Renewable Energy Finance Basics

NREL is a national laboratory of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy operated by the Alliance for Sustainable Energy, LLC

Michael MendelsohnSr. Financial Analyst

Paul SchwabeEnergy Analyst

February 1, 2012NREL

Renewable Energy Finance Basics

Agenda

• NREL Finance Team • Financing Background• Project Financial Structures• Financial Modeling Metrics

National Renewable Energy Laboratory Innovation for Our Energy Future2

NREL Finance Team


RE Project Finance Team – overview

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OpenEI

Technology-specif ic

PV, CSP, Geo, Wind

Financing structure-specif ic

PV, Geo

Markets and Financial AnalysisImpact on RE Financing

WebViewFinancing Tool

PV, Geo

Policy AnalysisPolicy Impact on RE Financing

WebView

PV, SPIA, GeoVisualization

Data/Information

RE PoliciesPV, Geo, SPIA, Int’l

ToolsSystem Advisor Model/SAM project f inancing

CSP, PV, SPIA, Geo

Cost of Renewable EnergySpreadsheet Tool/CREST

SPIA, PV, Geo

Renewable Energy FinanceTracking Initiative (REFTI)

SPIA, PV, Geo

IncentivesPV, SPIA

DATA: RE Finance Tracking Initiative (REFTI)

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REFTI collects and disseminates wide array of project and financial info including cost of tax equity and LCOE

CREST Models: Solar, Wind, Geo

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• Primary: Levelized Cost of Energy (LCOE), Yr. 1 Cost of Energy• Secondary: Rolled up and Detailed Cash Flows

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http://financeRE.nrel.gov

NATIONAL RENEWABLE ENERGY LABORATORY

Visualization - RE Project Finance Websitehttp://financeRE.nrel.gov

Feature Analyses: Unique NREL analysis about policies, innovations and market conditions that impact RE project financing

User Login: registered users can comment, rate content

Flexible Search: by keyword, or by filters (single/multi-) by sector, tech, size, policy, financing structure, and/or content type

Blog Analyses: Credible, objective policy and market observations from NREL analysts

http://financre.nrel.gov/

Financing Background


Key Metrics• Levelized Cost of Energy (LCOE) {or Levelized Cost

per Mile (LCPM)} = Discounted sum of costs / Discounted sum of energy produced

{or miles driven}• Return on Equity (ROE)= Discounted sum of returns to investor / initial investment• Internal Rate of Return (IRR)= Discount rate necessary to make returns to investor equal $0• Weighted Average Cost of Capital (WACC)= A calculation of a firm’s cost of capital in which each category

of capital (e.g. debt and equity) is proportionally weighted• Payback= number of years of benefits to recover initial investment


Project IRR impact on LCOE


Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “

Lower risk = lower required return = lower LCOE

Every 1% reduction in target equity IRR results in $4/MWh for wind and $8/MWh for PV

Sources of Investment CapitalInvestor Class Risk Tolerance MetricsDebt Low Debt service coverage

ratio (DSCR), Margin or Interest Rate

Mezzanine Finance

Medium. Will bear some operational risks but not completion risks. Includes “tax equity” common in U.S.

IRR, IRR target year, Default Probability (for Fixed- Income Instruments)

Balance-sheet Equity

High. Bears all project risks. IRR, Payback, other metrics relevant to internal decision-making

Project Finance Equity

High. Willing to concentrate project risk by increasing project leverage.

Project IRR, Levered IRR


Financing Risk Factors


Risk Explanation Fin. cost impactTechnology Risk

Any operational experience? High

Completion Certainty

Developer experience & balance sheet?

Medium - perceived risk can lead to high reserve or guarantee requirements

Revenue Certainty

Is buyer credit-worthy? Are prices firm?

Medium - high

Duration of Revenue Support

Debt duration (tenor) no longer than PPA minus 2 years, shorter based on risk perception

Very high

Cost Certainty

Are components already purchased? Or subject to significant re-pricing?

Low

Financing Risk Factors, cont’d


Risk Explanation Fin. cost impactInsurance Is contractor / operator properly

insured? What if something happens during construction

Medium

Site control Does developer own the development location?

