renewable project finance

renewable project finance

Exploring Renewable Project Finance: Strategies and Best Practices

1. Introduction to Renewable Project Finance

We define renewable project finance as project finance that employs a renewable energy resource or technology. Given the unique characteristics of renewable project finance, it is critical to tailor a financing strategy to fit the specifics of individual renewable energy projects. Depending on the type of power producer, the energy sources, the scale, the stage of development, the location, and the range of legal, social, and economic circumstances, a unique financing plan may be required. In some cases, the right financing structure can make an otherwise economically feasible project economically infeasible. For example, a project that will pay taxes does not need tax credits. A project that is eligible for grants may still need tax credits or other tax benefits. If renewables are added to a large thermal project, the value of the thermal system may determine the cost of financing the entire project.

Renewable energy project financing has a unique set of challenges and opportunities. Project finance is fundamentally different from traditional corporate finance. Generally speaking, it is a long-term financing of a capital-intensive investment in which the debt is repaid solely from the project’s cash flow and the collateral for the loan is the project itself. Project debt usually involves a loan structure that requires repayment over a period of 10 to 20 years, strict debt covenants designed to protect the interests of creditors, and a payment mechanism that provides a reliable and relatively predictable payment stream to the debt service account.

2. Key Players and Stakeholders in Renewable Energy Projects

Be it big or small, local or international, every renewable energy project (REP) is connected to, or directly exposed to, a variety of influential groups, namely stakeholders. These stakeholders determine the speed, quality, acceptance, and viability of each and every project. Their interests also impact the political and regulatory framework that governs the renewable energy sector, signifying that engaging and managing stakeholders can be both essential and, in the end, rewarding. The necessary know-how and skills for managing stakeholder expectations are the same for all renewable energy projects. At the same time, the size and nature of projects and their respective ownership, together with project developers’ goals and the existing level of acceptability in the area, will create different scopes and areas of action.

Power project development and operation of renewable energy plants are characterized by the involvement of different groups, stakeholders, and institutions. Their interests and expectations do not automatically support project development and long-term plant operation or even a stable political or regulatory environment. This chapter outlines the structure, typical types, and activities of stakeholders in renewable energy projects. Guiding principles define the relationship management process; reveal successful management techniques for involving and handling stakeholders; outline strategies on how to overcome stakeholder conflicts; and summarize the typical qualifications, knowledge, and experience needed by stakeholders involved in power plant permitting, financing, and operation. Correct management of the relationship with stakeholders not only is essential for project development, but also can significantly influence the returns on an investment by softening political and regulatory risks.

3. Financing Options for Renewable Projects

Third, project equity is used to establish a positive risk-return relationship between the sponsor(s) and the debt lenders. Equity investors who provide capital for a project generally share in the potential returns from that project. However, they also take on the most risk of losing the money that was invested. In this project finance structure, equity is defined as the part of the company’s capital that is supplied by the owners of the company and is not any type of outside borrowing. The last important feature of this detailed case study is the decision making of the equity sponsor. The equity sponsor typically possesses 100% authority within its board of directors to make decisions on behalf of the special project company. These decisions can include hiring a project manager, signing professional service contracts, resolving any potential disputes, and representing the company in formal legal matters.

4. Risk Management and Mitigation Strategies in Renewable Project Finance

In the last part of this chapter, we examine the question of flexibility in any financing agreement. The presence in the agreement of such qualifiers as commercially reasonable efforts, no material adverse effect, project economics available for reinvestment by sponsor, lender or project owner, make the analysis more than relevant. Clarity is necessary in any agreement between the transacting partners. Further, the lender must have confidence in the inner workings of the sponsor. While resource volatility, price volatility, and technology risk can each unbalance debt financing of a project, with respect to energy projects, inflation and execution risks are equally, if not more, demanding. Traditional energy project financiers specialized in projects that benefit from specific sectors, often with strong interactions and linkages. These specialists are extensively familiar with the risks and able to provide the necessary debt financing. But the companies that sponsored and financed these projects are converting to more of a generalist operation model. The dynamic economy, coupled with a more competitive energy market, forces analysis on the financing and retention of risk management related to renewable investment. The risks associated with the construction or operation of a specific project deserve a different approach to risk management. It is the goal of this analysis to put forth such different approaches and solutions.

The development and financing of energy assets have to address a tangled web of risks and create mechanisms for mitigating, managing, transferring, and absorbing such risks. The principal risks are grouped into four categories: resource volatility, federal and state incentives, price volatility, and technology risk. There are two main ways to mitigate these risks: insurance (catastrophic for force majeure and political risk, market-driven for counterparty and credit risk) and diversification. Four major structural solutions can be found for handling risk: prepaid hedges for project output, long-term service support contracts with a trusted technology provider, third-party engineering expertise, and wholesale outsourcing of in-house operational management experiences. These solutions are an integral part of the structure of successful project financing. In the distribution of risks between the lender, the sponsor, and the construction contractor, the sponsor is most likely to bear the cost of safety in the case of on the job-site performance or construction, while the financier is likely to be compensated through the interest spread for the exposure to project cost escalations and longer construction periods.

5. Case Studies and Success Stories in Renewable Project Finance

Those operating in the renewable energy space may easily become quagmired either through a quest to keep pace with changes in project finance capitalization or due to the sense that what was once considered a passive, “feel-good” investment, in fact, requires a unique skill set to optimize. However, the learning curve is both manageable and, managed correctly, can see vital job creation and economic boost in the areas which host these assets. While increased simplicity in technology and cost has meant that renewable projects are now adopted on a wide-scale basis with a variety of capital sources, public and private, project finance structures still play a vital role in providing the final sets of capital to help these deals reach fruition and become part of a functioning “energy bank” on which the nation continues to draw.

Renewable energy has transitioned from a niche to a vital part of the mainstream energy landscape, accounting for the lion’s share of new generation capacity installed. Financing renewable energy technology represents a significant opportunity for new investor groups attempting to tap into a high-yield asset class that requires less initial capital than many other infrastructure asset types, possesses a familiarity that extends beyond traditional power and infrastructure funds, and offers a measurable economic development outcome.