Financing Energy Storage: Deal Structures,

Revenue Streams, Issues for Stand-Alone and

Co-Located StoragePerformance Guarantees, Warranties, Full-Wrap EPC Contracts, ITC Rules, Addition of

Storage to Renewable Generation

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WEDNESDAY, SEPTEMBER 16, 2020

Presenting a live 90-minute webinar with interactive Q&A

Deanne M. Barrow, Attorney, Norton Rose Fulbright US, Washington, D.C.

James M. Berger, Partner, Norton Rose Fulbright US, Los Angeles

Amanda L. Rosenberg, Partner, Norton Rose Fulbright US, Los Angeles

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Norton Rose Fulbright US LLP

Energy Storage Financing: Tax, Revenues, Offtake Structures, Risks

Deanne Barrow

Jim Berger

Amanda Rosenberg

Outline

7

1. Financing options and deal structures

– Revenue

– Financing

2. Shifting risks and key considerations for developers, lenders, and

investors

3. Tax considerations

– Including stand-alone and co-located energy storage projects

Outline

Financing Options and Deal Structures

9

Two ways to look at project finance

1. Lock down costs and revenue to determine how much money you will have to pay debt service

2. An exercise in risk allocation

First challenge is to find a fixed revenue stream

Background

• A project developer will try to lock in a long-term

offtake agreement for each service provided. We

see five kinds of offtake structures currently for

standalone storage facilities.

Revenues

10

1. Capacity sale agreement

2. Capacity sale agreement with energy put

3. Ancillary services financial hedge

4. Demand response grid services agreement

5. Demand charge management agreement

Offtake Structures for Standalone Storage

11

Capacity Sale Agreement with Energy Put

• In addition to capacity sales, the project

company has a right to exercise a put option to

sell to the utility on an annual basis all of the

project’s stored energy and ancillary services at

a fixed $/MWh price.

12

Capacity Sale Agreement

• The project company receives a fixed $/MW

capacity payment in exchange for an obligation

to be ready to run (charge or discharge energy to

the grid) when called on by the ISO. The utility

solely purchases capacity, so the project

company may be able to earn additional revenue

from selling energy or ancillary services.

Capacity Sale Agreement

13

• The project company sells ancillary services to the market at

the spot price. It swaps floating payments for a fixed $/MWh

price calculated on a fixed volume of capacity for each

settlement period. As the floating price, the swap references

the market clearing price for the specific ancillary service

product sold.

Ancillary services financial hedge

14

• Involves aggregation of distributed storage facilities to form a

virtual power plant providing demand response service to the

utility. Projects may be used by customers for other

applications when not providing grid services.

Demand Response Grid Services Agreement

15

• Power from the storage facility is used to meet peak on-site load, thereby reducing demand charges.

Demand charge savings are split between the customer and project company under a shared-savings

model.

• Alternatively, the customer pays a fixed monthly subscription fee in return for guaranteed savings. This

provides revenue certainty for the project company but eliminates upside potential.

Demand Charge Management Agreement

• Storage developers are relying on merchant revenues

for an increasing part of their overall cash flows.

• In 2017 when we closed the first-ever non-recourse

financing of standalone storage assets, banks were

unwilling to lend against anything except a fixed

capacity payment locked in for a specific contract

term.

• We have seen the market shift towards giving credit

for uncontracted revenues from sales of energy and

ancillary services in the spot market.

Merchant Storage

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17

Merchant exposure for storage is fundamentally different from solar and wind in two ways:

• Variable fuel costs. For wind and solar, fuel is essentially free. Fuel for storage is the electricity used to

charge the battery and in a merchant project, it is purchased on the spot market. This opens up storage to

double merchant exposure on the input and the output side. The project might mitigate exposure on the

output side with a hedge that sets a floor under the electricity price.

• Overlap With Contracted Revenues. When calculating advance rates, lenders will credit a certain

number of years of revenue past the PPA term. Because of the unique ability of storage to provide

different services to different customers at the same time, storage can realize contracted and

uncontracted revenues during overlapping periods, rather than waiting for a merchant tail.

Merchant Storage: Differentiators

18

• Turning to forms of financing, there are various sources of

capital. The CFO at a storage company would normally stack

capital from cheapest to most expensive until he or she covers

the full cost of the storage facility.

Financing

19

• Government grants or subsidized debt are likely to be the

cheapest. Export credit agencies might be willing to offer the

latter for imported storage units.

• If the project qualifies for federal tax credits, then it might be

best to focus in the first instance on how to get value for them

and then build the rest the capital stack around tax equity.

Financing

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There are three main tax equity structures:

Partnership flips are the only structure that works for wind projects. Most solar deals are partnership flips,

as well.

