alternative financing for renewable energy projects...
TRANSCRIPT
Alternative Financing for Renewable Energy
Projects: Evaluating Options, Structuring
the Deal
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THURSDAY, MAY 31, 2018
Presenting a live 90-minute webinar with interactive Q&A
Paul N. Belval, Partner, Day Pitney, Hartford, Conn.
Caileen Kateri (Kat) Gamache, Senior Counsel, Norton Rose Fulbright, Washington, D.C.
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Alternative Financing for
Renewable Energy
Projects
May 31, 2018
Presenters:
Paul N. Belval Caileen Kateri Gamache
Agenda
I. Financeability of Renewable Energy ProjectsA. Regulatory Issues & Options
B. Tax Considerations
C. Offtake & Revenue AgreementsA. Market Offtake Options
B. Traditional PPAs
C. Alternative Revenue Contracts
II. Financing StructuresA. Traditional Project Finance
B. Balance Sheet Financing
C. Tax Equity Financing
D. Partnership Flip Structure
E. Leveraged Leasing
F. Back Leverage
G. Tax-Exempt Financing
H. 144A Bond Offerings
III. Questions & Discussion
Financeability of Renewable
Energy Projects
Financeability – Regulatory &
Tax Considerations
Regulatory Issues
9
• PURPA
• Interconnection Upgrades – FERC Order 845
• Energy Storage Boon – FERC Order 841
• Retail Choice
• Reactionary, Volatile & Inconsistent Regulatory Landscape
• Government Funding Opportunities
Regulatory Mitigants
10
• Declaratory Relief
• Diversify
• Portfolios
• Structure financing transactions consistent with FERC’s passive investment precedent
• Negotiate contractual protections
Tax Considerations
11
Solar
• Depreciation = 21¢ on the dollar
• ITC = 30% of Cost
• Value: 40-50% of the capital stack
Wind
• Depreciation = 21¢ on the dollar
• PTC = 2.4¢ per kWh (can opt into the ITC)
• Value: 50-60% of the capital stack
Impact of Tax Reform
Tax Equity Financing Factoids:
• There are approx. 18-25 active tax equity investors, including: JPMorgan, Citibank, Goldman Sachs, Morgan Stanley, US Bank, Berkshire Hathaway and GE.
• $10 billion in tax equity deals closed in 2017 (roughly $6 billion of wind and $4 billion of solar).
• $11 billion in 2016.
• Yields: 7% - 8%.
Tax Issues – Start of Construction (Solar)
12
Solar Assets
• Must begin construction by the end of 2019 for 30% ITC.
• 2020 – 26%
• 2021 – 22%
• Solar projects must be placed in service before 2024; otherwise the project will only be eligible for a 10% ITC.
Tax Issues – Start of Construction (Wind)
13
Wind Assets
• Must have started construction by the end of 2016 for 100% PTC.
• 2017 – 80%
• 2018 – 60%
• 2019 – 40%
• Physical Work vs. Safe Harbor
• Wind projects must be placed in service within four years of starting construction to satisfy the continuity safe harbor.
Financeability – Offtake &
Revenue Contracts
Revenue & Offtake Opportunities
15
• Merchant (good luck…)
• Capacity, Resource Adequacy, Ancillary Services
• Revenue Stacking
• Renewable Energy Attributes
• Net Metering; Green Tariffs
• Offtake Agreements
• Traditional PPAs
• Trending: Alternative Offtake Structures‒ Bank Hedges
‒ Virtual PPAs (aka Corporate PPAs)
‒ Proxy Revenue Swaps
Offtake Agreements – Issue Comparison
16
Power Purchase
Agreement
Bank Hedge Virtual PPA Proxy Revenue
Swap
Project’s
Counterparty
Utility Commodities
Merchant
(Financial/Strategic)
Corporation Weather Risk Investor
Physical vs
Financial
Physical Physical (e.g.
ERCOT) or Financial
Financial Financial
Product Energy and RECs Energy plus
potentially RECs
Energy and RECs Energy plus
potentially RECs
Unit Price Fixed Fixed Fixed Effectively Varies by
Volume
Settlement Point Project Node Trading Hub Project Node or
Trading Hub
Trading Hub
Price Basis Risk No Yes (but includes
Tracking Account)
Depends on
Settlement Point
Yes
Market Sales? No Yes Yes Yes
Offtake Agreements – Issue Comparison (cont.)
