Jon Powers:

Welcome to Experts Only podcast, sponsored by CleanCapital. Learn more at cleancapital.com. I’m your host, Jon Powers. Each week we explore the intersection of energy, innovation and finance with leaders across the industry. Thank you so much for joining us.

Tom Byrne:

Welcome to this week’s episode of CleanCapital’s Experts Only podcast. I’m Tom Byrne, co-founder of CleanCapital, guest hosting this week. In this week’s episode we talk to Graham Smith, CEO and founder of Open Energy Group. We talk about the challenges of financing small scale solar, as well as the opportunities presented by technology to simplify the process. Graham Smith, welcome to the podcast.

Graham Smith:

Hi, Tom. Thank you very much for including me in the Experts Only. I’m delighted to play a part in it.

Tom Byrne:

Graham, one of the interesting facts that we learned about you was that you were an Olympic rower. Starting out with participating in the ’96 Olympics, how did you navigate your way into the renewable energy space?

Graham Smith:

I think the straight answer is that it was not a clear path. I think I could cite some important and pivotal moments for me. I think the first one was from an early age… I can’t describe exactly why I think personality-wise I was interested in the green movement. I remember a few years ago the importance of the Kyoto agreement in the early 90s and how I was… Simpler things as reading books about recycling on… At the time, it was a book that was printed on terribly bad recycled paper so it was… You really had to be into it to believe, and I think I had that. So that was a gut, for a very strong feeling of mine. And then to be honest, it took a long time to germinate into it professionally. So there was the hope of how to get involved and then professionally, and it was not until the late 2000s that the solar movement in the UK really began to take off and professionally I was in a place…

Graham Smith:

And often the way it’s a personality or friend of someone at the company I was then with who proposed an idea. So it was a conceptual idea and I really… So it was renewable energy, financing renewable energy, and there wasn’t that much more detail to it, but I knew that it was enough to… I think that was the moment for me when I knew this was financing renewable energy for me, this is how I was going to move forward.

Tom Byrne:

And you started your career certainly in finance, right? You’re a finance guy. You’ve done trading, brokerage finance. So looking back at that, the late 2000s, ’09, 2010, when you were first going to dive into it, what did the landscape look like at that time? And where did you see an opportunity for your business at that point?

Graham Smith:

The landscape was post-crisis. I think that’s the first thing to be said. In fact for renewables, it wasn’t actually very good. It was challenging because renewables were still perceived or had taken a big hit. So I wasn’t part of the renewables business cycle pre the crisis. And they had been undoubted success for instance, in Spain, and installing a lot of solar. But post-crisis, there was much less, if you like, tolerance was much less of a bubble, if you like, it was very clinical and sterile and sober.

Tom Byrne:

Was that mostly from the lender’s perspective or the investor’s perspective? Were people post-crisis anxious about this new asset class?

Graham Smith:

I don’t think they were anxious. I think they were scared, because the people that could converse about renewables had invariably been burnt. So if you were an investor, so if you invest as a VC, you might have invested in a startup that probably would’ve gone bankrupt through the crisis. If you were an investor in the assets, you might have fared okay, but the value of your asset might have been written down for regulatory reasons. A country like Spain had enacted tariffs that actually changed the value of your asset.

Tom Byrne:

Can you remind our listeners what that situation in Spain was? That was a pretty monumental moment in renewables on the tariffs.

Graham Smith:

Yeah, it was monumentally bad. What’s done is done. But essentially much of Europe funded the renewables’ growth using feed in tariffs, which were, it simply put, was set by the government. So it was per unit of energy kilowatt. Our generated the government would pay a certain price. So it was extremely attractive because it was basically guaranteed by the government. And then Spain decided to not only change the future tariffs that renewable projects would get, they made the catastrophic and systematically damaging decision to retrospectively change tariffs. So if you owned… There was an operating solar asset that was due nine cents a kilowatt hour, for example, they might have changed it for example to six cents. So that completely might have bankrupted projects or certainly changed the equity return and devalued these investments. And then lastly it hit lenders doubly bad because obviously they had the loan on it and if it couldn’t support the loan, then the loan was bad. And so it was just a terrible sort of cycle of damage that was inflicted like that.

