podcast
The Infrastructure Behind the Energy Transition: Unlocking the Grid with Interconnection Capital
Listen to a discussion on the emerging opportunity of interconnection capital: a short-duration strategy designed to address critical grid bottlenecks while offering structural downside protection through regulatory refundability.
0:00
So let’s just look at the scoreboard for a second.
0:01
If you read the headlines, you’d think the energy transition is, well, basically won, the Capitol’s there.
0:07
trillions of dollars in ESG funds, infrastructure, private equity, all just sitting there ready to go.
0:14
The tech is mature.
0:15
Solar and wind are cheaper than coal in most places.
0:18
The public will is largely there.
0:20
So my question is, why does the data show that the actual deployment of new energy onto the grid is slowing down?
0:28
It’s the difference between having a Ferrari in the garage and having a road to drive it on.
0:33
And right now that road is closed, and we’re not talking about supply chain issues or lithium shortages today.
0:38
We’re looking at this invisible wall that thousands of perfectly Good renewable projects are just crashing into the interconnection queue.
0:45
The queue, it sounds so administrative, like a line at the DMV, right?
0:48
Exactly.
0:49
But based on the stack of research we’ve got in front of us from Citizen Mint, Lawrence Berkeley National Laboratory, recent FERC filings, this queue is actually where billions of dollars of value are being created or, you know, destroyed.
1:02
It is the single biggest bottleneck in the US energy market today.
1:07
And what’s so fascinating is that while everyone’s focused on the hardware, the panels, the turbines.
1:15
The smart money is looking at the friction.
1:17
They’re looking at something called interconnection capital.
1:20
So that’s our mission for this deep dive.
1:21
We’re going to strip away the green energy hype and look at the, the brutal mechanics of grid infrastructure and finance.
1:29
We need to understand why 300 acre solar farm can have the land, the permits, the funding, but still sit totally dead in the water for 4 years because of a PDF file on some utility engineer’s desktop.
1:42
And specifically we’re talking about the capital you need just to survive that wait.
1:47
All right, so let’s start with what you call the great gridlock.
1:49
I think most people, you know, generalists, have this misconception that the electric grid is kind of an open platform like the internet.
1:56
Yeah, you build a server, you plug it in, you’re live.
1:58
That analogy just falls apart immediately because the internet doesn’t have thermal limits.
2:03
The grid is a physical machine.
2:05
I mean, it’s the largest machine in the world, and it operates in real time.
2:09
Supply has to match demand perfectly every single millisecond.
2:14
So when you propose adding say 500 megawatts of solar in rural Texas, you’re not just plugging in.
2:21
No, not at all.
2:22
You are potentially changing voltage stability, thermal loading, reactive power flows, maybe 3 counties over, which is why we have this whole study phase right before you can connect the grid operator, the RTO or ISO, they have to run a whole series of engineering studies, feasibility studies, system impact studies, facility studies.
2:40
They have to literally model the grid to see if your project breaks it.
2:44
And this is where that Lawrence Berkeley National Lab data comes in.
2:47
The volume of requests isn’t just up, it’s like vertical.
2:50
Oh, it’s staggering.
2:51
Between 2019 and 2023, interconnection requests spiked by 325%, and the grid operators, I mean, they were not staffed for that, not even close.
3:00
They were built for a world where you’d add one giant coal plant every 5 years or so, not 4000 small solar projects every single year.
3:08
And so the system just choked.
3:11
Yeah, the data shows the median time from just the initial request to actually starting commercial operation has pushed out by nearly 30 months.
3:19
30 months.
3:20
That’s 2.5 years of added delay.
3:23
But think about what that delay actually does.
3:25
The second order effects are brutal.
3:27
If you’re a developer, you’ve got option agreements on that land.
3:31
You’re paying landowners every year just to hold the site.
3:33
You’ve got overhead.
3:35
You have investors who are expecting an IRR, so a 30 month delay doesn’t just push your revenue back, it burns your pre-development capital.
