Business of
Energy
Project Finance and Project
Structure
WHY DO WE NEED PROJECT FINANCE?
What is project finance?
• A method of financing where the lender accepts future
revenues from a project as a guarantee on a loan
– Different from corporate finance in that it does not guarantee
the loan through physical collateral in case of default
– Therefore, project finance is most suitable for a project where
there is a predictable revenue stream to support debt
repayment
• The twentieth century was marked by a reliance on the
public sector for developing infrastructure projects
– In the last two decades, however, there has been a shift from
the public sector to a hybrid public-private sector model
3
Generation costs vary by each energy type
Capital Cost ($M / 100MW) - 2010
$700
$600
$500
$400
$300
$200
$100
$0
Source: EIA 2010 Estimates http://www.eia.gov/oiaf/beck_plantcosts/
4
Generation costs vary by each energy type
Levelized Energy Cost
$250
$200
$150
$100
$50
$Solar PV
Advanced
Coal
Nuclear
Biomass
Geothermal
Wind
Coal
Hydro
Natural Gas
Cost ($/MwH)
Levelized Energy Cost (LEC) is the price at which electricity must be generated from a specific source
to break even over the lifetime of the project. It is an economic assessment of the cost of the energygenerating system including all the costs over its lifetime: initial investment, operations and
maintenance, cost of fuel, cost of capital, and is very useful in calculating the costs of generation
from different sources.
Source: http://en.wikipedia.org/wiki/Cost_of_electricity_by_source
5
High Level Project Finance Numbers
• $B spent worldwide in 2011 in project finance by
sector (source: Dealogic)
– Conventional power - $74.0B
– Renewable energy - $40.8B
– Infrastructure (airports, bridges, ports, hospitals, etc) $108.2B
– Oil & Gas - $77.4B
– Industrial / Telecom - $23.2B
– Mining - $21.0B
7
WOW! WHERE DO WE GET ALL OF
THAT MONEY???
What a mess! How do you keep track of
everything?
The typical project structure: allocates risk to the party
best able to bear it
Source: http://zeroemissionproject.com/
9
Project Finance Screen Credits:
starring…..
as the……
Sponsor Company
……….
Main Actor
Equity Investors
.……….
Supporting Actor
Banks
…………………..
Machinery Suppliers
…….
Store Clerk 1
Equipment Provider
……..
Store Clerk 2
………………..
Friends 1 - 5
Contractors
Power Purchaser
10
Director
………….
The best friend forever
What about the behind-the-scenes…..the stage
crew?
11
starring…..
as the……
Local Government ……….
The studio head
Joint Venture
.……….
The producer
Local Partner
……………..
The promoter
Regulatory Institutions .….
Local police force
Carbon Markets
The DVD sales
……..
The Business of Energy Ltd (BOE Ltd)– a
classroom example
BOE Ltd. (US)
Domestic
International
100%
BOE Wind Ltd. (US)
Acciona
(SPV)
(EU Wind Tech Co)
80%
20%
BOE Wind Europe
Ltd. (Cayman)
GDF Suez
(Local execution)
60%
40%
BOE Wind France Ltd.
(France)
12
French Utility
Steps:
14
Sources of Money
• Equity (Partners)
• Debt (Banks)
Source: http://transportationfortomorrow.com/
15
Sources of Money
How is it different from traditional funding?
Source: http://transportationfortomorrow.com/
16
Sources of Money
• Debt investors
– Banks
– Typically debt period is the same length of time as the
PPA contract
– Usually will account for 35% to 60% of a project's
costs
– Goal is to get the largest portion of the debt to be
"investment grade" by the ratings agencies (S&P,
Moody's, Fitch) as possible --> results in significantly
lower debt rates (~5-8%)
17
Sources of Money
• Equity investors
– When debt is involved
• Equity is more risky (will only get paid after debt gets paid off)
• Investors usually look for 14-18% IRRs
• Invest 5% to 20% of a project's costs
– When debt is not involved
• Investors look for ~10-12% IRRs
• Invest 5% to 50% of a project's costs
– Tax Equity: Typically will take a major stake in the project for the first
5 years (to maximize depreciation and tax benefits) and then become
a background player for remaining ~10 or so years
– Main equity investors at this point are: Banks and insurance
companies (and Google)
18
Tax Equity
• Occurs in projects that government wants to incentivize
through tax breaks, special depreciation schemes
• Sponsored by companies with large tax obligations
• Volatile source. Total funds available depend on state of
economy
• Types:
– Partnership Flip
– Sale Leaseback
20
Tax Equity – Partnership Flip
21
Tax Equity – Partnership Flip
• During the period when tax benefits are available or until such later
time as the Investor achieves a specified rate of return on its
investment (typically 6-7 years), a large majority (typically, 95% or
more) of taxable income, loss and tax credits are allocated to the
Investor.
• After the later of the expiration of the tax credit recapture period or
the achievement of the investor's specified hurdle rate of return, the
ownership of the LLC (partnership) interests flips, to, for example, 90%
or 95% to the Developer and the rest to the Investor.
• After target IRR is reached, Developer frequently has an option to buy
out the Investor's interest for fair market value determined when the
option is exercised. Option should not be continuous, but may be
exercisable at predetermined times.