Tom Byrne:

So within that rosy story, you decided to start your career in renewables.

Graham Smith:

Yeah, that’s right. What a perfect moment. I think that maybe the lesson to take is that if you believe, and you’re passionate about it then… And I remember actually reading Friedman’s books, the American journalist Friedman.

Tom Byrne:

Hot, Flat, and Crowded.

Graham Smith:

Exactly. And to be honest, I read it and it sort of sparked, it really just was such a catalyst for me. And then someone at work, at my then company Phoenix had this idea to finance in this case European projects because I was based in London. So there was a growing interest and Europe, I guess certainly historically has been inclined that way with Germany. So starting the solar movement arguably and having led it for so many years. So despite the sort of overall financial market, having a bearish view about renewables, there was still a sort of a regulatory and legal and executive commitment to build renewable. And there had been a renewable growth significantly through the early 2000s.

Tom Byrne:

It’s an interesting juxtaposition because I had been starting my career in renewables around the same time as a lawyer. And you had government policies out of the recession that really catalyzed renewable energy. You had the cash grant from the treasury, which was just a direct injection of cash into clean energy project. And you had even the DOE loan guarantee, that Department of Energy was guaranteeing loans on some of these projects. So it was actually out of the recession. The United States actually experienced almost the opposite impact, which was a very positive one for clean energy.

Graham Smith:

Yeah and I actually back that up and you’ve tweaked my memory because even less substantively when we were making the business case for what we do and clearly you can see our logic was or vaguely flawed. We saw the… When the Obama administration came in, there was mention of a carbon credit trading scheme. And in Europe it’s very or it was and has been quite robust. And so the idea, we were a securities trading house. So we saw the idea of carbon credit potentially starting up in the US as an opportunity to get into renewables. But that’s one of those, the ironies that it didn’t really take hold, but certainly got me going on my renewables career.

Tom Byrne:

So what exactly is a carbon credit?

Graham Smith:

Good question. A carbon credit is a per… If you attribute the carbon emitted from a fossil fuel generating power plant, carbon credit is essentially a ton of carbon dioxide emitted. And depending on the regime there is, essentially once you start to identify that and how much is produced by certain power plants and jurisdictions, countries, you can then… And then what happens is, connected to that is legislation around… Pretty complex, but very simply is the amount of, once a cap is set or a target for them, and then allowing how much is allowed to be produced, then you can start to create a pricing mechanism. And from there you can start to get to a market, so carbon credit.

Tom Byrne:

And I think there’s a lot of people who have navigated into this space similar to you through the lens of a trader and with carbon credits in the United States, it ultimately led to… Those folks sometimes then started working on SRX, which is a tradable commodity here in the United States. So it sort of was a logical flow from being a traditional trader in finance to ultimately looking at these assets and not the power necessarily, but these government created assets, carbon credits, SRX, things like that.

Graham Smith:

Yeah, absolutely. On the Genesis for our idea in 2009, it was to knowing that we would like to trade the credits. It was the underlying. So it was the idea that if we could bring finance in and own, or in some way, be involved with the origination of the credits you would control and have pricing power over the credits in due course. And then we thought, okay, well, how are we going to get into the finance of these assets? And then that started the process of well, which market? Wind, solar, biomass, et cetera, et cetera, that started that process off elimination. We were targeting the most attractive markets.

Tom Byrne:

And foreshadows conversation about the role of policy and renewable energy, I think this is a unique time in the United States where there’s a lot of different movements on the policy front. So here we’re trying to talk about finance, but inevitably in clean energy, you start talking about policy as a result. There’s a lot going on right now in the United States, from tax reform, that’s on the docket to the Suniva trade case. And I want to get your views on how you view those two material events, perhaps starting with the Suniva trade case. And it would be helpful, I think to give our listeners a little background on what that’s all about.