High in U.S.

Resource Certainty

Are long-term, quality measurements available? Variability in historic data?

“P” rating will impact debt service coverage ratios

Transmission Access

Who controls interconnection & dispatch? Proper oversight?

Medium – High. Prior operational experience will be assessed

Political Risk Are national / local governments stable; court action possible?

High

Currency Risk Are costs / revenues in desired currency? Is currency stable against the dollar / euro / yuan?

Low – can be hedged with currency swaps

U.S. Federal Tax Incentives & Tax Equity


Tax Incentives Designed to Spur RE Investment

• Two Primary Federal Incentives Available:1. Investment Tax Credit (ITC) / Production Tax Credit (PTC)2. Accelerated Depreciation

• Together, ITC/PTC and accelerated depreciation count for approx. 50-55% of a project’s capital investment


Tax Incentives: Only Good if You Can Use Them

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• Renewable energy projects and their developers don’t have sufficient taxable income (aka “tax appetite”) to utilize fully

• Without sufficient tax appetite, the tax incentives have to be “carried forward”• Greatly reduces the present value of the tax incentives, and thus

their ability to induce investment

• Credits and depreciation must be claimed by the owner

• Benefits are nonrefundable and non-transferable


Simplified Financial Structure Representation

1)Single Developer / Investor

2)Equity Partnership

3)Equity Partnership With Debt

Power, RECs, Tax Ben.

Corporate Parent

Project Company

Developer

Project Company


Tax Investor /

Govt.

Senior Lender

Developer

Project Company


Tax Investor /

Govt.

Commonly Used Financial Structures

1. Partnership Flip (PF) structures• All Equity PF

• Cash and tax benefits allocated to tax investor (primarily) until TI receives pre-defined IRR (flip point). After, allocations flip from TI to developer

• Leveraged PF• Similar to AEPF but debt at project level increases required yield

by tax investor by approx. 2%, often alters allocation schedule

2. Lease structures• Sale Leaseback

• Developer sells project to an entity (lessor) who then leases it back to the developer to operate and garner revenue

• Inverted lease (a.k.a. lease pass-through) • ITCs passed via Master Lease; Tenant operates equipment and

makes lease payments to Owner (not simulated in SAM)

3. Single-owner (balance sheet)


Leveraged Partnership Flip

Tax incentives can lead to complicated financial structures

Senior Lender

Tax Investor(99% of equity)

Developer(1% of equity)

Project Company(equity + PPA/cash debt)

Power (and REC) Sales

Cash RevenueITC/Cash Grant

lessOperatingExpenses

lessDebt Service

lessTax-Deductible Expenses

(including MACRS and interest on debt)

equalsTaxable Losses/Income

(which result inTax Benefits/Liabilities)

equalsDistributable Cash

99% / 100%

99% / 10% 1% / 90%

1% / 90% 99% / 10%

1% / 0%

Federal Incentive

Detailed Financial Structures in SAM


• Four Financial Structures Recently Added to SAM • All Equity Partnership Flip• Leveraged Partnership Flip• Sale Leaseback• Corporate (Single Owner)

• Allows For:• More realistic evaluation of RE costs• Information transfer from finance and legal RE experts to

and new industry participants• National lab analytic capability • Examination of complex support

policies

Financial Modeling Metrics: Capital Recovery Factor and Fixed Charge Rate



The FCR method is one of many standard approaches used to represent finance in LCOE equations

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FCR equation is a representation of a cash-flow model and determines the amount of revenue needed to cover investment and operating cost.

– Defined as the amount of revenue per dollar of investment that must be collected annually to pay the carrying charges on that investment as well as taxes

FCR equation, as we generally present it, combines a standard amortization equation (Capital Recovery Factor) and an equation that accounts for the additional revenue required to meet tax obligations.

