renewable energy project finance

renewable energy project finance

The Dynamics of Renewable Energy Project Finance: A Comprehensive Analysis

1. Introduction to Renewable Energy Project Finance

The increased efficiency of wind, solar, biomass, and small hydro energy conversion technologies has been a crucial driver in triggering the expansion of these energy sources; power plants operating with renewable sources of energy and substance burners with renewable fuels are fast becoming fixtures in the modern energy mix. Municipalities and other stakeholders also benefit from the decrease in negative externalities derived from the mean combustion of fossil fuels. Such benefits can be shared at both the local and global level. At the local level, renewable energy sources can significantly contribute to meet the demand for electricity in remote places without distribution costs or problems associated with lack of distribution infrastructure. This is especially important in areas with weak access to energy services, referred to as energy poverty which affects about a third of the world’s population. At a global level, the use of renewable energy sources contributes to decreased carbon emissions and other negative externalities resulting from the use of carbon-intensive fuels.

This paper examines 101 renewable energy projects implemented between 2002 and 2004, totaling over $8 billion in regulation investment costs. In particular, we analyze detailed quantitative and qualitative information for 55 projects in the wind sector, 31 projects in the solar sector, 11 in hydroelectricity, and four in geothermal energy. The database provides generalized ownership structures, income and cost structure and potential external financing constraints. This unique material has been collected by interviews with all project sponsors. Not surprisingly, the exact nature of the various financial sources reveals a complex pattern between the different types of renewable energy. Differences, for instance, include the cost of debt, leverage, or requirements for sponsor equity. Subsidies play an overwhelmingly important role.

Project finance has emerged as one of the most important forms of financing for infrastructure over the last few decades. It affects not only available investment in infrastructure, but also the financial risk and costs of power generation, transportation, water supply, and municipality infrastructure projects. It is especially important for renewable energy projects, as they are heavily dependent on the benefits that can be offered by the limited recourse model which characterizes project finance. The importance of renewable energy finance results from the large scale of investment necessary to meet the ambitious future targets for renewable energy and the cost of capital being a significant part of the costs of renewable energy. The transition away from carbon-intensive sources of energy is a critical issue if greenhouse gas emissions are to be stabilized at a level that will avoid the worst impacts of climate change.

2. Key Players and Stakeholders in Renewable Energy Project Finance

An ATP manager or specialist investment firm is typically the preferred party to conceive, promote, and structure renewable energy project finance proposals and deals. It plays a pivotal role—typically in collaboration with and in leading other stakeholders—to ensure that renewable energy infrastructure project financing deals are feasible, implementable, and the value-adding initiatives so necessary to ensure optimized realization and what is defined as stakeholder holistic ROI is comprehensively aimed at throughout the lifetimes of such initiatives are funded predominantly by non-recourse debt. All of these actions are performed by making judicious use of financial engineering and structuring techniques, methodologies, and numerous models. The ATP manager is also an innovative, multi-disciplined party—it employs leading-edge entrepreneurial managerialism and is tasked to promote and navigate cutting-edge innovation and research into what is envisaged as a significant contributor to the global societal health, societal and economic well-being, and yet also a considerable stimulant to the momentum and creation of burgeoning new business models.

When determining the key players and stakeholders in renewable energy project finance, one is generally dealing with an interdependent relationship where various parties and their objectives may often, to a lesser or greater degree, conflict with those of other major stakeholders. Within the realm of renewable energy project finance, deals are typically conceived, promoted, and structured on the pretext that they will be implemented in consonance with clear objectives and values guiding the local communities comprehensively concerned. This reality also typically necessitates the amicable acceptance and thereby the financing of their economic and direct benefits. The comprehensive nature of stakeholder management and the associated identification of risk-reward relationships between and integration of the financial and socio-political objectives of the various parties are therefore crucial to the practice of financial engineering and structuring of renewable energy project finance deals.

3. Financial Structuring and Risk Management in Renewable Energy Projects

When a full power purchase agreement is in place, a project becomes more fully merchant in character… but also more susceptible to the financial structures of traditional utility companies. Two principal problems are perceived. First, PE engineers’ ‘incremental’ investment, which are small in relation to the cash inflows received, offer to lower operating earnings. Second, PE provides a tax shield of far less importance to profit stream erosion than to ensuring the ability to raise low coupon bond money. Both arguments indicate a problem of reduced debt capacity. This concern illustrates the importance of developing increasingly efficient technology… or attracting a merchant of more substantial scale. The risks faced by owners and investors and the nature of financial strategy project decisions depend not only on technical characteristics but also on the incentives for project development created by public and private legal/regulatory institutions. However, fundamental issues do remain with whether and how private equity investors, that foundational pillar of the merchant model new generation finance, really take a slice of risk they are made to think they take and whether their being made to think they take enough isn’t necessarily just as problematical.

4. Case Studies and Best Practices in Renewable Energy Project Finance

We shed light on how structural, business, and financing arrangements can facilitate sponsors, lenders, and public sector stakeholders to optimize the capital and operational requirements of renewable energy technology investments while ensuring reliable and sustainable electricity supply along with socially and environmentally responsible outcomes. To achieve the goal of financial de-risking of renewable energy projects, we share practice insights on the art of developing and acquiring innovative project finance mechanisms addressing the specific barriers and risks associated with the financing and deployment of different renewable energy technologies. The financial structures intended to channel funding to individual projects typically focus on maximizing bankability for assets with long economic lives and concentrated revenues generated under a reliable, long-term supply regime with relatively low operating and fuel costs plus competitive or low capital costs.

In this chapter, we offer a comprehensive perspective by reviewing specific projects from both developed and developing countries to share best practices and lessons learned about the complexities, optimal structures, critical risk management techniques, and necessary innovations in renewable energy project finance in different renewable technologies, geographies, risk-return requirements, incentives, and/or constraining policy environments.

5. Emerging Trends and Future Prospects in Renewable Energy Project Finance

The prospect of international projects combined with the high interest in renewable energy to the international development donor community suggests that development finance should host or co-host the movement into new technological areas. The injection of significant amounts of long-dated, patient capital is one of the reasons for the existence today of debt instruments at the project level with repayment profiles of much more than fifteen years. This feature of the project finance market dovetails well with the demands of the renewables sector, to the extent that renewables developers are eager to use long-dated project debt to cheapen their financing and thereby gain advantages relative to fossil generators. It is surely unlikely that the supply of long-dated debt from developmental financial institutions for renewable energy projects will diminish. With an agreed size of the renewables market throughout the investor classes, there will also be a need to develop alternative investment strategies to satisfy the money donor’s diversification and other constraints.

Although niche areas such as offshore wind, marine, and solar photovoltaic await testing of the project finance model itself, it is widely believed that in general terms the structure of project finance, the identification of senior and junior finance providers, and the type of financial instruments that they use can be expected to be equally applicable to technologies such as solar photovoltaic as they have been to onshore wind transactions. It is notable that some larger financial institutions, classified by deal size as typically involved in what can truly be considered project finance transactions, have also been active lenders to onshore wind and indeed have sought to develop their experience and expertise in other renewable energy technologies. That tradition supports the notion that a functional project finance market can encompass renewable energy projects across the whole risk spectrum.