17
Power Purchase
Agreement
Bank Hedge Virtual PPA Proxy Revenue
Swap
Tenor Up to 25 years Up to 12-13 years Up to 15 years Up to 10 years
Project Credit
Support
Typically a letter of
credit; Possibility of
parent guaranty
Pre-COD: Letter of
credit + second lien
Post-COD: First lien;
Possibility of parent
guaranty
Typically a letter of
credit
Typically a letter of
credit; Possibility of
parent
guaranty
Counterparty Credit
Support
None (counterparty
typically creditworthy
utility)
Downgrade protection
(mark-to-market)
Downgrade protection
(fixed)
Downgrade protection
(mark-to-market)
Basis Risk (Node vs
Hub)
No Yes Depends on
Settlement Point
Yes
Revenue Based on
Production?
Yes Yes Yes No
Fixed Delivery
Obligations
None Hourly Delivery
Obligations (P99) if
physical
None None
Minimum Delivery
Obligations
Annual Minimum
Production
None Annual Minimum
Availability
None
Alternative Offtake - Bank Hedges
18
• A fixed volume price swap with a commodities merchant (either financial or strategic)
• Project receives fixed price
• Hedge provider receives market price
• Volumes typically set based
on P99 production
• Tracking Account
Wind
Project
Hedge
Provider
Market
Merchant
Revenue at
Node
Settlement Amount
Bank Hedges -- Financing Interfaces
Sponsors of U.S. renewables projectsface a complex set of interface pointsamong their contract counterpartieswhen they must rely on third partydebt for construction and operations,they cannot use the PTC or ITCefficiently, and (given the lack ofavailable power purchaseagreements) they seek to use bankhedges to fix project revenues.
For example:
• Construction lenders wantassurance that their loans will berepaid in full at project completion,while tax equity seeks an ability tore-size their investment based onas-built conditions and changes intax law.
• Back-leverage lenders wantassurance that distributable cashwill be available to service debt,while tax equity investors seek theright to divert sponsor cash tocover indemnity claims.
• Hedge providers seek to have theability to exercise remedies ontheir lien-based collateral, whiletax equity investors seek anopportunity to protect theirinvestment and avoid recapture ofpreviously-claimed tax credits.
.
19
Construction Debt Tax Equity Back-Leverage Debt
Tax Equity • Tax Equity Funding
Conditions
• Tax Equity Pre-
Funding Sizing
Adjustments
Back-Leverage Debt • Back-Leverage
Funding Conditions
• Back-Leverage
Sizing Adjustments
• Tax Equity Cash
Sweeps
• Tax Equity Post-
Funding Sizing
Adjustments
• Equity Transfer
Restrictions
Energy Hedge • 1st lien/2nd Lien
Collateral Structure
and Intercreditor
Arrangements
• Forbearance
Arrangements
• Mark-to-market
collateral posting
requirements
• Mark-to-market
collateral posting
requirements
Bank Hedges: Strategic Considerations for
Sponsors & Lenders
20
• When to execute relative to financial close?
• Should your hedge provider and other financing parties be affiliates?
• How many potential hedge providers should you negotiate with?
• Exclusivity?
• Hedge provider credit support?
• Critical for financing
Alternative Offtake – Virtual / Corporate PPAs
21
• Variety of forms‒ On-site, contract for differences, back-to-back
• Payment for Physical PPA: fixed price to Seller
• Payment for VPPA:1. Seller gets fixed price; Buyer gets floating price, either at node
or hub.
2. Floating Price: market price at time of delivery (locational marginal price or LMP).
3. Netting: If fixed price payments exceed floating price payments, Buyer pays Seller the difference. If fixed price payments are less than floating price payments, Seller pays Buyer the difference.
Corporate PPAs: Strategic Considerations for
Sponsors & Lenders
22
• Importance of the Settlement Point • What basis risk is palatable?
• Market disruption events
• Negative Price Risk• Should there be a floor price?
• What is the impact on PTC?
• Credit Support – Is the offtaker creditworthy? Should there be downgrade options?
Corporate PPAs: Strategic Considerations for
Sponsors & Lenders (cont.)
23
• Who owns the Environmental Attributes?
• Corporate offtakers often do not have RPS requirements, yet want to retire RECs).
• How about future attributes?
• Apportionment of capacity rights and participation costs and penalties?