3:42
It can completely kill the project’s economics before you even stick a shovel in the ground.
3:47
So the queue isn’t just a waiting room, it’s more like a death valley, exactly.
3:50
And to manage this, the grid operators had to install a filter.
3:54
They couldn’t just let anyone with a map and a dream submit a request because it was just clogging up all the modeling software.
4:00
They need a way to screen for only the serious projects, which brings us to the financial gatekeeper.
4:07
The deposit.
4:09
This feels like the crux of it.
4:10
It is.
4:12
To get into the queue and keep your spot, you have to post a really substantial financial deposit.
4:18
And this is not some nominal application fee.
4:21
We are talking millions of dollars per project, and you’re posting this capital while the outcome is still totally uncertain.
4:28
That’s the kicker.
4:30
You’re posting this capital just to find out if you can even connect.
4:33
The deposit is meant to fund the utility’s network upgrades, you know, new substations, bigger power lines, if you end up proceeding.
4:40
But for the whole time you’re in the study process, which we just said can take years, that cash is just trapped, trapped.
4:47
This sounds like a massive balance sheet advantage for the big incumbent players.
4:51
It is the defining asymmetry of this market.
4:53
If you are a huge utility like Nextterra or Duke Energy, you have a massive balance sheet.
4:59
You can post a $5 million deposit with a letter of credit or just cash on hand, and for you that’s a rounding error.
5:04
You can just absorb the opportunity cost of that capital for sure.
5:07
But if you’re a mid-market independent.
5:10
Power producer and IPP.
5:12
Maybe you’re more innovative.
5:13
Maybe you’ve got a better site picked out, but you don’t have $50 million in cash just sitting around to park in restricted accounts for 10 different projects, precisely.
5:21
And so it forces this premature consolidation.
5:25
Really efficient, smart developers are forced to sell their project to the giants at a huge discount simply because they can’t handle the capital requirements of the Q.
5:34
OK, but the regulators, they’re not blind to this.
5:37
The Federal Energy Regulatory Commission, FERC, they dropped what looks like a bombshell in July 2023.
5:45
Order number 2023.
5:46
The interconnection reforms.
5:48
I mean, this is the most significant regulatory shift in the space in probably two decades.
5:53
The big headline.
5:53
was that it creates cluster studies.
5:56
So instead of studying projects one by one serially, they study them in batches, which just makes sense from an engineering perspective.
6:02
If you have 10 projects in the same county, you should model their combined impact, right?
6:06
But the mechanism FERC used is what matters for our deep dive today.
6:10
They moved from first come, first served to first ready, first served, first ready.
6:16
That sounds efficient, but usually ready in this industry is just another word for well funded.
6:21
You absolutely nailed it.
6:22
To be considered ready, you now have to prove you have exclusive site control.
6:27
You own the land or have a binding lease before you even enter the queue, and you have to post much higher deposits, significantly higher, and those deposits become at risk much, much faster.
6:38
So they basically raised the stakes to fold the people who are bluffing.
6:42
Exactly.
6:43
They wanted to purge all the speculative projects from the queue, and to be fair, it worked, at least partially, but the paradox, and the sources are very clear on this.
6:51
Is that by raising the bar to get in, they drastically increase the short-term capital needs for the legitimate developers.
6:58
So FERC solved the traffic jam by raising the toll to a price that a lot of the mid-market just can’t afford.
7:04
It creates a liquidity crisis.
7:05
Correct.
7:06
The need for this interconnection capital didn’t go away with Order 2023.
7:11
It actually intensified.
7:13
The developer now needs to bridge a larger amount of money for a clearer, yes, but also much more strictly enforced timeline.
7:20
OK, so let’s break down the anatomy of this investment then.
7:24
Citizen Mint calls this interconnection capital.
7:27
Where does this actually sit in the capital stack?
7:30
It’s not construction finance and it’s not early stage VC.
7:33
Think of the project life cycle in, say, 3 phases.
7:37
Phase one is development.
