for less than two bucks a watt, where as a wholesaler, I can't even compete with that.
There's no shot I could compete with that, because of how many soft costs we have here in the United States. The local bureaucracies, the local authorities having jurisdiction, our cost per acquisition, all of these things continue to keep the costs artificially, I say artificially high, because we already have precedent where Australia has 30% market penetration and they install for a fraction of what we do it here. And so there's obviously precedent, so there's something to be said about that. I will say, generally speaking, that I would say that there's a lot of positive things. So I do think direct pay, which you referenced, which we should just talk about what that is, I think that is actually a component of this, although the final wording isn't, I think, all the way out and passed through the Senate.
And it also, so a few things about it, one, the idea is, is it's trying to lower energy costs for Americans. That's actually one of the thesis statements, is we're trying to make energy more affordable for everybody. And our antiquated grid, if we continued on that system forever, we would have ridiculously high energy costs. That's just a fact. And so local microgrids using solar and other renewables is actually a better way to provide electricity to homeowners, and this bill and this plan admit that. People could debate whether that's true, but I actually think that's actually a math problem that's easily solved. It's not really a philosophical argument. It's just math. It's so much less expensive to generate electricity for a homeowner by doing it on your roof than it is to use this macro grid, ask any Californian or any person in Hawaii specifically, but across the country.
The second thing it does is it increases the American energy security. So the idea is, is that we become energy independent. That's something that's fairly important. We're trying to decarbonize all sectors, so it does reach into other renewables. So there is a tax advantage and a tax benefit for other renewables. But one of the things that this bill is trying to do as well, is it's trying to bring manufacturing into the United States. In fact, while it is a 30% tax credit, a lot of that, at least for the TPO products, is going to require, and it's really more like a 6% tax credit with a plus plus plus plus component to it. So in order to be able to get the full 30% as a corporation or as a business, how and where you source materials, for example, is going to matter. And there's a lot of other provisions.
And probably, I don't fully understand them yet either because this is late breaking news, but each of those things are critically important for people that are now putting these TPO products together, is understanding how direct pay works, how to take advantage of the full tax credit. So there's lots of components, and as with every other bill, it's overly complicated and it talks about a lot of other things, but one of the last things that it does address as well, that I think is great, is the direct pay makes it so that solar has been, in some ways, a luxury of the rich for a long time. The PPA and the lease have made it so that people that didn't have, and you called it tax appetite, but essentially if you don't have a tax, if you don't have taxes that you're offsetting, you can't take advantage of the tax credits associated with solar.
So essentially if you're part of the 50% of Americans that have enough tax write offs already to offset your tax liability, meaning you don't actually ostensibly pay taxes, or federal taxes anyway, you pay sales tax, and gas tax, and taxes in lots of other ways. But if you're offsetting 100% of your tax liabi