# Financing Renewable Energy Projects By [agilibus.es](https://paragraph.com/@agilibus-es) · 2022-06-07 --- We all know about global warming ================================ * We all also know about the main advantage of renewable energy projects: **reduction of CO2 emissions** * Required low-carbon investment levels in green infrastructure to keep temperature increase below 1.5ºC threshold are enormous ($460B/yr until 2030, $1560B/yr thereafter)\* * There are additional considerations: * What if your country does import oil and/or gas? * Take advantage of your local resources * Fuel is free! All countries have wind and/or solar to some extent * Benefits to local communities _\* What investments are needed in the global energy system in order to satisfy the NDCs and 2 and 1.5 °C goals? – International Institute for Applied System Analysis_ What are renewable energy projects? =================================== * Electricity is generated from a **renewable energy source** (e.g. wind, solar, hydro, biomass, tides, geothermal) * Instance of **infrastructure projects**. As such, characterized by: * Capital intensive before any revenue is generated * High risk / high return * Long term investment horizons (10+ years) * Complex contractual interplay between many parties (construction contracts, loan agreements, land leases, offtake agreements, interconnection rights, operation and maintenance, and many more) * Once these projects are up and running, the **cost of running them is almost zero**! Examples of renewable energy projects ===================================== ![Ciudad Victoria & La Mesa wind farms in Tamaulipas, Mexico](https://storage.googleapis.com/papyrus_images/f658f07b401cd6b68c3779fec78ecea49d6ba3c387583917f3db687b1d27f630.jpg) Ciudad Victoria & La Mesa wind farms in Tamaulipas, Mexico ![Los Remedios solar PV project in Acajutla, El Salvador](https://storage.googleapis.com/papyrus_images/5e7a44174567704a3b21832a926a3380c5e52c8416335f66636c6f75f8bb1504.jpg) Los Remedios solar PV project in Acajutla, El Salvador Examples of the contractual structure of a renewable energy project =================================================================== ![Source: Tice and Walter [2014] based on Smith, Walter and De Long [2012]](https://storage.googleapis.com/papyrus_images/2a08c103e27c536a00dd88beccff1ea7b6d12b18719d0ac6a2e2a0174a882dc1.png) Source: Tice and Walter \[2014\] based on Smith, Walter and De Long \[2012\] Let’s build a renewable energy project! ======================================= * Not so quick… what options are available? * You can start a development from scratch (**greenfield projects**) - High risk and high return * Long development times * High probability of failure, project development is complex and risky * You can acquire a partially developed project (**brownfield projects**) – Medium risk and medium return * Usually ready to build * Construction risk * Or you can acquire a project already **in operation** – Low risk and low return * Think of it as a bond * Stable and predictable cash flows * All major risks behind Show me the money! ================== * Once project development is ready, the time has come to commit serious money (mostly construction and purchase of equipment) * The most common tool used to finance renewable energy projects is **Project Finance**: * Project owned by a SPV (**Special Purpose Vehicle**), completely separated from the project Sponsor * **Finance is provided to the SPV**, that assumes the risks and the financial consequences * If things go south, banks have **no recourse to the project Sponsor**, “only” the equity is exposed * The project Sponsor keeps a **“clean” balance sheet** ### Corporate Finance vs. Project Finance ![Source: Financing and Investing in Infrastructure – Università Commerciale Luigi Bocconi](https://storage.googleapis.com/papyrus_images/9204176d626ece8d4dec04d527aaaf91fa4fb1778ff9840428218db87d4c4c61.png) Source: Financing and Investing in Infrastructure – Università Commerciale Luigi Bocconi Hold on… how much did you say you need!? ======================================== * Renewable energy projects have **big capital expenditure** **requirements** (CAPEX) and are highly leveraged (small equity vs. big debt) * Banks tend to be wary * If things go well, **no upside** * If things go wrong… **only recourse to the SPV** * Process to finance a renewable energy project tends to be long and complex * Banks spend a high amount of time studying in detail the project (**Due Diligence**) * Usually they do not want to do it alone – **Syndicate of banks** What will the weather be like tomorrow? ======================================= * Renewable energy projects rely on electricity generation to generate cash flows * The problem with renewable energy generation: you cannot control when it is going to be sunny or windy * Through thorough measurement campaigns, it is possible to estimate the level of renewable energy resource of a project * Banks rely on these analysis to estimate the amount of debt the project is able to accommodate: * **P-levels**: Annual generation levels to be exceeded (P50 and P90) * **Coverage Ratios**: CFs available vs. debt service ![Source: Excel Probability Functions – Project Finance Institute](https://storage.googleapis.com/papyrus_images/86e6e732af5707171c952356794b826136ebd12e6a1cc14090e6e26afb07e9ef.png) Source: Excel Probability Functions – Project Finance Institute The future ain't what it used to