We all know about global warming

• We all also know about the main advantage of renewable energy projects: reduction of CO2 emissions

• Required low-carbon investment levels in green infrastructure to keep temperature increase below 1.5ºC threshold are enormous ($460B/yr until 2030, $1560B/yr thereafter)*

• There are additional considerations:

  • What if your country does import oil and/or gas?
  • Take advantage of your local resources
  • Fuel is free! All countries have wind and/or solar to some extent
  • Benefits to local communities

  * What investments are needed in the global energy system in order to satisfy the NDCs and 2 and 1.5 °C goals? – International Institute for Applied System Analysis

What are renewable energy projects?

• Electricity is generated from a renewable energy source (e.g. wind, solar, hydro, biomass, tides, geothermal)
• Instance of infrastructure projects. As such, characterized by:
  • Capital intensive before any revenue is generated
  • High risk / high return
  • Long term investment horizons (10+ years)
  • Complex contractual interplay between many parties (construction contracts, loan agreements, land leases, offtake agreements, interconnection rights, operation and maintenance, and many more)
• Once these projects are up and running, the cost of running them is almost zero!

Examples of renewable energy projects

Examples of the contractual structure of a renewable energy project

Let’s build a renewable energy project!

• Not so quick… what options are available?
  • You can start a development from scratch (greenfield projects) - High risk and high return
    • Long development times
    • High probability of failure, project development is complex and risky
  • You can acquire a partially developed project (brownfield projects) – Medium risk and medium return
    • Usually ready to build
    • Construction risk
  • Or you can acquire a project already in operation – Low risk and low return
    • Think of it as a bond
    • Stable and predictable cash flows
    • All major risks behind

Show me the money!

• Once project development is ready, the time has come to commit serious money (mostly construction and purchase of equipment)
• The most common tool used to finance renewable energy projects is Project Finance:
  • Project owned by a SPV (Special Purpose Vehicle), completely separated from the project Sponsor
  • Finance is provided to the SPV, that assumes the risks and the financial consequences
  • If things go south, banks have no recourse to the project Sponsor, “only” the equity is exposed
  • The project Sponsor keeps a “clean” balance sheet

Corporate Finance vs. Project Finance

Hold on… how much did you say you need!?

• Renewable energy projects have big capital expenditure requirements (CAPEX) and are highly leveraged (small equity vs. big debt)
• Banks tend to be wary
  • If things go well, no upside
  • If things go wrong… only recourse to the SPV
• Process to finance a renewable energy project tends to be long and complex
  • Banks spend a high amount of time studying in detail the project (Due Diligence)
  • Usually they do not want to do it alone – Syndicate of banks

What will the weather be like tomorrow?

• Renewable energy projects rely on electricity generation to generate cash flows
• The problem with renewable energy generation: you cannot control when it is going to be sunny or windy
• Through thorough measurement campaigns, it is possible to estimate the level of renewable energy resource of a project
• Banks rely on these analysis to estimate the amount of debt the project is able to accommodate:
  • P-levels: Annual generation levels to be exceeded (P50 and P90)
  • Coverage Ratios: CFs available vs. debt service

The future ain't what it used to be*

* Quote attributed to baseball-playing philosopher Yogi Berra

• Historically renewable energy projects have been developed leveraging government support
• Goal: Achievement of technological maturity through subsidized tariffs
• Every unit of renewable energy generated was paid at a fixed price not determined by the market (Feed-In-Tariffs)
• This model has worked very well in the past: Renewable energy technology has achieved grid parity
• Now what? An additional layer of complexity enters the game

It's tough to make predictions, especially about the future*

* Again Yogi Berra

• Governments around the globe have slashed subsidized tariffs
• Renewable energy projects sell electricity directly to the market
• Electricity market price tends to be volatile and unpredictable, hence direct exposure to market risk
• Debt tenors tend to be long (10+ years)
• The project needs stable cash flows to pay back the loan
• Banks get scared off, cancelling lending or reducing debt size and at hardened terms

PP… what?

• There are several tools available to transform volatile market prices into stable and predictable cash flows:
• Power futures
  • Traded in exchanges (e.g. European Energy Exchange EEX)
  • Shorter-termed than required (max. 10 years) and low liquidity
• Insurance products
  • Derived from weather insurance
  • Revenue swaps exchanging variable revenues for a fixed payment
• Long-term electricity contracts (aka PPAs)
  • PPA stand for Power Purchase Agreement
  • An agreement between a buyer and a seller to sell a certain amount of electricity for an agreed term at an agreed price
  • OTC market, bespoke agreements

Some additional notes on PPAs

• Preferred tool
• PPAs can be physical or virtual
  • Physical: there is a physical link between the renewable energy project and the off-taker
  • Virtual: Financial contract (CfD); the renewable energy project and the off-taker can be not connected by a grid or even in different countries
• As OTC products, PPAs can have several structures
  • Fixed price
  • Discount to market with floor (basically a put option)
  • Cap and floor (collar)
• PPAs are not risk-free
  • Market risk, shaping risk, volume risk, balancing risk…

Physical PPA

Financial/Virtual PPA

PPA Pricing Mechanism - Fixed price

PPA Pricing Mechanism - Floor Price with Discount to Market

PPA Pricing Mechanism - Zero Cost Collar

Investment metrics

• Leveraging renewable energy projects with debt usually adds value to investors
• Most common metrics to evaluate renewable energy projects (i.a.):
  • For investors:
    • NPV, IRR, MOI…
  • For banks:
    • Debt-to-Equity ratio, Debt Service Coverage Ratio (DSCR), Loan Life Coverage Ratio (LLC)

Key takeaways

• Building renewable energy projects require big capital investments upfront and feature long investment horizons
• Project Finance is the preferred tool to finance renewable energy projects
• Financing renewable energy projects is challenging due to volatility of cash flows (intermittent generation and market risk) – Tools available to mitigate these risks
• There are several metrics available to evaluate the quality of renewable energy projects from a financing perspective, depending on your side in the transaction (investor vs bank)

Contact

• Rubén Martínez Fanals
• agilibus.es