Yesterday, First Solar (FSLR) announced that it had sold its interests in a big solar project called Topaz. The buyer was MidAmerican Energy Holdings, a subsidiary of Berkshire Hathaway. So Warren B. is behind the transaction. I think he got another sweetheart deal. This time, it’s the taxpayers who will be making Buffett richer.
The transaction is between two companies. As a result there has been little disclosure of the actual terms and conditions. The following is my thinking on what is behind the transaction. If I have it wrong, the nice folks from Omaha can send me a note and I’ll publish their response.
There are a number of angles to consider in this story. I’ll outline a few and try to tie them together.
The Topaz solar project is in San Lois Obispo, California. Construction began a month ago, and will not be completed until 2015. The facility is designed to produce 550MW of energy. The cost per MW of these types of facilities is between $3mm and $4mm per MW. Using the mid point of $3.5mm you get an estimated cost of construction of $1.925 billion. Add in another $75mm of soft costs and the total should come to $2 billion. Bloomberg confirms my estimate on the completion costs of Topaz with this headline.
Buffett has purchased the rights to build a solar farm. The money he is putting up will be the construction costs over the next four years. First Solar will get some consideration as it has absorbed all the front-end costs, but it would be a mistake to assume that FSLR is getting anything close to $2B from Buffet. (Neither of the press releases from the companies mentions cash consideration.)
Buffett’s only condition to the deal is that the Power Purchase Agreement ("PPA") that Topaz has previously entered into is affirmed to Berkshire’s lawyer’s satisfaction. This is a critical part of the deal.
California’s monster electric utility, Pacific Gas & Electric (PGE), has entered into a 25 year PPA with Topaz. With PGE taking all of the power from Topaz, the risks in the deal fall sharply. The output of Topaz has already been successfully monetized. All that needs be done is complete the construction and then let the sun shine.
It’s important to understand that Uncle Warren has a seat at this table because the Department of Energy failed to approve a big loan to Topaz prior to 9/30/2011 (the deadline to get federal subsidies). The DOE did substantial work before nixing the deal. This PDF link to the DOE shows just how much had been accomplished prior to 9/30. (How much did this report cost the DOE/us? Many millions.) All of the necessary approvals and engineering work had been completed. Construction of these solar farms is not all that complicated once the approvals and site work has been signed off on. Buffet got a deal that was teed up and ready to go. Construction commenced a month ago. Warren bought into a deal in the 11th hour. He got a shovel ready investment. He has very little risk at this point.
When Topaz is completed, energy will be produced. Pursuant to the PPA Topaz/Buffet will receive checks monthly from PGE for the next 25 years. That stream of revenue is assured. PGE is a single A. Its long-term debt yields are in the mid 4% range. I’m certain that Buffet got a better yield than that. But the yield is not what brought Buffet into the deal. It was taxes and his desire to avoid them that got this deal inked. Again, that Bloomberg Headline:
It's clear that as part of the deal, Buffett got the tax breaks associated with Topaz. The federal tax subsidies for solar construction belong to Buffett. The numbers are huge. Once completed, the owners of a solar farm get one of two massive incentive payments:
1) The owner gets a cash grant equal to 30% of the construction cost, or;
2) The owner gets a break on their federal taxes equal to (get this) 100% of the cost of the project. This “Bonus tax deduction” can be used to reduce federal taxes in the year that that the project is first completed.
Berkshire Hathaway paid 29% taxes in 2010. This would imply that it would opt for the cash payment of 30% ($600MM!). But BRK is actually faced with a statutory tax rate of 35%. Therefore the value of the tax reduction could be as high as $700mm. (Warren can engineer any income necessary to max out the tax deduction.)
The PPA with PGE will return all of Buffett’s $2B of investment plus a return of at least 5%. But when you add into the calculation that in four years Buffett gets a mega tax-break the implied returns soar. I did an IRR assuming a 2015 construction completion, $2b cost and a 25-year payback. It comes to a return of 15 -17% pa.
This monster result is exclusively the result of the tax breaks Buffet will enjoy. In other words, “you” are making Warren richer.
As I indicated, the PPA with PGE is central to Buffett’s investment. It’s important to understand why PGE has stepped up to facilitate Topaz. California (and 30 other states) have passed laws that mandate that electric utilities MUST produce or acquire a percentage of their electricity from alternative sources. In California. Executive order S-14-08 mandates that 30% of all power sold in California must come from alternative sources by the years 2020. This means that PGE is in a bind. It HAS to have alternative energy or it can’t grow. So PGE came into the Topaz deal desperate for a supply of power that did not come from fossil fuels. Topaz solved (in part) PGE’s problems.
There is one technical aspect to the Buffet/Topaz deal that I don’t quite understand. The rules on the tax breaks/rebate are very clear. Not less than 5% of construction must have been completed by 9/30/2011 in order to qualify for the subsidies. As I have indicated, construction of Topaz did not commence until November. It would appear that the requirements for the subsidies has not been met. The possibility exists that the DOE agreed to allow for the subsidy and waived the 9/30 deadline. Another possibility is that the DOE gave credit toward the 5% completion by allowing for the pre-construction soft costs of the project. If it's the latter, I’m confused. Other projects that I’m aware of did not get credit for pre-construction soft costs. One additional possibility is a waiver of the completion requirements was granted, AKA "Side Deal".
When the DOE money did not come through, it must have been a big blow to the White House. Topaz was a big prize for them. I wonder if Obama called his pal Buffett and asked for a "fix". Warren B. delivered. But, as usual, he charged a pound of flesh. Obama got what he wanted. He avoided another solar disaster when WB stepped in.
-Buffett gets another sweetheart deal that makes him richer.
-PGE gets a long-term supply of alternative energy that allows them to grow for a few more decades.
-First Solar gets out of a huge headache. It gets get to sell solar panels to Topaz.
-The citizens of California that will use this power will get nothing. They will continue to pay the highest rates for electricity in the country.
-The US tax payers foot the bill for another $600 - $700mm. That's the "Vig" for Warren. Those taxpayers also get nothing in return.