Warren Buffett's Solar Energy Venture

 | Jan 04, 2013 | 4:00 PM EST  | Comments
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Warren Buffett's solar deal is important. It signals that the power industry appears to be pivoting away from wind and focusing on solar. The drivers are risk, reward and tax credits.

Berkshire Hathaway (BRK.A) knows a thing or two about the power and natural gas industries. Through its holding company, Berkshire owns Pacific Power, Rocky Mountain Power, MidAmerican Energy (electric and gas utility), Northern Natural Gas, Kern River Gas Transmission, Northern Powergrid (U.K.), CalEnergy Generation, and MidAmerican Renewables. The combined companies control 38,600 miles of natural gas pipelines, 177,000 mile of electric power lines, and 22,000 megawatts of generating capacity.

Berkshire's solar deals are taking place in its MidAmerican Renewables subsidiary. The company already owns a number of geothermal, wind, hydroelectric and solar assets. In its solar sector, MidAmerican has two solar projects already under development. Its Topaz Project is located in San Luis Obispo County, Calif. At 550-megawatts, it is huge. Better, it is hedged against PG&E's (PCG) subsidiary, Pacific Gas and Electric; the company will buy Topaz's electricity under a 25-year power purchase agreement.

MidAmerican's Agua Caliente Project is located in Yuma County, AZ. At 290-megawatts, it is large. It is supported by a $967 million federal loan guarantee. It is also financially hedged with a long-term power purchase agreement from Pacific Gas & Electric.

Now, MidAmerican Renewables plans to buy SunPower's (SPWR) 579-megawatt Antelope Valley Solar Projects, which are co-located in California's Kern and Los Angeles counties. Combined, these new facilities will become one of the largest photovoltaic power facilities in the world.

Although many are focused only on Antelope, it is only part of a larger solar picture. Here are five key facts to consider about MidAmerican's solar initiative:

1. The deal to buy Antelope has little to do with the fiscal cliff. Of course, anything can happen in Congress. But unlike wind, solar power was largely immune from the expiring tax laws. Previous Congresses treated renewable energy from photovoltaics as a special case. Photovoltaics facilities were not entitled to the production tax credits that have been offered the wind power industry. Instead, they earned a 30% investment tax credit. However, that tax credit requires the owners to take the entire risk of project development before they can claim any tax benefits. The tax credit expires in 2016.

2. All of MidAmerican's solar projects will be completed, considered "used and useful" and in commercial operations well before the investment tax credit is set to expire. If the 113th Congress alters tax credits before the end of 2015, MidAmerican's projects may not be completed.

3. After MidAmerican's solar projects celebrate their sixth birthdays, they will incur almost zero production costs. They are expected to have very low operating costs and no depreciation expenses will remain. These facilities will drift to the very top income tax rates at both the federal and state levels where they will stay for the next 20 years. Any tax benefits earned in the early years will be offset by higher taxable earnings in subsequent years. The offset could be multiples of the tax benefit.

4. MidAmerican appears to be willing to pay $4.30 million per megawatt. This price seems to be above the market for comparable facilities (about $3.75 million). However, MidAmerican may be willing to pay a premium for SunPower's advanced technology, which produces electric power at approximately 18% efficiency. By comparison, First Solar's (FSLR) lower-cost thin film technologies is approximately 12% efficient.

5. The massive infusion of new power from photovoltaic may affect margins at Edison International's (EIX) San Onofre Nuclear Generating Station (SONGS). It could also affect other regional independent power producers, such as Calpine (CPN) and NRG Energy (NRG). The reason is that massive amounts of solar power will come on line and it will consistently displace price-setting peaking facilities. That displacement will cause average market-clearing prices to decline for the region. Lower average prices usually cause lower margins and lower earnings for all participants in that market.

Few other utilities have the financial might to pull off projects of this magnitude. For solar to work at these levels, owners not only have to have strong balance sheets, they also must be hugely profitable so they can afford to absorb massive amounts of tax equity. This is why MidAmerican's solar projects integrate nicely with Berkshire's financials. They company offers tax losses in the first several years of operations and it will provide strong and reliable earnings in subsequent years.

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