Graham Smith:

Yes, of course. And what I will try to do is be objective, but the reality is for both you, Tom and myself, these are huge, but have been huge for us. So this Suniva trade case came about because an otherwise unknown financing group provided a loan to Suniva as part of its day to day business is called SQN Capital Management. And Suniva being a panel maker, it took a loan from this company. Unfortunately, then what happened was that subsequent of that loan being made, Suniva went bankrupt or put in a bankruptcy filing in April of this year.

Graham Smith:

And thereafter it was… What happened was a series of steps that took an otherwise innocuous process to potentially having huge ramifications for our market. So during what SQN decided to do was to fund Suniva during bankruptcy, and then to take the next step of filing a complaint under US trade law, essentially saying that the lack of protection for US solar panel makers against panel makers coming into the country was unfair competitively. And what happened was they submitted a trade case to the ITC, the internal trade commission. And where we are now, so through 2017, there was a petition, there were hearings and the ITC, the international trade commission, excuse me, not internal, decided in favor of the complaint filed by Suniva.

Tom Byrne:

So very practically this means potentially developers were developing projects thinking that solar panels would cost X and now they potentially cost X plus Y.

Graham Smith:

Exactly and that in a market where… Exactly, that’s a great context. So if the pricing solar project is made up of many components, but principally inverters and panels, and there’s the cost of building it, and then the cost of financing and the development. And like anything, if there is an assumption around fixed costs, following a trend line, or even… A trend line against the cost of panels and that changes radically. And we’re talking about hard assets, these things take a long time to plan. There’s a long process of preparing, investing, and drawing up finance for these assets. So if your metrics are thrown out, because of the long time it takes to prepare these assets, then essentially there’s a few outcomes. It can either mean that because they’re more expensive, the financing is no longer capable of financing. And then the ramifications of that, you are likely to see potentially a lot of projects that colloquial don’t pencil, so they don’t get built. And that has a negative impact on the growth of solar.

Tom Byrne:

So just this seemingly or arguably simple concept of adding to the cost of solar panels runs the risk if too punitive of derailing substantial solar development here in the United States.

Graham Smith:

Absolutely. It absolutely runs the risk of derailing or challenging the rate of growth. I don’t want to be melodramatic, but it’s absolutely the case that we’ve seen during the second half of the year that the material effects, I can describe it, seeing a project getting built, but the owner of a project cannot get access to the panels because the panel suppliers are in high demand because there is an increasingly limited supply because the perceived costs has gone up. And as a result, they’re in danger of not competing their project. And that’s just one instance. So it’s a very real. We’ve seen the effects already.

Tom Byrne:

And fast forward from Suniva. We quickly started diving into tax reform, which also has an impact on the renewable energy space. As of the recording of this podcast, there’s a House bill and a Senate bill. It has not gone to conference yet, so we don’t know what the outcomes are, but at a high level Graham, why does tax matter? And why does the tax reform potentially matter?

Graham Smith:

So as you know and the listeners know there’s two things that are certain in life, death and taxes. I am not an expert in trying to decipher. There are certain… I’ll make a plug here for Keith Martin from Norton Rose, because he’s written some great stuff on this and I don’t see us doing a good job of explaining. But given the type of financing that solar requires under the current or up until now, the tax rules, it’s already complex and it’s about to be made more complex and that’s tough. The more complex it is, the more expensive it is, the less people understand it and the harder it becomes to roll out. I think there’s uncertainty with the way you described it reflects the uncertainty. And with uncertainty that makes things harder to price and ultimately less valuable.

Tom Byrne:

And these solar and wind projects and other renewables, they are in part finance by tax equity investors.

Graham Smith:

Exactly.