• Risk of curtailment by market operator
• Impact on minimum performance requirement; payments for energy
• Development risks – delay damages and termination
• Minimum Performance requirement
• Availability vs. production & performance excuses
Examples of Corporate Renewable PPAs
24 Source: World Business Council for Sustainable Development, Corporate
Renewable Power Purchase Agreements (2016)
Alternative Offtake – Proxy Revenue Swaps
25
• New risk management tool
• Swap of fixed annual payment for floating revenues of a renewable (primarily wind) project
• Driven by the hourly wind resource and power prices
• Hedge providers are participants in weather risk market looking for weather-derived exposure not correlated with other financial markets
• Merchant power price risks and wind resource risks both transferred in an integrated derivative contract
• Short tenors, but long enough to support project financing
Proxy Revenue Calculation
26
• Power Curve-Derived Generation: Energy (in MWh) for a wind turbine during a Calculation Interval (e.g. 10 minute period) estimated based on:
• Power Curve and Measured Wind Speed at Turbine
• Proxy Generation: Sum for all wind turbines during each Calculation Interval of:
• Power Curve-Derived Generation x Expected Operational Efficiency
• Proxy Revenue: Sum for each Calculation Interval during the Settlement Period (e.g. 3 months) of:
• Proxy Generation x Day-Ahead Hub Energy Price
Two-Way Settlement
27
Wind
Project
Hedge
ProviderSettlement Amount
If Proxy Revenue >
Fixed Payment
High winds,
high prices, or a
combination during
settlement period
Wind
Project
Hedge
ProviderSettlement Amount
If Proxy Revenue <
Fixed Payment
Low winds,
low prices, or a
combination during
settlement period
Proxy Revenue Swap: Strategic
Considerations for Sponsors & Lenders
28
• Additional Fees
• Upfront Structuring Fee & Annual Fees to Hedge Provider
• Service Fees for Calculation Agent and Reporting Services
• Accurate Data Collection Critical
• Provisions for installation, operation and maintenance of anemometers, permanent met towers
• Wake Impacts of Neighboring Projects & Other Non-Weather Interferences
• As-Built Conditions – Consistent with Assumptions?
• Credit Support, Delay Risks, Dodd-Frank – Similar to Bank Hedge
Proxy Revenue Swaps Signed in 2016-17
29
Project Market Sponsor Lender Tax Equity Hedge
Provider
Back-to-
Back Price
Hedge
Provider
Calculation
Agent
Bloom
(KS)
SPP Capital
Power Corp.
N/A Goldman
Sachs
Allianz Risk
Transfer /
Nephila
Capital
Microsoft
Corporation
REsurety
Old Settler
(TX)
ERCOT Apex Clean
Energy
Deutsche
Bank
JPMorgan
(lead)
Allianz Risk
Transfer /
Nephila
Capital
Confidential REsurety
Confidential
(OK)
SPP Confidential N/A N/A Allianz Risk
Transfer /
Nephila
Capital
Confidential REsurety
Upstream
(NE)
SPP Invenergy Santander N/A Allianz Risk
Transfer /
Nephila
Capital
Confidential REsurety
Miscellaneous Financing “Pressure Points” in
Renewable Offtake Agreements
30
• Documentation
• ISDA, EEI, “tested” PPAs
• Change in Law Risks
• Lender Notice, Cure & Estoppel Rights
• Assignment & Collateral Assignment
• Term & Performance
• Development Risks; Uncontrollable Delays
• Liability Limitations
Disclaimer
Norton Rose Fulbright US LLP, Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP and Norton Rose Fulbright South Africa Inc are separate legal entities and all of them are members of Norton Rose Fulbright Verein, a Swiss verein. Norton Rose Fulbright Verein helps coordinate the activities of the members but does not itself provide legal services to clients.
References to ‘Norton Rose Fulbright’, ‘the law firm’ and ‘legal practice’ are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together ‘Norton Rose Fulbright entity/entities’). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a ‘partner’) accepts or assumes responsibility, or has any liability, to any person in respect of this communication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity.
The purpose of this communication is to provide general information of a legal nature. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright.
31
Caileen Kateri Gamache (“Kat”) works
with project developers, investors,
utilities and financial marketers to find
solutions to complex energy regulatory
issues, develop ideas into operational
projects, draft and negotiate material
contracts and close deals.
Contact Information:
+1 202-974-5671
Thank you!
© 2018 Day Pitney LLP
Financing StructuresMay 31, 2018
33 | 5/31/2018
Traditional Project Finance
WHAT IS IT?