This method was adopted by all program areas during the EPRI/DOE Technology Characterization from 1995/996 and the wind program has used it ever since

Fixed Charge Rated(1+d)n

(1+d)n - 1

Capital Recovery Factor

Value of Taxes and Depreciation

1- (T*PVdep)(1-T)


The use of different Fixed Chare Rates can result in LCOEs that measure different cost aspects

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FCR calls for an after-tax discount rate (d) and can be either nominal or real (depending on discount rate input). WACC method generally used to estimate d

Fixed Charge rates can represent different scenarios:

1. No-tax Investment Scenario:

2. Cost After Tax Deductions Scenario:

3. Before Tax Revenue Required Scenario:

d(1+d)n

(1+d)n - 1FCR

d(1+d)n

(1+d)n - 11- (T*PVdep)

(1-T)FCR

d(1+d)n

(1+d)n - 1FCR [1- (T*PVdep)]

Determines before-tax cost of energy that will allow investor to recover costs, meet tax payments, and achieve target ROR

Determines after-tax cost of energy that will allow investor to recover costs and achieve target ROR assuming full monetization of tax benefits

Determines cost of energy that will allow investor to recover costs and achieve target ROR without considering tax obligations

Thank you

Michael Mendelsohn

Paul Schwabe


Extra Slides


Tax Equity a Critical Component to RE Financing

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• To take advantage of tax incentives, often a separate investor with tax appetite is brought into the project

• Generally referred to as “tax equity”• Currently very small pool of tax equity investors

(investment banks, insurance companies known as institutional investors)• Continued tax appetite required (MACRS 6 year recovery

period)• Complexity of the project structure• Wide array of risks perceived:

• Technology• Developer• Off-taker (utility or commercial entity) credit rating and contract

duration• Regulatory (e.g., can regulators alter the PPA contract?)• Site access

Wind Project Development ProcessIdentify

New MarketSelect Sites

Acquire or Control Land

Assess Wind Resource

Acquire Permits

Obtain Transmission

Negotiate PPA / Offtake

Agreement

Design Project

Turbine Supply

Negotiate Turbine / BOP Installation

Contracts

Finance Project

Install Infrastructure

Install Turbines

Testing & Commercial Operations

Operate & Maintain ProjectSource: Holland & Hart, RE Project Development & Finance

• Entire process can take 3-4 years to reach operational phase

• Pick any two: “Fast, cheap, or good”

Risk Factor Mitigants


Category Examples

Private

(Market)

Long-term contracting PPAs, leases

Insurance Construction, operation, debt obligation

Advanced financial structures Partnership flips, sale leasebacks

Securitization N/A (none currently for RE industry)

Public

(Governmen

t)

Investment support structures • Tax credits (ITC, PTC, MACRS) • Loans or loan guarantees• Grants• Foreign exchange risk mitigation• First loss reserves• Securitization underwriting (FNMA, GNMA)

Market support structures • Demand targets (RPS)• Guaranteed prices (FIT)• Guaranteed markets (e.g. military contract)• Net metering policies

Indirect support structures • Transmission build-out• Labor education• Infrastructure development (roads, shipping)

Project IRR impact on LCOE


* Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “

How do we de-risk projects in order to lower required return?

Deutsche Bank calls it TLC:*

Policy Financing Impact

Transaction Costs

LCOE Impact

Tax Credits Good High TBD

Loan Guarantees Excellent Very high TBD

Cash Grants Good-excellent Low TBD

Production Grants Good? Moderate? TBD

How do different policies impact financing and transaction costs?

U.S. Wind Investment in Response to Policy


Feed-In Tariff Design Considerations


Design Issue Options

Eligibility What resources? Solar, wind, biomass, geothermal, etc.?

Contract Length 10 years? 20 years?

Rate-Setting Basis Cost-based? Value of power?

Payment Structure Fixed or variable with power production?

Tariff Differentiation Based on project size, resource?

Interconnection & Purchase Requirements

Utility required? Cost allocation?

Purchasing Entity Publicly-traded (and rated) entity? Political longevity?

Payment Adjustments Declining or increasing payments? One-time adjustment after bond repayment?

Purchase Caps Limited by total expenditure or per project expenditure

Documents

Renewable Energy Finance Basics