Renewable Energy project financing is a relatively young industry, where transaction structures continue to evolve.
Due to the unique nature of risks in most renewable energy financings, transactions need to be constructed with a fine balance of risk allocation.
GLOBAL SOLARIS GROUP offers meaningful insight on maintaining this fine balance and works with the most reputed and experienced Renewable Energy investment firms.
Project finance is a structure employed to finance capital-intensive projects that are either difficult to support on a corporate balance sheet or that have become more attractive when financed on their own. Renewable energy projects in the United States are typically financed using project finance and generally include a mix of project equity investors, tax equity investors and project-level loans provided by a syndicate of banks. Terms set forth by both lenders and equity investors are based on the project’s perceived riskiness and its expected future cash flows.
The project finance structure revolves around the creation of a “project company.” The project company holds all of the project’s assets, including its contractual rights and obligations. The project company is typically a limited-liability company (LLC) or, in some cases, a limited partnership (LLP). Project-level loans are usually non-recourse, meaning that they are secured by the project’s assets and paid off by the project’s cash flow: the investors’ assets are shielded should the project be unable to meet loan repayment terms.
Most renewable energy projects require a signed power purchase agreement (PPA) in order to reach financial close and commence construction. The commercial terms of the PPA and the engineering, procurement and construction (EPC) contract, together with the project’s associated market and technology risks, will largely determine whether lenders consider the project “financeable.” The maturing of the wind power market in recent years has allowed some major wind parks to receive project financing in the absence of a long-term PPA (known as “merchant projects”), but solar projects rarely receive financing in advance of a PPA being signed.
I - Direct Equity
Project equity (aka “cash equity” or“private equity”) is supplied by private equity firms or the developers themselves. Direct equity investors invest a specified amount in a project in return for a certain stake in the project’s future cash flows.
II - Tax Equity
Renewable energy project developers typically do not have tax liabilities large enough to efficiently capture the full amount of tax credits available for large projects. To circumvent this issue, project developers can pair with a tax equity partner that is better able to utilize a project’s tax benefits. Traditionally, tax equity investors have been large investment banks, commercial banks and insurance companies with a high tax burden that seek to offset some portion of their expected tax liability. In some cases, large equipment manufacturers are able to provide tax equity.
The two primary tax equity financing structures of renewable energy projects in the U.S. are the sale-leaseback model and the partnership flip model.
1 - Sale-Leaseback Model
The sale-leaseback model allows a project developer to recoup its entire investment in a project, eliminating the need to invest directly. In this model, the developer finances and installs a project and then immediately sells it to a tax equity investor at full value. The tax equity investor then leases the project back to the developer at a fixed rate for a period exceeding the PPA schedule. The developer uses PPA revenue to fund rent payments to the tax equity investor, who also claims all tax benefits associated with the project. At the end of the lease term, the tax equity investor either remains the owner of the project or the developer can buy the project back at its residual value.
The benefit of the sale-leaseback model is that the tax equity investor is able to pass tax savings on to the project developer in the form of lower rent payments. In turn, lower rent payments result in a lower PPA price and lower rates charged to end customers.
2 - Partnership Flip Model
A partnership-flip model is structurally more complex than a sale-leaseback model, but gives more freedom to the project developer within the partnership. The project developer and tax equity investor form a partnership company (typically a limited-liability company), through which they co-own a project. The partnership becomes the formal owner of the project, receiving all associated revenue and tax credit. Once formed, the partnership will negotiate over the distribution of revenues and tax credits, which is done on a project-by project basis. In all cases, the tax equity investor requires a certain rate of return within a certain time frame (typically six to ten years). For example, during this time frame the tax equity investor may claim 99 percent of revenue and tax incentives within the partnership and the developer just one percent. Once the tax equity investor achieves its required return, the partnership structure flips and the developer may receive 95 percent of revenue and the tax equity investor receives five percent.
A benefit of the partnership-flip model is that the project developer receives assistance in financing the construction of the project from the tax-equity investor; financing is often difficult to source for large-scale projects.
III - Debt
Project debt is supplied by a bank or a syndicate of banks, which lend against the expected future cash flow of a project. Debt packages inevitably vary by project size and technology, but most solar, wind and geothermal projects incorporate one or more of the following:
1 - Term Loans
Term loans are a basic vanilla commercial loan. Term loans typically have fixed interest rates with monthly or quarterly repayments.
Term loans for renewable energy projects are typically “long term,” with maturity dates generally between 10 and 20 years (though tenors dropped significantly directly following the financial crisis). The collateral for term-loans is typically the project itself.
2 - Construction Loans
The potential risks and returns to an investor during the construction period differ from those expected once a project has reached commercial operation. As such, most large renewable energy projects have a construction loan component in the overall project-financing package. Construction loans are generally distributed in several installments. After the first installment , and through the term of the construction loan, the borrower makes interest only payments on the installments received to date. When construction is complete, payment is due for the entire amount. In some cases, construction loans will automatically convert to term loans once commercial operation is reached. The interest rate on construction loans is generally higher than on term loans.
3 - Equity Bridge Loan
Equity bridge loans have grown in popularity since the introduction of the ITC cash grant in 2009. Because cash grants (which cover 30 percent of a project’s installed cost) are made 60 days after the project commences operation, developers still need bridge financing to get through the project’s construction phase. Equity bridge financing is often furnished by equity investors until the grant comes through, at which time the investor is typically repaid. Cash grant bridge loan spreads are similar to term debt spreads, if not somewhat lower.
IV - Other
There are several additional financing instruments available: 144A bonds, Clean Energy Renewable Bonds (CREBs), which are available to co-ops and municipalities, Class B memberships, and prepaid service contracts.