Project financing basics in the power sector
presentation to School of Engineering
Columbia University
A.J. Goulding
New York, NY
October 24th, 2014
Speaker background
2
My career, both before and after SIPA, has largely focused on the
energy industry
Joined ICF
Resources,
focusing on natural
gas resource base
and Section 29 tax
credit for nonconventional fuels
production
1991
1993
Commenced
studies at
SIPA
1995
Moved to New Delhi,
ultimately joined USAID
working on bagasse
cogeneration and clean
coal technologies
1996
Worked with
top ten power
marketing
company on
asset
restructuring
1997
Summer
associate at
London
Economics
International
1998
Set up
private
equity
firm
2000
Joined London
Economics
International as
senior
consultant
Control 16 MW
of hydro at 11
sites
2003
2014
Led management
buyout of North
American
operations of
London Economics
International LLC
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Speaker background
3
Ampersand has been targeting one acquisition per year
T
T
Tannery Island
1.875 MW T
T
T
Moretown
1.2 MW
Hollow Dam
900 kW
Brooklyn Dam (under construction)
600 kW
Sebec Lake
876 kW
Gilman
4.85 MW
Burt Dam
600 kW
Brockway Mills
500 kW
Mount Ida
2.9 MW
Collins
1.5 MW
Peterborough
690 kW
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Intro to project finance
4
Principles of project finance focus on risk isolation and
financing efficiency
Project Finance is a subset of the global financing markets designed to finance
large infrastructure projects


Somewhat independently of changes in global financial markets, project finance maintains its own
framework of terms and conditions that set long-term expectations among project finance lenders
Project Finance is a specialized practice served by dedicated bankers and lawyers with subject
matter expertise
Project Finance is structured to depend solely on the cash flows from the
project, and is thus “non-recourse” or “limited-recourse” financing

This means that the lenders have limited recourse to the owner of the infrastructure project if the
project is unable to meet its financial obligations
Project Finance supports the development of new infrastructure projects