Tax Equity Structures—Sale Leaseback

Partnership flips

Sale-leasebacks

Inverted leases

21

Tax equity usually insists on being ahead of any debt in the capital structure. The rest of the capital stack is

usually back-levered debt and equity.

Tax Equity and Debt

22

Partnership flips are straight forward structures. A tax equity investor owns the storage project in a

partnership with the developer and is allocated 99% of the tax benefits and a share of the cash until a flip

date anywhere from five to nine years out. The investor is allocated 5% of the economics after the flip.

Tax Equity Structures – Partnership Flips

Partnership flip structure with back-leverage: financial close (start of construction)*

Sponsor

Holdco/TE

Partnershi

Borrower

Project

Company

Credit Agreement

Equity Capital

Contribution Agreement

Back-Leverage

Construction and Term

Loan

100% of Project

Company Interests

and Project assets

Tax Equity

Commitment

* This is the current structure preferred by the market. Other structures are available, but the illustrated structure

eliminates the need for (a) two separate credit agreements during the construction and operating periods and (b) a

long-term forbearance agreement between the back-leverage lender and the tax equity investor.

23

Partnership flip structure with back-leverage: tax equity funding (around COD)

24

Back-Leverage Term

Loan

Sponsor

Holdco/TE

Partnersp

Borrower/Class B Member

Project

Company

100% of Class A Interests100% of

Class B Interests

Limited Liability

Company AgreementTax Equity

Credit Agreement

Cash Diversion

Indemnity

Shifting risks and key considerations for developers, lenders and investors

26

• Most of the risks in energy storage projects are similar to the risks in any other project financing

• Financing parties focus first on anything that might interrupt the revenue stream

Other risks include:

Risks

Technology Operating

Contract Structure

Regulatory

27

• Lithium-ion technology generally considered bankable

– requires an extended warranty from a supplier with a strong credit rating.

• Financing parties are less comfortable with other emerging technologies

– may only finance them with an additional performance guarantee

Technology

28

• Storage projects have a shorter operating track record than gas, wind and solar because the technology

is newer. Poor operational performance can jeopardize offtake contracts and subject developers to heavy

non-performance penalties in certain wholesale markets.

• Project finance lenders do not like technology risk. For storage, the key technology risk is capacity

degradation.

– Lenders will look for a performance guarantee or capacity maintenance agreement under which the

service provider refreshes the battery with new cells to maintain capacity at minimum levels, albeit

decreasing with time. The cost of disposal and recycling of the old cells should be factored into the

model if the service provider does not assume responsibility.

– DSCRs for storage projects are typically more conservative than for other assets to reflect the risk of

the project realizing lower revenues if degradation occurs at a faster rate than what is warranted in the

performance guarantee. Lenders may also want to build a reserve account in the financing docs.

– Creditworthiness of the performance guarantor is a major issue.

Performance Guarantees and Warranties

Contrasting Performance Guarantees and Warranties

Performance Guarantees Warranties

Storage Capacity Guarantee

Round Trip Efficiency Guarantee*

Auxiliary Load Guarantee

Charge Time Guarantee

Response Time Guarantee

Ramp Rate Guarantee

Availability Guarantee

Contractor Warranty (EPC) (for design, parts, workmanship, construction)

Service Provider Warranty (LTSA) (for general O&M services and parts)

Cells Warranty

Inverter Warranty

Enclosure Warranty

Solar Performance Ratio

Output Guarantee

Capacity Guarantee

Availability Guarantee

Contractor Warranty (EPC) (for design, parts, workmanship, construction)

Provider Warranty (O&M) (for general O&M services and parts)

Inverter Warranty

Racking Warranty

Module Warranty

Wind Power Curve

Noise Guarantee

Availability Guarantee

BOP Warranty (BOP) (for workmanship, construction)

Supplier Warranty (TSA) (for turbines)

Provider Warranty (O&M) (for general O&M services and parts)

29

*Analogous to a heat rate guarantee

30

The role of the asset manager is extremely important. The asset manager optimizes dispatch. Lenders will

insist on an asset manager with a good track record, although this is difficult given the nascent nature of the

industry.

Operations

Fixed-price, Turnkey vs. Split EPC

• Project lenders have historically

preferred a fixed-price, turnkey EPC

contract that aggressively shifts as

much risk as possible from the owner

to a single EPC contractor.

• By contrast, a split structure may

have multiple equipment supply,

construction and installation

contracts.

• Split contracts are more common in

storage projects than in solar (without

storage).

– Compare with wind.

Contract structure

31

32

• More risk under a split arrangement than a full wrap structure.

– Splitting creates interfacing risk with time and finger-pointing risk with defects.

• Is the additional risk exposure is sufficiently mitigated? Here are some key questions:

Contract structure – Ensuring Bankability

• Does the owner protect against claims of one contractor when work is done by another contractor? For example, has the owner negotiated a common dispute resolution mechanism in the event of a dispute as to which contractor is to blame for a construction issue?