22
Tax Equity – Partnership Flip
• Fund is the owner of the solar installations (via lower tier LLCs
disregarded for tax purposes)
• Tax Benefits
• Depreciation deductions
• 30% ITC flows through to the tax credit equity investor
• State incentives – Rebates, Renewable Energy Certificates
• (RECs) and state tax credits
• Cash flow from PPA / Lease revenue
23
Tax Equity – Sale Leaseback
24
Tax Equity – Sale Leaseback
• Developer lessee bears all operating costs, costs of insurance,
etc.
• At the end of the lease term, the system is retained by the
Investor/lessor (who is its owner all along)
• Developer/lessee typically has an option to purchase the system
at the end of the lease term (and sometimes at one or more
specified times before the end of the term)
• Purchase option at fair market value
25
Tax Equity – Sale Leaseback
• More effectively frontloads economics to developer
• Allows developer to grow business with current cash flow
• More effective use of developer’s corporate capital?
• Developer establishes track record
• Sacrifice of residual interest for current cash flow
• Investor has flexibility to get into the deal within 90 days of PIS
mitigating/eliminating construction risk
26
Tax Equity – Sale Leaseback
• System is owned 100% by investor
• Efficient monetization of tax benefits
• No leakage of tax benefits compared to a partnership (e.g.
1% to G.P.)
• Sales taxes paid over life of the lease agreement
• Simplicity of structure, Cost effective
• Investor utilization of lease optimization model
27
Tax Equity – Lease Pass-through
Lease Pass-Through
Sale of PV Panels
$
$
Loan Proceeds
Debt Service Payments
$
Install/Maintenance
State Incentive
Programs
Lender
Developer/
Installer
Manufacturer
P/L
No basis reduction to depreciable basis
LESSOR SOLAR LP
$
Capital Contribution
Pass through
Election
Lease
PV System Owner
Capital
Contribution
General Partner
51% 99%
partnership interest
1% 49% LP interest
in losses
SOLAR MASTER TENANT LP
Basis Reduction Income
$
P/L and Credits
Credits
Cash – Preferred Return
Call Option – Cash, Capital Loss
99% Limited Partner
(Corporate Investor)
Power
Lease
Capital
Contribution
Lease
Payments
1% General Partner
(Developer)
Host
28
116
Why don't more people invest in this space?:
• Primarily, because it's very complex to structure
these projects, and most companies don't have
(or want) the expertise needed to do so
effectively.
• As they'll tell you in finance…invest in what you
know. Most companies don't know this type of
investment, so they don't invest in it.
• The White House has tried to bring more
investors into the space, but it's a slow process
29
WE’VE SPENT $400M ON A POWER
PLANT, HOW DO WE MAKE MONEY?
Revenue comes from “off-takers”
• Sell product to “off-takers”
• For Oil and Gas
–
–
–
–
Refineries
Other Oil companies
Commodity Market
Foreign governments
• For Electricity
– Utility
– Factories
– Private establishments
Source: http://sunetric.com/solar-for-business/
31
ALLOCATING RISK? HOW DO WE
KEEP ALL THE PARTIES IN LINE?
Risks
What are the risks involved in setting up a power plant?
Source: http://transportationfortomorrow.com/
33
Types of Risk
1. Construction phase risk (Completion risk)
2. Operation Phase risk
3. Common risks
1. Participant risk
2. Technical risk
3. Currency risk
4. Regulatory risk
5. Political Risk
6. Force majeure risk
34
Due to the impact & monetary scale, it is critical
to minimize risk
Source: http://transportationfortomorrow.com/
35
In energy, contracts are everything
• Contracts govern all transactions
• Contract Examples:
–
–
–
–
–
–
Power Purchase Agreement (PPA)
Land rights
Drilling Right
Subcontractor Agreements
Operating Agreements
Interconnection Agreement
• Can see sample contracts here (U.S. Dept. of
Energy):
http://www1.eere.energy.gov/femp/financing/ppa_
sampledocs.html
36
Contractual provisions play a critical role in
project success
• In order to ensure timely completion of a
project; penalties are built into contracts
– Late completion penalty: $/Day late
– Money set aside in an escrow to pay for nonperformance
– Reduce post project completion $ awards
• Penalties are written to reduce risk of the
receiver of benefits. One down-day can cause
millions in lost rev.
37
NOW THAT WE’VE MET ALL THE
PARTIES, WHAT ELSE DO WE NEED TO
CONSIDER
Projects are heavily regulated and need to abide
by Gov. laws
• Typical Gov agencies that govern energy projects:
–
–
–
–
–
–
–
–
–
–
–
39
State Government
Local Government (mayor)
Energy Agency
Real Estate Agency
Environmental Protection Agency
Department of Natural Resources
National Transmission Company
Wildlife Agency
Marine Agency
Transportation Agency
Local bureaucrats
Projects are heavily regulated and need to abide
by Gov. laws
• Each agency is created to protect the public,
however…
– You have to understand and cater to each one’s
needs
– You might see more agencies and more red tape
in countries with high corruption
• The application and approval process is at
times very painful
– Applications are long, the processing time is long,
and simple mistakes can cause a rejection
40
Governments, international agencies & Local
partners can be your best partner
• Various International Agencies can help with projects
• Financial help
– IFC
– ExIm banks
• Operational Help
– World Bank
– U.S. EPA
– Local business development agencies
• Risk assistance
– OPIC
– World Bank
41
Q&A
TYPES OF RISK
BACKUP
Source: World Energy Outlook 2011
Example of a letter of intent