Reduces the cost of capital for new projects with no operating history
Allows developers and lenders to take calculated and managed risks in new or uncertain markets
that require a large upfront investment
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Intro to project finance
5
Project Finance is available in many forms from a range of
sources
Project Finance is available in many forms:
 Senior Debt
 Mezzanine Financing
 Preferred Equity
 Tax Equity
 Project Equity
and from many different sources:
 Commercial Banks
 Life Insurance Companies
 Pension Plans
 Multilateral Institutions
 Export-Import Banks
 Taxable Bond Markets
 Municipal Bond Investors
 Infrastructure Funds
 Hedge Funds
With so many different
forms and sources of
project finance, how do
we choose?
The goal is always to
reduce financing costs
and maximize the return
to the Developer
The optimal structure
depends on the
project’s details
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Intro to project finance
6
IPPs are essentially a stack of interrelated contracts
► Typically there will be a special purpose company formed to
house one or potentially many projects
 Generally non-recourse financing is sought for the special purpose
entity
 The project itself must be creditworthy
► Engineering, Procurement and Construction Contract for the
supply of the equipment and construction
 Consider direct purchase of equipment and performance
guarantee coordination as part of this process
 Direct purchase may be more economic but potentially sets up
developer to be at risk for non-performance
 Requires very close coordination
Loan
agreement
Power
Purchase
Agreement
Site control
agreement
EPC
contract
SPV
► Operations and Maintenance (O&M) contract
 Possible to self-perform some or all of the maintenance
 Economies of scale, geographic presence or specific expertise
► Negotiate site control: land lease or purchase
► Interconnection agreement with utility or grid
Manufacturer
warranties
O&M
agreement
► Utility agreements for water and other site infrastructure
► Power Purchase Agreement (PPA)
► Financing Agreements
Permits
► Key terms of all of these agreements need to be closely
coordinated
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7
Intro to project finance
Engineers play an important role in project financing
► New projects lack operating history, leaving lenders unsure of performance
► Engineers opine on two key aspects:
resource
availability
technical
capability
► Opinions are critical in terms of new technologies or uncertain resource
quality
► Experience suggests that resource quality estimates can be dramatically
wrong; data may focus on an impact (wind speed) without knowledge of
conversion effectiveness
► While equipment performance can be guaranteed, engineering report
influences cost of insurance
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Example project finance structure
8
Ampersand corporate structure reflects influence of project
finance approach
Ampersand Energy
Partners LLC (“AEP”)
► All debt at SPV level
controlling interest
with AJG
100%
Ampersand Operations
Company LLC (“AOC”)
Ampersand Hydro LLC
(“AHL”)*
► Operations separate from asset
companies
► PPAs at asset companies
► Equity generally at holdco level
► HOWEVER: holdco guarantee in place
100%
100%
100%
ASLH
100%
ANHH
ACH
AMH
100%
ABMH
80.1%
100%
ATIH
ANYH
55%
AGE***
100%
51%
AHI-P
ABDH
100%****
AMIH**
Key
ABDH
Ampersand Brooklyn Dam Hydro
ASLH
Ampersand Sebec Lake Hydro LLC
AGE
Ampersand Gilman Energy LLC
AMIH
Ampersand Mount Ida Hydro LLC
AGH
Ampersand Gilman Hydro LP
ANHH
Ampersand New Hampshire Hydro LLC
AHDH
Ampersand Hollow Dam Hydro
ANYH
Ampersand New York Hydro
AHI-P
American Hydro Inc. - Peterborough
AOHH
Ampersand Olcott Harbor Hydro LLC
AMH
Ampersand Moretown Hydro LLC
ACH
Ampersand Collins Hydro LLC
ABMH
Ampersand Brockway Mills Hydro LLC
ATIH
Ampersand Tannery Island Hydro LLC
AOHH
AHDH
AGH
Notes:
*
shows only active subsidiaries
**
AMIH has similar ownership
structure to ANYH, but is owned
directly by AHL
***
AGE has other subsidiaries which
hold the former paper mill buildings
and associated land
****
represents voting interest; partner
holds residual 45% economic
interest
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Project life cycle and target returns
9
Target Return %
Diversity of financing types available depends on stage of project
development
Conceptualization
PPA Signing
Construction
Operations
Retirement
Financing Type
Equity
Preferred
Equity
Mezzanine
Equipment
Senior
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Project life cycle and target returns
10
Example returns to investor classes for highly leveraged project
by small developer
Proportion
of Capital
Floor
Return
Share of
Upside
Targeted
Returns
Senior Debt
65%
7%
0%
7%
Mezzanine Capital
10%
10%
10%
13%
Preferred Equity
24%
15%
81%
20%
Developer Capital
1%
0%
9%
25-50%
100%
9.15%
100%
10.65%
Investor Class
Total/Weighted Avg
Example returns to investor
classes for highly leveraged
project by small developer.
(Note example uses simplified
project returns and disregards
investor-level taxes)
Returns to Investor Classes
Returns to Investor Classes
140%
120%
100%
40%
Senior Debt
20%
Mezzanine Capital
Preferred Equity
0%
Developer Capital
-20%
-40%
-60%
-80%
-100%
Project Return
60%
-40%
-36%
-32%
-28%
-24%
-20%
-16%
-12%
-8%
-4%
0%
4%
8%
12%
16%
20%
24%
28%
Project Return
80%
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
-70%
-80%
-90%
-100%
Senior Debt
Mezzanine Capital
Preferred Equity
Developer Capital
4%
8%
12%
16%
20%
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Project debt considerations
11
Project Debt
Covenants, default, and guarantee
► Project debt is arranged under a core set of terms and conditions that are similar throughout
the world
► The details will vary from project to project, but certain key features remain consistent
 All of the collateral sits within the four corners of the project company
 The project company is fully secured, including assets, shares and assignability of key contracts
to lenders
 Limitations on modifying key contracts or taking actions outside the ordinary course off business
without lender approval
 Reserve accounts for debt service, major maintenance or other project risks
► The loan provisions anticipate that an owner will “walk away” from a project once their
resources are exhausted, but give lenders the time and tools to assume control of the project
and continue operating it for the benefit of the lenders
 Owners do in fact “walk away” from projects when prospects for a return on equity have been
eliminated
 As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive
some return on their loans and ultimately for the project capital structure to be rearranged –
original lenders may become the equity, with new lenders brought in
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Project debt considerations
12
There are six key drivers to optimizing Project Finance
structures
Local bankruptcy and
foreclosure laws

Lenders ability to enforce
remedies drives view of
project risk


Global financial
conditions

Changes in financial
markets create swings in
investor appetite

Euro crisis caused many
prominent French project
lenders to withdraw from
senior debt market
Currency and regional
markets
Tax laws
Many jurisdictions provide
tax incentives for debt over
equity

Investors and lenders are
different in different regions

Management of currency
risk
Presence of tax incentives
for renewable energy
projects
Project type

