In recent months, dramatic share price declines across the yieldco sector have generated extensive commentary on the future viability of yieldcos as a means of financing renewable energy projects. While analysts have adopted divergent viewpoints, a number of alternatives to the prevalent yieldco model may constitute more promising avenues for future project development if yieldcos continue to struggle. In particular, companies may look to third-party sales or move projects to warehouse funds, and potential changes to the Internal Revenue Code could ultimately facilitate the use of master limited partnerships ("MLPs") as an alternative to yieldcos.
Renewable energy firms form yieldcos to hold operating power generation assets, which generate stable cash flows that the companies then use to develop additional projects in addition to providing investors with generous returns. The success that yieldcos have enjoyed since 2013 has created high demand for contracted assets, driving up prices and forcing yieldcos to consider acquisition of riskier projects. Faced with the attendant risk of lower returns, many investors have retreated from the yieldco market, forcing renewable energy firms to consider new ways of raising capital. The companies maintain that the overall market for renewable projects remains strong, and observers have suggested that new categories of investors, such as pension funds, may take the place of hedge funds and others that have departed.
While the future of yieldcos in their current form remains to be seen, renewable energy companies are also revisiting their strategies moving forward. New yieldcos are hesitant to proceed with IPOs in the face of the current uncertainty, and a number of publicly traded yieldcos have already stopped issuing equity for new project acquisitions, at least for the present. In addition, one company has announced that it will discontinue dropdowns of assets into its yieldco for the time being. The company will instead market its projects to third parties or move them into warehouse funds.
Warehouse funds, which have sometimes been called "private yieldcos," are a new variation on a financial structure that MLPs have used to acquire assets. The funds serve as vehicles for companies to hold projects outside yieldcos, providing liquidity while allowing companies more flexibility in timing the eventual dropdown of the project assets. However, the introduction of warehouse funds to hold projects that companies would otherwise drop into yieldcos has raised new concerns. The need for warehouses reflects yieldcos' inability to acquire the warehoused projects at the best possible prices, and companies forego significant profits by electing to warehouse projects instead of selling them to third parties. Still, at least some renewable energy firms appear confident that the options offered by warehouse funds justify the drawbacks.
It is also possible that, given the opportunity, renewable energy firms will choose to shift away from the yieldco structure in favor of MLPs. While traditional oil and gas assets are commonly held in MLPs, the Internal Revenue Code currently does not grant renewables the same favorable tax treatment. The MLP Parity Act (S.1656, H.R. 2883), a bill that was reintroduced this summer after failing to pass in a previous session of Congress, would amend the Internal Revenue Code's definition of "qualifying income," set forth at 26 U.S.C. § 7704(d)(1)(E), to include renewables among the types of assets that may be held in MLPs. Identical versions of the bill are currently before the Senate Finance Committee and the House Ways and Means Committee. Should the MLP Parity Act become law, and should certain passive activity loss rules change, it could spark a rush toward renewables by acquisition-starved MLPs while also offering renewable energy firms a promising alternative to their current options. That outcome of course will also be a function of whether the pipeline of contracted renewable projects is sufficiently large enough to accommodate any new demand.
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