7:38
That’s land acquisition, permitting, zoning.
7:42
It’s super high risk.
7:43
You might find an endangered bird on the land or the county board denies your permit.
7:47
That’s binary risk.
7:48
You lose, the value is zero, right?
7:50
Then you have phase 3, which is the long-term hold.
7:53
The solar farm is built.
7:54
It’s selling power to Amazon for 30 years.
7:57
That’s basically a bond, low risk, low return.
8:00
So interconnection capital is phase 2, the narrow band, as they call it.
8:04
The developer has already secured the land and the permits, so that binary development risk is gone.
8:10
But they haven’t started construction yet.
8:11
They just need to post the deposit to finalize that grid connection.
8:15
So an investor’s coming in after the project is de-risk from a permitting standpoint, but before the huge capital expense of construction.
8:23
Exactly.
8:23
It’s a 12 to 24 month bridge.
8:25
You’re essentially renting your balance sheet to the developer so they can get through this one administrative gate.
8:31
OK, let me play the skeptic here.
8:33
I’m an investor.
8:34
I put up $5 million for a deposit on a solar project.
8:38
The study comes back.
8:39
And the grid operator says, Sure, you can connect, but it’s going to cost you $40 million in upgrades.
8:45
And the developer says, I can’t afford that.
8:47
Right?
8:48
The Project dies.
8:50
My $5 million is sitting with the utility.
8:52
Is it gone?
8:53
And this is the most critical part of the entire thesis refundability.
8:58
This whole asset class relies on the regulatory obligation of the utility to return unspent funds.
9:04
Regulatory obligation sounds nice, but you know, regulations can have loopholes.
9:08
How solid is this really?
9:09
It’s surprisingly robust, and that’s because it’s not based on whether the project succeeds or fails.
9:14
It’s based on the custody of the funds.
9:16
When you post that deposit, it goes into a restricted account held by the utility.
9:21
It is not revenue for the utility, it’s a liability on their books.
9:24
So if the developer just walks away, the utility can’t just keep it as some kind of cancellation fee.
9:30
Under FERC rules and specifically in the tariffs for regions like New York, California, PJM.
9:37
The utility can only keep the costs they’ve actually incurred, you know, the engineering hours they spent running the study.
9:43
I did see that FERC increased the withdrawal penalties to discourage speculation.
9:47
They did, and they can be significant, but relative to the principal amount, we’re usually talking about a penalty structure that ramps up over time.
9:56
But the vast majority of the capital, often 85 to 95% of it, must be returned by law.
10:02
The sources mention the PG&E bankruptcy as kind of the ultimate stress test for this idea.
10:07
That’s the in case of emergency break glass scenario.
10:11
I mean, when PG&E went under one of the biggest utility bankruptcies in history, there’s a real fear that these interconnection deposits would just get swept up by all the other creditors, right, treated like any other unsecured creditor.
10:21
But the courts and the regulators held the line.
10:24
They deemed those deposits to be customer funds, not utility property, and they were returned.
10:31
That precedent suggests this capital is bankruptcy remote from the utility itself.
10:36
OK, so you have a regulated floor.
10:38
So what about the upside?
10:39
Explain the return mechanics, because if I’m tying up my capital for 2 years, I need more than a savings account return.
10:45
Of course, the return profile is a kind of hybrid.
10:49
First, you often get the interest on the deposit itself.
10:52
In a lot of places, Kansas, Oklahoma, New Mexico are examples.
10:56
The utility is actually required to pay interest on those held funds.
10:59
OK, so that’s the base layer, a small return.
11:02
Then you have your deal with the developer.
11:04
The developer will usually pay a coupon or an interest rate for the use of your capital.
11:08
But the real upside comes from the equity kicker, the sweetener.
11:12
When the project successfully gets through the queue and reaches what’s called notice to proceed, it’s usually sold to a big long-term owner or it gets recapitalized at that liquidity event.
11:22
The interconnection investor gets a percentage of the project’s total value.