Different generation types
have different risk profiles
Project size

Larger projects have more
options because of the
greater liquidity of
corresponding financial
securities
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Project debt considerations
13
Closing mechanics and closing costs
► Project Financing is a legally intensive process
 Each class of financing generally represented by its own law firm
 Attorney for Senior Lenders frequently coordinates documents, signature pages, and the project
does not “close” (i.e. fund) until signatures are released by everyone’s counsel
 A typical project financing will include several hundred pages of documentation
 Legal fees alone can range from $250K to $1 million depending on complexity
 Because legal fees do not change much with the size of the project, larger projects enjoy
economies of scale
► Lead financial arrangers also receive an upfront fee at close
 Fees vary, but arranging senior debt can equal 2% of gross senior debt raised and mezzanine
capital can be ~3-5% of gross subdebt
► Upfront fees and legal bills are funded out of proceeds at close and thus indirectly increase the
all-in cost of debt
 If closing costs are 2% of total debt raised for a 20-year term, this drives up the all-in cost of debt
by ~0.37-0.50% (37-50 basis points)
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Project debt considerations
14
Types of Project Finance available
Mezzanine Financing
► Subordinated Debt, often referred to as Mezzanine Financing, sits between senior debt and
equity
 “Mezzanine” is “an intermediate or fractional story that projects in the form of a balcony over the
ground story1”
 Similarly, mezzanine financing is paid after senior debt (the ground story in the analogy) but
before equity
 Mezzanine is used to finance cash flows with too much uncertainty for senior lenders but
supported by enough collateral for debt financing
► Funding sources are seeking higher financial returns and thus are willing to accept incremental
risk
 Cannot declare default without senior lender consent
 During distress, senior debt often traps cash until project stabilizes or is refinanced
 Mezzanine lender relies on likelihood of recovery in foreclosure process to protect downside risk
and some sharing of upside economics
 Lenders include specialized funds, hedge funds, insurance companies and some equipment
manufacturers
1. Source: Merriam Webster Dictionary
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Project debt considerations
15
Project Debt
Covenants, default, and guarantee
► Project debt is arranged under a core set of terms and conditions that are similar throughout
the world
► The details will vary from project to project, but certain key features remain consistent
 All of the collateral sits within the four corners of the project company
 The project company is fully secured, including assets, shares and assignability of key contracts
to lenders
 Limitations on modifying key contracts or taking actions outside the ordinary course off business
without lender approval
 Reserve accounts for debt service, major maintenance or other project risks
► The loan provisions anticipate that an owner will “walk away” from a project once their
resources are exhausted, but give lenders the time and tools to assume control of the project
and continue operating it for the benefit of the lenders
 Owners do in fact “walk away” from projects when prospects for a return on equity have been
eliminated
 As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive
some return on their loans and ultimately for the project capital structure to be rearranged –
original lenders may become the equity, with new lenders brought in
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Project debt considerations
16
Project Debt
Establishment of Debt Service Coverage Ratios
► The Debt Service Coverage Ratio (“DSCR”) is one of the more
heavily negotiated terms

Calculated over a 12-month period as the sum of (i) cash generated from
operations net of any costs that are paid before debt service divided by (ii)
payments to lenders

The “Total DSCR” will include all payments to lenders, including payments
Forecasted minimum and
average DSCRs reflect
amount of leverage project
can support:

Highly stable and
contracted projects, like
Solar PV, might have
minimum DSCR 1.125
and average of 1.5,
which supports high debt
proportion

Projects with higher
technology or operating
risk will have higher
required minimum and
average DSCRs and
thus a lower proportion of
debt (e.g. biomass could
have a min DSCR of 1.4
and an average of 2.0)
to mezzanine or other subordinated lenders

The ”Senior DSCR” only considers payments of principal, interest and fees
to senior lenders
► Debt is structured around Minimum DSCR and Average DSCR

There is generally a minimum DSCR before cash is trapped at the project
and payments to equity or subordinated lenders are prohibited

There is also a minimum DSCR that can trigger an Event of Default (often
a DSCR < 1.0)

The average DSCR is a measure of the degree of financial risk that the
lenders are willing to assume
► For projects with uneven project cash flows, the amortization of
the debt can be shaped to ensure sufficiently high minimum DSCR
throughout life of loan
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Role of offtake agreement
17
Are PPAs necessary?
►
Greenfield merchant plant is very difficult to
finance, unless on balance sheet
►
Project financing is non-recourse to sponsors; if
non-recourse, need something to prove creditworthiness


