Project Finance and Project Structure

Business of Energy

WHY DO WE NEED PROJECT FINANCE?

3

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

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Generation costs vary by each energy type

Source: EIA 2010 Estimates http://www.eia.gov/oiaf/beck_plantcosts/

Small

Photovolta

ic

Offshore

Wind

Single

Unit IGCC w

ith CCS

Dual Unit N

uclear

Single

Unit Adva

nced PC w

ith CCS

Large

Photovolta

ic

Solar

Therm

al

Geotherm

al – B

inary

Single

Unit IGCC

Dual Unit I

GCC

Single

Unit (Adva

nced PC)

Hydro

-elect

ric

Dual Unit (

Advanced

PC)

Onshore

Wind

Advanced

NGCC with

CCS

Conventional

NGCC$0

$100

$200

$300

$400

$500

$600

$700

Capital Cost ($M / 100MW) - 2010

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Generation costs vary by each energy type

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 energy-

generating 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.

Solar PV Advanced Coal

Nuclear Biomass Geothermal Wind Coal Hydro Natural Gas $-

$50

$100

$150

$200

$250

Levelized Energy Cost

Cost ($/MwH)

Source: http://en.wikipedia.org/wiki/Cost_of_electricity_by_source

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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

WOW! WHERE DO WE GET ALL OF THAT MONEY???

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What a mess! How do you keep track of everything?

Source: http://zeroemissionproject.com/

The typical project structure: allocates risk to the party best able to bear it

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Project Finance Screen Credits:

starring….. as the……

Sponsor Company ………. Main Actor

Equity Investors .………. Supporting Actor

Banks ………………….. Director

Machinery Suppliers ……. Store Clerk 1

Equipment Provider …….. Store Clerk 2

Contractors ……………….. Friends 1 - 5

Power Purchaser …………. The best friend forever

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What about the behind-the-scenes…..the stage crew?

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

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The Business of Energy Ltd (BOE Ltd)– a classroom example

BOE Wind Ltd. (US)(SPV)

BOE Ltd. (US)

BOE Wind Europe Ltd. (Cayman)

BOE Wind France Ltd. (France)

100%

80%

Acciona (EU Wind Tech Co)

French Utility

GDF Suez(Local execution)

20%

60% 40%

Domestic International

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Steps:

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Sources of Money

Source: http://transportationfortomorrow.com/

• Equity (Partners)• Debt (Banks)

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Sources of Money

Source: http://transportationfortomorrow.com/

How is it different from traditional funding?

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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%)

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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)

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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

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Tax Equity – Partnership Flip

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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.

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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

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Tax Equity – Sale Leaseback

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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

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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

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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

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Tax Equity – Lease Pass-through

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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

WE’VE SPENT $400M ON A POWER PLANT, HOW DO WE MAKE MONEY?

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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/

ALLOCATING RISK? HOW DO WE KEEP ALL THE PARTIES IN LINE?

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Risks

Source: http://transportationfortomorrow.com/

What are the risks involved in setting up a power plant?

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Types of Risk

1. Construction phase risk (Completion risk)2. Operation Phase risk3. Common risks

1. Participant risk2. Technical risk3. Currency risk4. Regulatory risk5. Political Risk6. Force majeure risk

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Due to the impact & monetary scale, it is critical to minimize risk

Source: http://transportationfortomorrow.com/

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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

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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 non-

performance– 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.

NOW THAT WE’VE MET ALL THE PARTIES, WHAT ELSE DO WE NEED TO CONSIDER

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Projects are heavily regulated and need to abide by Gov. laws

• Typical Gov agencies that govern energy projects:– 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

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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

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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

Q&A

TYPES OF RISK

BACKUP

Source: World Energy Outlook 2011

Example of a letter of intent