• Do all supply, installation and construction schedules match to meet target milestone dates?

• Is the construction contractor excused from its obligation to pay delay liquidated damages if delays are attributable to the owner’s other contractors? If so, has the owner adequately mitigated the risk that unexcused delays by one contractor will result in excused delays in performance by the others?

• If the software provider is different from the battery system supplier, is the software capable of integrating with the hardware?

Regulatory issues

Regulatory regimes for storage are in

a state of flux. FERC and RTOs are

struggling with whether to classify

storage as generation, transmission

or a hybrid. Projects are more likely

to get financed the clearer the

regulatory framework.

ISO/RTO market rules for storage

participation vary widely. It is crucial

to have a deep understanding of the

particular market in which the project

is located.

Tariffs, trade policies and national

security policies may impact

procurement of storage system

components.

Shifting regulatory

frameworks

ISO/RTO market

participation rules

Tariffs, trade and national

security

33

34

• On May 1, President Trump issued an Executive Order banning the use

of certain foreign-manufactured equipment used in the nation's bulk

power system, i.e. the interconnected electric grid.

• There are three key questions for storage developers.

Executive order

Are battery cells, modules and packs covered by the

order?

• The order defines bulk power systems as “facilities and control systems necessary for operating an interconnected electric energy transmission network” as well as “electric energy from generation facilities needed to maintain transmission system reliability.”

• It appears a standalone battery connected to the transmission grid and injecting energy to provide voltage support would be covered by the order because it ensures transmission system reliability.

• The order does not apply to batteries that are sited behind the customer meter or on the distribution system.

Are balance of system components covered by the

order?

• The order's inclusion of “control systems” could potentially cover inverters, power conversion systems and battery management system (BMS) hardware.

• The order states that it is intended to guard against “malicious cyber activities”, among other threats to the grid. This could signal an increased level of scrutiny for the BMS given its vulnerability to remote attacks and the crucial role it plays in maintaining the battery system in a non-hazardous state.

Are Chinese battery vendors covered by the order? What about

US companies that have manufacturing facilities in China?

• The order covers bulk power system equipment “designed, developed, manufactured, or supplied by persons owned by, controlled by, or subject to the jurisdiction or direction of a foreign adversary.”

• It appears the order is aimed at China. If batteries are covered equipment, then the order could have significant ramifications for supply chains. According to BloombergNEF, China accounted for 73% of global lithium-ion cell manufacturing capacity in 2019. The US was a distant runner up with 12% of global capacity.

• It is unclear whether US companies that have established manufacturing plants in China would be considered "subject to the jurisdiction or direction of a foreign adversary". Tesla, for example, recently opened a Gigafactory in Shanghai although production appears to be geared towards the electric vehicle market.

Three questions

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• The Secretary of Energy is required to publish regulations explaining how the order will be implemented

in practice no later than September 28. The implementing regulations are expected to identify the

particular countries and persons that will be considered foreign adversaries and establish procedures to

license transactions otherwise prohibited by the order.

• In the meantime, storage developers may want to consider doing the following:

– Use alternative suppliers to Chinese companies and companies manufacturing equipment within

China.

– If the battery will be directly tied to the transmission grid, frame the utility’s dispatch rights in terms of

regulating the ramp rate at which the utility will accept power rather than balancing frequency of the

grid.

– Seek clarification from the DOE. In an interview with Politico, DOE Assistant Secretary Bruce

Walker suggested developers of power plants that tie into the grid could “work with the Department of

Energy ... with regard to understanding places on the system that we're more concerned about or not.”

Next Steps

Tax Considerations

38

Batteries that are combined with wind or solar projects on which investment tax credits are claimed

potentially qualify for such tax credits at the federal level. There are two important eligibility rules.

1. The battery has to be considered part of the generating equipment as opposed to a transmission asset.

2. At least 75% of the energy stored by the battery should come from the renewable generator to which it

is coupled. Standalone storage does not qualify at this time.

Tax Credits

39

A tax credit for standalone storage and an extension of the solar tax credit are likely early next year if Biden

is elected. The November election is starting to play into construction and financing strategies. Possible

new IRS regulations next year could provide upside in solar-plus-storage projects.

Tax Credits

Tel +1 202 974 5763

deanne.barrow@nortonrosefulbright.com

Senior Associate

Washington, D.C./San Francisco

Deanne Barrow

Tel: +1 213 892 9365

amanda.rosenberg@nortonrosefulbright.com

Partner

Los Angeles

Amanda Rosenberg

Questions?

40

Tel +1 213 892 9385

james.berger@nortonrosefulbright.com

Partner

Los Angeles

James Berger

Law around the world

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