current market will support 5 to 7 year
contracts; is this in turn enough to support
new construction?
depends on whether equity will accept backended returns
►
Question of whether contracts are necessary
depends on what bank will accept and whether
you believe that prices will be allowed to signal
supply shortages
►
Plenty of other capital intensive industries show
massive capital investment without long term
contracts
►
►
Clearly, however, larger facilities are less likely
to proceed without some sort of long term
contract backing
Key PPA clauses
 parties involved
 output guarantees
 length of contract
 cost allocation of
interconnection
facilities
 tariff rate
 billing, invoice, and
payment terms
 force majeure
conditions
 settlement of disputes
and arbitration
 termination of contract
So called “gentailer” models pairs retailer with
IPP; retailer load may substitute for PPA
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Role of offtake agreement
18
Well designed PPAs effectively allocate risk and reward
in an administratively straightforward fashion
TABLE OF CONTENTS
TABLE OF CONTENTS
(continued)
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Role of offtake agreement
19
Structure of the PPA incorporates number of key terms
►
►
PPAs can be lengthy – upwards of 60-80 pages (including schedules)
Two parties: Buyer and Supplier (Developer)
 Payment period length varies between different jurisdictions, but typically in the range of 2025 years r Buyer’s eligible renewable technologies
 PPA length is intended to match up with expected useful life of equipment and repayment
period for project financing
 In Ontario, the length of all renewable power PPAs is 20 years, except for hydroelectric
power which has a 50-year payment period (better aligning to the life of hydro assets)
►
Main objective is to establish price paid to the Supplier for electricity
►
PPA also defines the allocation of risks and responsibilities between Buyer and Supplier
Language from draft PPA:
20-year length: “ending at the beginning of the hour
ending 24:00 hours (EST) on the day before the 20th
(twentieth) anniversary of the date that is the earlier of (A)
the Milestone Date for Commercial Operation and (B) the
Commercial Operation Date”
Energy-only structure: “For each hour in a Settlement
Period, the Contract Payment shall be an amount expressed
in $US and equal to the Hourly Delivered Electricity
multiplied by the Indexed Contract Price applicable during
the corresponding calendar year”
Examples of PPA length
35
30
25
20
15
10
5
0
30
25
25
20
20
Saudi
Arabia WEC
Quebec
15
Brazil
Calif ornia Connecticut
India
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Project financial modeling
20
Initial screening model evolves into project pro forma to
support financing
Initial Screening Model
Resource
Evaluation
Site
Acquisition
Cost
Financing
Assumptions
Technology
and Vendor
cost
estimates
Cost of
Development
Initial
Screening
Model

Develop estimates of all project
parameters based on experience,
industry data and vendor quotations

Multiple sites and technologies will be
considered at this stage

Narrow alternatives through iterative
process
Project Pro Forma

Discounted cash flow model that
assists project team from initial
screening through project financial
close and even into operation

All projects contain common risks
 Capital cost overruns
 O&M cost overruns
 Production shortfalls
 Force Majeure risks
 Schedule delays
 Conversion efficiency

Evaluate what resources should be
expended to mitigate risk

Communicate to investors key aspects
of the project
Vendor
performance
guarantees
Revenue
Interconnect
Cost
Operation
and
Maintenance
Cost
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Project financial modeling
21
Pro forma underpins range of contract negotiations
INPUTS
Project Specific
» Capacity
» Capacity Factor
» Degradation
Factors
»
»
»
»
Finance
Leverage Ratio
Debt Rate / Term
ROE
Reserve Req’t
Construction
» Term
» Debt Cost
Operating Costs
» Fixed O&M
» Variable O&M
» Fuel Costs, inc.
Start-up
OUTPUTS
Taxes
» Income Tax Rate
» Foreign Owner’s
» Depreciation
Capital Costs
» Pre-construction
» Construction
» Technology Cost
Improvement
Rates
Contract
» Term
» Escalation
Post-Contract
» Asset Life
» Terminal Value
Levelized
Cost of
Energy
First Year
Contract
Price
Debt
Service
Coverage
Ratios
Weighted
Average
Cost of
Capital
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Project financial modeling
22
Such models can be extremely detailed, and examine the
project from a variety of perspectives
► Discounted cash
flow model
Indicative Snapshot of the Output Sheet of a Solar PV Financial Model
► Main cost inputs are
the capital, O&M and
financing costs
 Updated
iteratively as
inputs change
from assumptions
to actual numbers
Indicative Snapshot of the Output Sheet of a Solar PV Financial Model
► Coverage ratios are
critical element
► Primary output is
expected bid price
► Can be calculated
for different
sensitivity scenarios
(contract term,
technology, and size
of project)
► Accounts for
relevant taxation
regimes
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23
Conclusion
Concluding remarks
► Project finance is the norm rather than the exception for new infrastructure
projects
► When markets are liquid, sponsors can achieve greater amounts of non-
recourse financing
► Unexpectedly low gas prices caused many merchant project financings to fail;
rising interest rates will pose refinancing risk
► Successful project financings require creativity and flexibility from
participants
► Teams of bankers, lawyers, engineers, and developers with strong working
relationships help to reduce costs
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