be\* ===================================== **_\*_** _Quote attributed to baseball-playing philosopher Yogi Berra_ * Historically renewable energy projects have been developed leveraging **government support** * Goal: Achievement of **technological maturity** through subsidized tariffs * Every unit of renewable energy generated was paid at a fixed price not determined by the market (**Feed-In-Tariffs**) * This model has worked very well in the past: Renewable energy technology has achieved **grid parity** * Now what? An additional layer of complexity enters the game ![Source: enie.nl](https://storage.googleapis.com/papyrus_images/2f425d5401fbb6d8f0940c86025200d6cb21ba8c8242bb3156a78d21b7b8e61c.png) Source: enie.nl It's tough to make predictions, especially about the future\* ============================================================= _\* Again Yogi Berra_ * Governments around the globe have **slashed subsidized tariffs** * Renewable energy projects sell electricity **directly to the market** * Electricity market price tends to be volatile and unpredictable, hence direct exposure to **market risk** * Debt tenors tend to be long (10+ years) * The project needs **stable cash flows** to pay back the loan * Banks get scared off, cancelling lending or reducing debt size and at hardened terms ![Source: Operador del Mercado Ibérico de Energía – Polo Español (OMIE)](https://storage.googleapis.com/papyrus_images/2fe1a9d235c84c5638a372db0eb0e2e67f12457b953acf69dda895c4a18f0026.png) Source: Operador del Mercado Ibérico de Energía – Polo Español (OMIE) PP… what? ========= * There are several tools available to transform volatile market prices into stable and predictable cash flows: * Power futures * Traded in exchanges (e.g. European Energy Exchange EEX) * Shorter-termed than required (max. 10 years) and low liquidity * Insurance products * Derived from weather insurance * Revenue swaps exchanging variable revenues for a fixed payment * Long-term electricity contracts (aka PPAs) * PPA stand for Power Purchase Agreement * An agreement between a buyer and a seller to sell a certain amount of electricity for an agreed term at an agreed price * OTC market, bespoke agreements Some additional notes on PPAs ============================= * Preferred tool * PPAs can be physical or virtual * Physical: there is a physical link between the renewable energy project and the off-taker * Virtual: Financial contract (CfD); the renewable energy project and the off-taker can be not connected by a grid or even in different countries * As OTC products, PPAs can have several structures * Fixed price * Discount to market with floor (basically a put option) * Cap and floor (collar) * PPAs are not risk-free * Market risk, shaping risk, volume risk, balancing risk… ### Physical PPA ![](https://storage.googleapis.com/papyrus_images/b5d079aabbec2f83d3e0993254f1b37c363510daefd1f4d20e57df643a5f1a49.png) ### Financial/Virtual PPA ![Source: B. Douglas, G. Brindley, M. Labordena, and S. Dunlop, “Introduction to Corporate Sourcing of Renewable Electricity in Europe,” RE-Source, RESource, European platform for corporate renewable energy sourcing, Jan. 2020](https://storage.googleapis.com/papyrus_images/b42e7c56224df83e3d6f4d1cf4f09b59115d804cb5757c37fb14f6ae79c6319d.png) Source: B. Douglas, G. Brindley, M. Labordena, and S. Dunlop, “Introduction to Corporate Sourcing of Renewable Electricity in Europe,” RE-Source, RESource, European platform for corporate renewable energy sourcing, Jan. 2020 ### PPA Pricing Mechanism - Fixed price ![Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective](https://storage.googleapis.com/papyrus_images/e173ed5e324b5393b1f5e93fc9ac824437bf069655dae81b717d90a5056dbcab.png) Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective ### PPA Pricing Mechanism - Floor Price with Discount to Market ![Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective](https://storage.googleapis.com/papyrus_images/b721cd99f6f02e30140cff67d6db6c2f82f658af50f2db4caa9937745bba702f.png) Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective ### PPA Pricing Mechanism - Zero Cost Collar ![Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective](https://storage.googleapis.com/papyrus_images/06c7fd78af9aeb118241e3a28115b8967d29559be465eaff649fa9ce83b4bfe9.png) Source: Alastair Carrington (GE Renewable Energy), Power Purchase Agreement – A European Perspective Investment metrics ================== * Leveraging renewable energy projects with debt usually adds value to investors * Most common metrics to evaluate renewable energy projects (i.a.): * For investors: * NPV, IRR, MOI… * For banks: * Debt-to-Equity ratio, Debt Service Coverage Ratio (DSCR), Loan Life Coverage Ratio (LLC) Key takeaways ============= * Building renewable energy projects require big capital investments upfront and feature long investment horizons * Project Finance is the preferred tool to finance renewable energy projects * Financing renewable energy projects is challenging due to volatility of cash flows (intermittent generation and market risk) – Tools available to mitigate these risks * There are several metrics available to evaluate the quality of renewable energy projects from a financing perspective, depending on your side in the transaction (investor vs bank) Contact ======= * [Rubén Martínez Fanals](https://www.linkedin.com/in/fanals/) * [agilibus.es](http://agilibus.es/) --- *Originally published on [agilibus.es](https://paragraph.com/@agilibus-es/financing-renewable-energy-projects)*