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Yieldcos generally own large solar projects like this one. Image source: SunPower.

The solar industry got a big boost this week when Congress agreed to extend the 30% investment tax credit through 2019 with a drawdown in the subsidy to 10% in 2022. Solar stocks shot higher, and it appeared that for the time being all was right in the world of renewable energy.

One forgotten segment of the industry has been yieldcos, once the hottest investments on the block but a group of stocks thrown out with master limited partnerships and other energy investments in 2015. As we head into 2016, we may finally be seeing the fortunes of yieldcos turn and that would be good news for everyone in renewable energy.

The downward slide of yieldcos
Some of the biggest yieldcos on the market have been terrible performers over the past six months despite what should be a very consistent business model. By definition, a yieldco owns energy projects that generate cash through long-term contracts and it pays that cash out to shareholders in the form of a dividend. Since you can reliably predict the cash generation of wind and solar projects fairly accurately, one would think these would be attractive investments in a low interest rate environment.

Still, 8point3 Energy Partners (NASDAQ:CAFD), TerraForm Power (NASDAQ:TERP), NRG Yield (NYSE:NYLD), and NextEra Energy Partners (NYSE:NEP) have all plunged in the past six months with very little in the way of bad news to drive the fall.

CAFD Chart

CAFD data by YCharts.

In fact, most yieldcos have been increasing dividends, which investors should be pleased with. In October, NextEra Energy Partners more than doubled its dividend to $0.27 per share and said it was on track for 12%-15% distribution growth through 2020. 8point3 Energy Partners said its fourth-quarter dividend would grow 3.5% to about $0.22 per share and implied that more growth is coming in 2016.

In general, yieldcos have been operating as planned, but falling stock prices have made future growth potentially more difficult. Part of the problem with yieldcos is that they rely on the ability to purchase more projects to grow distributions. But to buy projects, they need to issue debt and equity. To be economical, that equity has to be issued at a low cost of capital (i.e., low dividend yield). With dividend yields are near 10%, as they have been recently, there's no ability to issue new equity and buy projects at compelling economics. So, the yieldco model falls apart for both yieldcos and the companies hoping to sell projects to them.

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Image source: SunPower.

Why yieldcos are needed
If the ITC extension can get investors excited about renewable energy again and bid up shares of yieldcos, it could help boost renewable energy growth, mainly because yieldcos are needed to drive project economics.

When a solar developer bids for a project, they have to assume some cost of capital for what they're installing. If your cost to build a system is $100 million, you expect to generate 100,000 MWh of electricity per year, and your cost of capital is 8%, then you can bid $0.08 per kWh. If yieldcos fall and the value of projects falls along with them, then the cost of capital goes up. A rise to a 10% cost of capital would mean you could only bid $0.10 per kWh to develop the same project economically.

This puts many developers in a bit of a bind because they were counting on selling projects to yieldcos or third parties with a low cost of capital. So, when yieldcos began to fall, that low cost capital dried up as well.

To fuel further growth of the solar industry, ITC or no ITC, there needs to be buyers for projects. So, a recovery in yieldcos would be good news for solar as a whole.

Yieldcos could finally be on a path to recovery
There's at least a little life in yieldco shares lately, and that's welcome news for both the solar industry and yieldcos themselves. If yieldcos can get back to a low cost of capital, they'll have a growing pool of assets to buy from with the ITC extension. That could lead to further dividend growth, which would make yieldcos even more valuable.

It's a self reinforcing loop that drives value in yieldcos, but it all starts with a low cost of capital and shares still need to recover to get capital costs down. If they do, this could be a booming asset class for the next decade.

Travis Hoium owns shares of 8point3 Energy Partners and SunPower. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.