renewable energy finance basics
DESCRIPTION
Renewable Energy Finance Basics. Michael Mendelsohn Sr. Financial Analyst Paul Schwabe Energy Analyst February 1, 2012 NREL. Agenda. NREL Finance Team Financing Background Project Financial Structures Financial Modeling Metrics. NREL Finance Team. RE Project Finance Team – overview. - PowerPoint PPT PresentationTRANSCRIPT
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
National Renewable Energy Laboratory Innovation for Our Energy Future3
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
Financing Background
National Renewable Energy Laboratory Innovation for Our Energy Future8
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
National Renewable Energy Laboratory Innovation for Our Energy Future9
Project IRR impact on LCOE
National Renewable Energy Laboratory Innovation for Our Energy Future10
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
National Renewable Energy Laboratory Innovation for Our Energy Future11
Financing Risk Factors
National Renewable Energy Laboratory Innovation for Our Energy Future12
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
National Renewable Energy Laboratory Innovation for Our Energy Future13
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
National Renewable Energy Laboratory Innovation for Our Energy Future14
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
National Renewable Energy Laboratory Innovation for Our Energy Future15
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
National Renewable Energy Laboratory Innovation for Our Energy Future17
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
Power, RECs, Tax Ben.
Tax Investor /
Govt.
Senior Lender
Developer
Project Company
Power, RECs, Tax Ben.
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)
National Renewable Energy Laboratory Innovation for Our Energy Future18
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
National Renewable Energy Laboratory Innovation for Our Energy Future20
• 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
National Renewable Energy Laboratory Innovation for Our Energy Future21
NATIONAL RENEWABLE ENERGY LABORATORY
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)
NATIONAL RENEWABLE ENERGY LABORATORY
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
National Renewable Energy Laboratory Innovation for Our Energy Future24
Extra Slides
National Renewable Energy Laboratory Innovation for Our Energy Future25
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
National Renewable Energy Laboratory Innovation for Our Energy Future28
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
National Renewable Energy Laboratory Innovation for Our Energy Future29
* 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
National Renewable Energy Laboratory Innovation for Our Energy Future30
Feed-In Tariff Design Considerations
National Renewable Energy Laboratory Innovation for Our Energy Future31
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