To secure financing for renewable energy projects, developers must find investors willing to manage a suite of technological, financial and political risks.
Most technologies in renewable energy are relatively new and untested. On top of that, competition from markets with lower manufacturing costs is pressuring solar panel and wind turbine manufacturing, and fluctuating agricultural and transport fuel prices are adding uncertainty to investments in biofuels.
And shifting political winds have the potential to upset incentive programs for renewable energy technologies, many of which might not prove viable when pitted against coal, natural gas, or petroleum products.
There is money to be made in renewables for those willing to take the risk. Read more: Follow The Money To… Clean Technology?
“Some of these projects do have some nice robust returns,” said Elias Hinckley, a partner at law firm Kilpatrick Townsend.
“Some of the problem is finding enough financial capital to finance all these projects,” he said. And stiff competition for funding is likely to persist.
But existing financing mechanisms are continuing to channel money into promising ventures, and new mechanisms are evolving to enhance the volume and efficiency of financial flows.
Tax Equity Financing
Impending changes to government incentives will likely spur an uptick in tax equity financing for renewable energy projects.
Renewable energy project developers currently have the option to receive 30% of project costs as an up-front cash grant in lieu of a tax credit. That option is expected to expire at the end of this year.
The investment tax credit can reduce overall project costs considerably. But 30% of a project’s costs may well exceed a small renewable energy firm’s tax liabilities in the first few years of the project. To access funding more quickly, a firm may seek out potential investors with larger tax liabilities for the purpose of exchanging tax credits for financing.
“You can bank them for 20 years, but firms don’t want to wait until then, they would rather sell that tax credit to somebody who needs it for an infusion of cash into their project,” said Mark Riedy, founder and general counsel to American Council on Renewable Energy (ACORE) and partner at law firm Mintz Levin.
Riedy and Andrew Gilligan, an associate with solar finance firm Sol Systems, have noted that the number of large investors capable of providing tax equity financing — such as Goldman Sachs or, previously, Lehman Brothers — has dwindled since the onset of the global financial crisis in 2008. Gilligan estimated the number of potential tax equity investors at roughly 15 now, down from around 25 in 2007.
If the expiry of the cash grant option results in a rush by renewable energy firms to tap a limited pool of tax equity investment funds, “what you might see next year is a bottleneck where the solar projects that get tax equity financing are going to work, and the ones that don’t, wont,” according to Gilligan.
But increased activity in tax equity financing may prove lucrative for the tax equity investors.
“Having that tax liability, the ability to participate as a tax equity investor, is a potentially really big advantage,” Hinckley said.
A large industrial concern that branches out into manufacturing wind turbines or solar panels could secure end-users for its products as a condition of a tax equity finance deal, he said.
Another financing option is an insurance wrap, which is designed to guarantee stable rates of return for project investors. Read more: Finance Advice from a Renewables Guru.
There are numerous project-specific risks against which an investor might seek protection — construction completion on time and within budget, production meeting expected levels, operational integrity of the facility, accelerated degradation of system components, full and timely payment from off-takers.
Any of these risks can be evaluated and mitigated by an insurance product.
“An EPC (engineering, procurement, and construction) wrap is a very conventional construction process risk management tool,” Hinckley told Breaking Energy.
But an insurance company can also design a broader project insurance wrap, which “can be structured to protect against a number of risks and provide a near-guaranteed return,” said Hinckley.
“It’s a smaller return, because you’re reducing risk, but it’s a safer set of returns,” he said.
He added that these products can broaden the appeal of renewable energy to investors who are unfamiliar with the sector and may not feel fully equipped to evaluate the risks specific to it.
Insurance wraps work particularly well for solar projects, which have predictable operating costs and off-take prices. Biofuels projects are more vulnerable to volatility in feedstock costs and transport fuel prices, and require a more sophisticated product designed to protect against those additional layers of risk, Hinckley said.
Credit-Enhanced Bond Financing
A more recently developed mechanism, credit-enhanced bond financing, allows commercial lenders to profit from participating in renewable energy finance without putting their own capital at risk. Read more: Financing That Could Revolutionize Renewables Industry.
“If you don’t have access to that money you’ve got to be creative and come up with a way to fill that big hole, because the project’s got to get financed,” Riedy said.
Using this mechanism, a project company issues bonds backed by a US government loan guarantee. A commercial lender — a federal- or state-chartered bank — applies to the government for project borrowing and acts as a trustee for the bonds, handling their sale to investors, as well as interest and principal payments to bondholders.
This offers protection to the project developer and the commercial bank, as well as to investors.
The project company that executes the project holds a license to the parent company’s patented technology, but does not own it. This structure ensures that in the event of a default, the parent company’s primary asset is not at risk.
The project company’s bonds alone are not investment-grade. It is “a shell company at that point — the only asset is the project that has yet to be built,” said Riedy.
But when backed by a US government loan guarantee, these project company bonds become attractive to investors. They have “the full faith and credit of the US government, which is triple-A rated with an asterisk,” Riedy said.
Riedy also noted that a loan guarantee means the US government bears risks of any new technology. A contractor building a large project will normally provide a performance bond or technology wrap — a guarantee to repay investors if the facility does not work. But for many renewable energy technologies, “they can’t put that up on the first project because they’ve never done it before,” Riedy said.
These safer securities can help renewable energy project developers access the institutional investor market, which represents trillions of dollars a year in virtually untapped investment potential, according to Riedy.
“We can sell those bonds when they’re credit-enhanced with a loan guarantee to the institutional investors — pension funds, banks, mutual funds, insurance companies, and the like — they’ll buy it in a heartbeat,” he said.
And servicing credit-enhanced bonds is less risky for commercial lenders than putting up their own funds. “Their money is not at risk because they didn’t pull the money out of their pockets to loan,” said Riedy.
Innovations in renewable energy finance have begun to address an additional obstacle to project development — linking project developers to potential investors.
Solar finance firm Sol Systems launched an online platform, SolMarket, on 31 August. SolMarket is designed to add a level of transparency to the solar financing market by easing communication between project developers and potential investors.
“The communication channels, the financing channels, the due diligence channels were all disrupted and fragmented,” Sol Systems CEO Yuri Horowitz told Breaking Energy.
Participation in the platform appears to be growing. In the first two weeks of operations, SolMarket’s partnership funds — those that have agreed to use the platform for due diligence purposes — rose to $400 million from $350 million.
Much like a social networking site, each company and project has a searchable profile that it can make available to potential investors. This allows both sides to more efficiently identify partners or projects of interest.
“They’re not picking up the phone to call 50 developers or 50 investors,” Horowitz said. “That in and of itself is going to save the industry huge amounts of money.”
Resources for solar firms include standardized documents which, when developed by independent firms, can be costly and may not include the information that investors consider vital, as well as standardized analysis tools to evaluate a project’s performance under different financing scenarios or off-take prices.
The site also offers member discounts on solar modules, which may prove particularly valuable to “mid-tier” developers of projects in the 50kW-1MW size range.
“Group purchases are really focused on those small systems, providing them with pricing that they otherwise could not get,” Horowitz said. And they seek to offer the advantage of volume to SolMarket’s partners on the manufacturing side.
“There’s a lot of room there to grow, but what’s really holding that market back are the transaction costs,” he said.
Photo Caption: Goldman Sachs Managing Director David Lehman (right) extends his hand for a hand shake with former Senior Vice President and Chief Financial Officer of AIG Financial Services Elias Habayeb (left) prior to the second day of a hearing before the Financial Crisis Inquiry Commission July 1, 2010 on Capitol Hill in Washington, DC.