11:26
The sources estimate that at around 1.5 to 2% of the project value, which sounds small, but on a $100 million project, that’s up to $2 million straight to your bottom line on top of all the interest you already earned, right?
11:39
And this brings us to the scenario modeling in the source material, which I found really counterintuitive.
11:44
They modeled a portfolio of 40 projects.
11:47
I have the numbers right here.
11:48
KA 100% success rate.
11:51
Every single project gets built.
11:52
The IRR is 16.8%, which is very strong for what is essentially a secured asset.
11:59
But look at Case B.
12:01
A 40% success rate.
12:03
So that means 60% of the projects in the portfolio fail.
12:06
They get canceled, they die in the queue.
12:08
In venture capital, if 60% of your portfolio dies, you are out of business.
12:12
Absolutely.
12:13
But in interconnection capital, the model shows a 14.6% IRR in that failure scenario.
12:19
Wait, walk me through that.
12:20
How does the return only drop by 200 basis points when the failure rate more than doubles?
12:25
Because of the refundability.
12:27
When a project fails, you don’t lose the principal.
12:30
You get the vast majority of your deposit back minus maybe a small penalty, and you probably still collected some interest during the time it was held.
12:38
Exactly.
12:39
The only thing you miss out on is that equity kicker.
12:41
I see.
12:42
So the floor is really high because the capital is preserved, not burned.
12:47
It’s this asymmetry where your downside is capped at the cost of your time and some small fees, but your capital recycled.
12:56
It creates a portfolio resilience that is completely decoupled from the price of electricity or the weather.
13:02
You’re not an energy speculator.
13:03
You’re an arbitrager of bureaucratic process.
13:06
You’re effectively turning the grid’s biggest bottleneck into a yield generating asset.
13:12
I want to zoom out for a second though.
13:13
We’ve talked about the mechanics.
13:14
What does this all mean for the energy transition at large?
13:17
I think it means we’re moving from the innovation phase to the implementation phase, meaning the tech is basically done.
13:22
Now we just have to actually build it.
13:24
And building it is boring.
13:26
It’s plummits, it’s easements, it’s cube positions.
13:29
The sexy part of the energy transition is kind of over.
13:32
The hard part has just begun.
13:34
It feels like a shift in the power dynamics too.
13:37
You know, 10 years ago, the power was with the person in the lab coat who was inventing a better solar cell.
13:42
For sure.
13:44
Today, the power is with the person who understands FERC Order 2023 and has the balance sheet to endure a 4 year wait time.
13:53
It’s a pretty sobering thought.
13:54
We often frame the energy transition as this, this inevitable technological wave.
14:00
But listening to this, it sounds like the whole thing could just stall out in a spreadsheet.
14:03
It absolutely could.
14:05
In fact, I would argue that without liquidity mechanisms like interconnection to capital, the transition will stall.
14:11
If we restrict grid access to only the players with billion dollar balance sheets, we lose all the dynamism of the market.
14:17
We need those mid-market developers to push boundaries and find new sites and drive costs down.
14:23
So in a way this financial engineering is just as critical as the electrical engineering.
14:26
It’s the lubricant.
14:28
The grid is the engine, but capital is the oil.
14:30
Without it, the engine seizes.
14:32
So to wrap this up, if you’re a listener trying to understand where the energy market is really going, Maybe stop looking at the solar panels.
14:39
Stop looking at the panels.
14:40
Look at the queue.
14:42
Look at the regulatory filings.
14:43
That’s where the constraints are.
14:45
And in finance, profit is always found at the constraint.
14:49
The constraint is the opportunity.
14:51
Always a fascinating look into the plumbing of the grid.
14:55
Leave it there.
14:56
Thanks for diving deep with us.
14:57
My pleasure.
First Pacific Financial is a registered investment adviser and the opinions expressed by First Pacific Financial on this show are their own and do not reflect the opinions of Citizen Mint. All statements and opinions expressed are based upon information considered reliable although it should not be relied upon as such. Any statements or opinions are subject to change without notice.
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