January 2, 2020

Energy Project Finance

What is Project Finance in Renewable Energy?

Project finance is an established debt and equity financing technique used to finance large, high cost, long-duration infrastructure and energy assets. It is called Project Finance, because it is typically done one project at a time, unlike financing an entire company.

At its most basic level, renewable energy project finance refers to the financing of a renewable energy assets on a stand-alone basis. “Stand alone” means that the debt and equity investors in the projects only earn their returns from the earnings of the individual projects they invest in, rather than from any growth of the original development company. For example, an investor in a project financed Solar PV project will earn returns from what that project generates, it does not benefit from all the other activities of the Independent Power Producer that might purchase the power generated (e.g. no revenues from transmission or distribution of power, or selling energy services to customers). If the project fails, the investment fails. Therefore, project financing presents different risks than corporate financing.

What is Project Finance?

Project finance is the funding (financing) of long-term infrastructure, industrial projects, and public services using a non-recourse or limited recourse financial structure. The debt and equity used to finance the project are paid back from the cash flow generated by the project.

 

Project financing is a loan structure that relies primarily on the project’s cash flow for repayment, with the project’s assets, rights, and interests held as secondary collateral. Project finance is especially attractive to the private sector because companies can fund major projects off-balance sheet.

Why do we use Project Finance in Renewable Energy?

Debt is the cheapest form of capital, and equity the most expensive. Traditionally Utilities may have funded a project with 50% debt and 50% equity. In project finance debt levels are often 80% which means the Weighted Average Cost of Capital (WACC) is lower. An equity investor would be unable to achieve 15% Internal Rate of Return (IRR) if required to provide 50% of the capital costs, if however this dropped to only a 20% requirement, a much higher IRR could be possible.

Why is equity cheaper than debt?

It’s really a simple risk vs reward calculation. Within the project finance structure, if there is a cost that overruns or unanticipated construction delay, equity is at a much higher risk. A project will typically repay the lender (debt) before an equity investor. With higher debt levels, there is less margin for error. If something goes wrong equity can find themselves in a loss position faster than in less geared structure. So equity can expect a much higher return on capital as their capital faces a much higher capital risk. 

What is Structured Finance in Renewable Energy?

Structured can mean that it is highly technical and subject to a number of conventions. Structured finance therefore is an umbrella term for any sort of off balance sheet finance whereby there is a collateral asset (a wind farm through to a multi gigawatt portfolio), which generally creates predictable cash flow. This may include project finance (off balance sheet infrastructure finance), securitizations, structured trade finance, etc.

Structured finance in a project finance context generally means a portfolio of assets to be structured into a single placement (such as ten Energy Storage Assets as the “collateral” on the asset side), rather than one single big project. “Structures” tend to blur together regardless of name due to how the risks are allocated. 

What jobs are there in Renewable Energy Project Finance and Structured Finance?

There is no simple answer here as the role or function will be dependent on the type of organisation. Touching on perhaps the four most prominent in Renewable Energy:

 

Project Developer / Project Sponsor – Within a project developer, the terms are often combined. Typically referred to as Structured Finance or In-House Investment Management, these teams typically coordinate the raising of project debt, external equity fundraising, financial modelling and latterly asset divestment.

 

Investor (Equity) – For an Investment Manager, the company will exist to deploy equity capital into projects (greenfield and brownfield) which will require the raising of debt. Some organisations will leave this up to the individual Investment Managers to hold relationships with the banks whilst others will have a dedicated individual or team. Others still will rely entirely on their Advisor (see below). 

 

Lender (Debt) – Conversely, the lender or bank exists to deploy debt capital. The lender will work closely with advisors, Investors and Developers to understand opportunities and provide lending facilities or long term debt finance. 

 

Advisor – An Advisor will typically support a project sponsor or investor by originating, designing and executing all forms of structured finance debt.

What is M&A within Renewable Energy?

Mergers and Acquisitions refers to the secondary market for Renewable Energy Assets. Many types of investors in Clean Energy will not support the risk profile for new build (greenfield) project development and look to partake only at the point of operational assets being sold on in secondary markets. Investment Banks often facilitate these transitions and allow the entry of an additional pool of capital to be recycled at the development end.