Tom Byrne:

These are investors who have tax liabilities that can be offset by tax credits to oversimplify things. But in order for them to know the value of their investment, they need to know what their tax rate is. And right now, going through, trying to navigate uncertainty about what that tax rate is and therefore what the cost of their investment is, is that accurate?

Graham Smith:

I think that’s actually very, very clearly articulated. I think one of the things the way has been described to me and I’ve picked up and I must say being a Brit, I’ve so struggled to understand the US tax system, even some of the basic elements. But some of the things that have cropped up in this current go round of the alternative minimum tax, it’s the idea that corporations did use the tax credits available from renewable energy products to reduce their tax. But there seems to be in between the House and the Senate bill, the fact that the case erosion tax is going to reduce the… Potentially I should say, potentially reduce the ability of companies to use the tax credits available on projects to reduce their tax bill, that then reduces the appetite for companies to invest in renewables, which could affect renewables.

Tom Byrne:

I’m going to put you on the spot a little bit. Do you think investment tax credit and tax credits are good for renewables?

Graham Smith:

I absolutely do. Yeah, I think the car business, the fossil fuel energy business have all been built. Substantial industries have been built, but they started often with sizable subsidies and support from the state to allow them to grow, to gain the economies of scale, to become ultimately enshrined and effective. And there can be no doubt that the solar sector has benefited, has created jobs and welfare following certain subsidies, tax benefit, tax credits or otherwise. So yes is the answer to your question.

Tom Byrne:

So I’m going to now turn to what you’re doing now, and particularly at Open Energy, want to hear a little bit about Open Energy and with the last four or five minutes here, really dive into what you guys are doing there and some of the particular nuances and complexities of the space that you guys are operating in. So maybe we can start very simply, what you guys are focused on at Open Energy?

Graham Smith:

We address the commercial solar markets in particular, so the non-residential are not to the utility scale. So there’s three areas, that’s residential, commercial and then at the very large scales utility. And we look at the commercial scale. And what we do is we are a platform lending, providing loans to finance projects in the commercial sector.

Tom Byrne:

And you guys embrace technology at various points in the transaction process. Can you give us a sense of why you think that’s an important piece of your processes to lend to this space?

Graham Smith:

Yeah, absolutely. So when we first looked at it, we looked at the type of financing that was going on and utility scale is a good example. It uses project finances and loans or financing comes in and it finances individual solar projects, but like mini gas fired power stations. And that’s an attractive form of financing. It works, but it can be quite expensive. It can be quite slow based on historically conventional approaches, partly because large scale financing could support, say of a gas fired power station could support with a lot of documentation, could support the costs that come with that, put very simply.

Graham Smith:

But if you’re looking to serve to finance, say a solar plant, that’s one megawatt and a 500th of a gas fired power station. Some of the documentation, some of the legal processing, some of the engineering, the ways to make a project finance will make it…. It’s just too expensive. So technology comes in because if we can look at that process, we can mimic and we can automate a lot of the commoditized areas of that process. So understanding the process and then using technology to standardize, make more transparent and ultimately reduce the cost, which then makes it possible to finance.

Tom Byrne:

And just taking a quick step back. What is… Maybe you could explain for the listeners who aren’t necessarily in banking and lending the financing process or how these assets are financed and what lenders and investors look to.

Graham Smith:

Yeah, that’s a great question. I’m clearly way too in the weeds. So what investors look at, whether that’s an equity investor’s going to own a solar asset or a lender, is they look at the cash flows coming off one of these assets and they say, well, how risky are these? Because if I’m going to lend or I’m going to buy something, then these are quite expensive. So there’s a high upfront investment, not dissimilar to say, building a house or a building. And it’s going to be the residual payments that come off this asset and how risky or not that will affect paying back my investment. So there’s an upfront payment whether owning or lending and over time that will get paid back.