• Highly structured bankruptcy-remote borrowers
• Projects with substantial remaining useful life
• High ratio of debt-to-equity leverage
• 70% to 90% debt
• No guarantees
• No or very limited recourse to sponsor
• Predictable cash flow
34 | 5/31/2018
Elements of Traditional Project
Finance Model
• Lockbox for payments
• Waterfall payment structure
• Reserve accounts
• Lien on all project assets/all project equity
• Strong covenants (positive and negative)
• Strong lender consent rights
35 | 5/31/2018
Benefits of Traditional Project Finance
• High leverage
• Off-balance sheet financing
• Sponsor is often less than 50% of equity
• Preserve borrowing capacity
• Non-recourse debt not counted against
sponsor
• Risk limited to amount of equity invested
• Credit analysis based on off-taker
36 | 5/31/2018
Disadvantages of Traditional Project
Finance
•Increased lender risk (relative to return)
•Higher interest rates and fees
•High transaction costs (legal, consultants,
engineers, insurance)
•Intense lender oversight for borrower
•Expensive and time consuming due diligence
•Restrictive covenants
•Restrictions on distributions
37 | 5/31/2018
Balance Sheet Financing
• Large developers (often associated with utility)
have adequate capital to finance project
development with their own funds
• Will often move to project finance model post-
COD
• Lower cost of capital for project already in
operation
• More leverage in negotiations if already built
38 | 5/31/2018
Tax Equity Financing
• Benefit for equity investor is primarily through
tax credits and other incentives• PTC and ITC
• Accelerated Depreciation
• Pass-through entity (partnership or LLC)
• Needed to take advantage of tax benefit
• May include preferred return to attract investors
• Forbearance Agreement with lenders• Preserve tax credit during recapture period
39 | 5/31/2018
Advantages of Tax Equity Financing
• Creates another layer of financing
• Except for preferred return, share distributions
• Equity has greater risk tolerance than debt• Merchant risk - can tolerate some level of
uncontracted offtake sales
• Often lighter due diligence than debt, so time
saving
• Tax equity investors pay own expenses
(although cost factors into return)
• Use in portfolio transactions
40 | 5/31/2018
Disadvantages of Tax Equity Financing
• Must have, or find investor with, tax liability that
can use credit
• Still some control over project operation
• Transactions can be highly structured• Can impact ability to project finance later
• Disappearing tax credits• PTC – See above
• ITC - Declining to 10%/0% in 2022
• Base Erosion Anti-Abuse Tax • Foreign investors can generally take at least 80% of
credit through 2025
41 | 5/31/2018
Partnership Flip Structure
• Allocations of profit and loss between classes
of investors change over time• For ITC, flip after five-year recapture period
• For PTC, after end of credit availability• IRS safe harbor on percentages before and after flip
(99%/1% to 5%/95%)
• Can also flip based on returns
• Allows developer to retain residual value
• May result in Deficit Restoration Obligation if deficit at
time of liquidation of partnership
42 | 5/31/2018
Leveraged Leasing
• Sponsor sells project to a trust, then leases the
project back from the trust
• Sales proceeds finance project
• Equity investor is owner of trust and gets tax
benefits
• Trust issues notes or bonds to finance project
• Lease payments provide cash to repay
• Residual interest reverts to sponsor at expiration
of lease, before end of useful life
• Forbearance Agreement to protect ITC
43 | 5/31/2018
Back-Leverage
• Loan financing at Holdco/Sponsor level, not at
project company level
• May include limited recourse or limited sponsor
guarantee
• Secured by pledge of equity in project company
• Distributions into lockbox account
• Usually does not include project company-level
debt
• If so, sponsor level lender is structurally subordinated
• If not, negative pledge by project company with
respect to assets
44 | 5/31/2018
Back Leverage (cont.)
• More attractive to tax equity if no lien on project
• Avoids recapture issue
• Avoids need for project contract consents
• Reduced time and cost
• Useful in portfolio transactions
• Less secure than traditional project finance, so
higher cost of capital
• Still requires negotiation between debt and
equity regarding what happens post-default
45 | 5/31/2018
Tax-Exempt Financing
• Financing through a government entity that can
issue tax-exempt debt
• Typically an economic or industrial development
agency
• “Conduit” financing – project issues debt to
government agency, which then issues its bonds
secured by that debt
• Tax-exempt means lower cost of capital
• Restrictions on use of project under IRS rules
• Limitations under enabling legislation
46 | 5/31/2018
144A Bond Offerings
• Quasi-public offering of bonds to “qualified
institutional buyers” under Rule 144a
• Exempt from registration with SEC
• Underwritten by investment bank, which negotiates
documents before offering
• Offered on a “take it or leave it” basis
• Generally less bondholder oversight
• Need to know market well enough to know sorts of
covenants that will be expected