Graham Smith:

So a lender investor says, okay, well, it’s a solar asset. How reliable are those? How does the equipment work? And you can… Quickly we can look at that and say, well, actually solar equipment is pretty reliable these days. So you look at the reliability and then we say, say, well, what likelihoods are there that the payments that are going to occur over time won’t occur and therefore affect our investment? So essentially it’s looking at what is generating the power and the risks against it, generating power and money over time to pay back and invest.

Tom Byrne:

Got it. And what’s so challenging about the small scale market?

Graham Smith:

It’s challenging because a one megawatt if I’m giving an example, which is quite small, it’s not very big and it’s not usually small, but the way a one megawatt or 500 kilo project for that matter works, is not wholly dissimilar to a very large solar project, such as a 100 megawatts plant. And so the ways to assess the asset, which I described, how do we know this project is going to perform? Number one, it’s the same process, but a bigger financing can support the engineer going to see it, the test being run on the panels, the projections of power. So essentially those actual fixed costs are not the same, but because you’re talking about a much smaller investment, the percentage of that investment and therefore the cost of the financing becomes higher. And then likewise, how you assess the risks to the cash flow are the very same. So what I’m trying to say is that we’ve used technology to make those tasks less, still to the same standard, but less expensive. And that’s the challenge for that small projects within the sector.

Tom Byrne:

Yeah and I think that’s one of the more exciting ways to tackle the space is by figuring out technology solutions that really streamline processes, so that’s super exciting. What do you see…. How do we get more capital markets participation in this segment of the market?

Graham Smith:

That’s a super question. I think our outlook is on bringing debt capital into the market. So that the idea of essentially with, again, the analogy with property, how do we get more mortgages available? On our view is quite nuanced, but it’s saying that institutional money, I think we start with, I would we say that money’s from pension funds, from banks is the key way to grow the sector. That’s where vast pools of capital are available to invest. And what these type of institutions or this institutional money needs is certain standards. They need to know that the way a loan is underwritten conforms to a particular standard. And so once you do that, once you create standards so that people can compare loans, can compare the way loans are or the way the asset is underwritten and therefore how a loan is made against a solar asset, then large pools of capital can be made.

Graham Smith:

For instance, insurance companies can’t invest in less, the particular investment is rated or has a public rating. So just a move towards securitization so that segment of the market can access the capital markets, some lower cost capital.

Tom Byrne:

That’s really exciting. And that’s really important work that you guys are doing to try to accelerate the capital markets’ participation in this space. So we’re winding down right now. And there’s a question that my co-founder Jon Powers always asks at the end of these podcasts that I’m going to ask to you as someone who’s had a great career in this space. If you could sit down with yourself, your younger self from high school or college, what advice would you give?

Graham Smith:

That’s a super question. I think for my own self, the advice would be to focus and maybe this is a reflection of the current dynamic in which we live, but it would be focus on some of the basics in life. So I’m taking for granted working hard or some of the things that we constantly have trotted out as advice and say kind of courtesy and some of the more fundamentals in the way of going about business, having respect for people, tolerance and persistence, because we live in a time when often those things are not forthcoming or the belief in the importance of those as being challenged. So while a bit generic, I think it would be to try and instill and to say, keep strong to some very important basic qualities, not just in business, but in life.

Tom Byrne:

Those are awesome words to end with Graham Smith, CEO of Open Energy. Thanks very much for joining us on the Experts Only podcast.

Graham Smith:

Thank you very much. It was a pleasure.

Tom Byrne:

Thank you to Graham Smith of Open Energy for joining us this week. I also want to thank our producers, Lauren Glickman and Emily Connor. Please visit cleancapital.com for more information on CleanCapital. And don’t forget to go to iTunes and give the Experts Only podcast, a five star review.

Jon Powers:

Thanks for listening in today’s conversation. Find more episodes on cleancapital.com, iTunes or wherever you get your podcast. If you like what you hear, be sure to subscribe and leave us a five star review. We look forward to continuing our conversation on energy, innovation and finance with you.