6. Project Finance
6.1 Overview
Project finance is a critical aspect of most clean energy projects. The difficulty of obtaining sufficient and suitable financing can be a major constraint in the development of such projects.
Obtaining financing is usually dependant on having all other pieces of the legal puzzle in place-a reputable lender will not lend until all major legal issues have been satisfactorily addressed. For example, most financiers will want to examine the terms of the power purchase agreement before committing funds, thus underscoring the importance of this and other key documents.
Legal documentation for financing can be involved and complex. Normally, it will be the lender or investor who insists on a suite of documents of its own choosing, as it is the lender or investor assuming the financial risk. In this case, it is critical to have your own counsel review the documents to ensure that they are drafted in your interest insofar as possible and palatable to the lender.
Finance issues are generally more important and more complex for larger scale projects, but they can also be important for smaller projects. At the household or small business level, government grants or loans (or other tax and other fiscal incentives) may be available to retrofit buildings or generate clean energy.
Project costs encompass a broad spectrum and include the costs associated with site assessment; land acquisition; permitting; interconnection (including studies); construction; capital equipment purchase, installation, and commissioning; operation; maintenance; downtime costs; warranties and insurance; administrative and legal costs; and decommissioning.
Project finance is a means of meeting these costs. The basic sources of project finance are equity, debt, government, and public-private partnerships; often, a combination of financing sources will be required. Project revenue is a component of project finance. The primary components of project revenue are the sale of energy or energy savings, the sale of environmental attributes, and governmental incentives.
Project finance is a critical aspect of most clean energy projects. The difficulty of obtaining sufficient and suitable financing can be a major constraint in the development of such projects.
Obtaining financing is usually dependant on having all other pieces of the legal puzzle in place-a reputable lender will not lend until all major legal issues have been satisfactorily addressed. For example, most financiers will want to examine the terms of the power purchase agreement before committing funds, thus underscoring the importance of this and other key documents.
Legal documentation for financing can be involved and complex. Normally, it will be the lender or investor who insists on a suite of documents of its own choosing, as it is the lender or investor assuming the financial risk. In this case, it is critical to have your own counsel review the documents to ensure that they are drafted in your interest insofar as possible and palatable to the lender.
Finance issues are generally more important and more complex for larger scale projects, but they can also be important for smaller projects. At the household or small business level, government grants or loans (or other tax and other fiscal incentives) may be available to retrofit buildings or generate clean energy.
Project costs encompass a broad spectrum and include the costs associated with site assessment; land acquisition; permitting; interconnection (including studies); construction; capital equipment purchase, installation, and commissioning; operation; maintenance; downtime costs; warranties and insurance; administrative and legal costs; and decommissioning.
Project finance is a means of meeting these costs. The basic sources of project finance are equity, debt, government, and public-private partnerships; often, a combination of financing sources will be required. Project revenue is a component of project finance. The primary components of project revenue are the sale of energy or energy savings, the sale of environmental attributes, and governmental incentives.
6.2 Equity Financing
Equity financing refers to the sale of a portion of the project to an investor, through such means as private equity or the selling of shares of the project company's stock. Equity investors do not have a guaranteed return on their investment and indeed, may lose part or all of the investment. At the same time, there is a potential for unlimited upside on investment return as well as the possibility of receiving dividends. An equity investor may obtain financial rights and/or governance rights in the project.
Equity financing refers to the sale of a portion of the project to an investor, through such means as private equity or the selling of shares of the project company's stock. Equity investors do not have a guaranteed return on their investment and indeed, may lose part or all of the investment. At the same time, there is a potential for unlimited upside on investment return as well as the possibility of receiving dividends. An equity investor may obtain financial rights and/or governance rights in the project.
6.3 Debt Financing
Debt financing is the use of borrowed money from a lender. The borrower must pay back both principal and interest, but the lender does not get an ownership stake in the project. The lender will normally insist on security for the debt, which could comprise the projects assets, or even personal guarantees of the project principals. The two most commonly used types of debt financing are full recourse financing (or balance sheet financing) wherein a project's debts are backed by all of the project owners' assets, including personal assets and assets not related to the project; and limited or non-recourse financing (also called project financing), wherein repayment of debt is expected to come only from the cash flow and possibly assets of the particular project.
Debt financing is the use of borrowed money from a lender. The borrower must pay back both principal and interest, but the lender does not get an ownership stake in the project. The lender will normally insist on security for the debt, which could comprise the projects assets, or even personal guarantees of the project principals. The two most commonly used types of debt financing are full recourse financing (or balance sheet financing) wherein a project's debts are backed by all of the project owners' assets, including personal assets and assets not related to the project; and limited or non-recourse financing (also called project financing), wherein repayment of debt is expected to come only from the cash flow and possibly assets of the particular project.
6.4 Government-Related Financing
6.4.1 Financial Incentives
Financial incentives and subsidies offered by various levels of government often help ensure a clean energy project's financial viability.
Financial incentives and subsidies offered by various levels of government often help ensure a clean energy project's financial viability.
6.4.1.1 Tax and Other Financial Incentives
Tax issues and financial incentives offered by various levels of government are, at present, a critical part of almost all clean energy projects and can often mean the difference between profit and loss. These sorts of incentives and tax schemes are constantly changing and can include income tax deductions, tax rebates, sales tax exemptions (on equipment), production tax credits, tax-free periods and locales, import duty concessions, subsidies (direct, indirect, production, consumption, export, tax, etc.), regulatory advantages, and trade regime preferential treatment, to name just a few. Tax and financial incentives specific to the jurisdiction you plan to operate in are fundamental to the financial viability of the project and are dependant on project location, size, and other criteria; a detailed analysis of what is available should be the first step in project financing. In some jurisdictions, tax incentives can even comprise fully one-half to two-thirds of the total revenue stream of a project, particularly in the initial years of project operation.
Tax issues and financial incentives offered by various levels of government are, at present, a critical part of almost all clean energy projects and can often mean the difference between profit and loss. These sorts of incentives and tax schemes are constantly changing and can include income tax deductions, tax rebates, sales tax exemptions (on equipment), production tax credits, tax-free periods and locales, import duty concessions, subsidies (direct, indirect, production, consumption, export, tax, etc.), regulatory advantages, and trade regime preferential treatment, to name just a few. Tax and financial incentives specific to the jurisdiction you plan to operate in are fundamental to the financial viability of the project and are dependant on project location, size, and other criteria; a detailed analysis of what is available should be the first step in project financing. In some jurisdictions, tax incentives can even comprise fully one-half to two-thirds of the total revenue stream of a project, particularly in the initial years of project operation.
6.4.1.2 Net Metering
Net metering is another important financial incentive in which the owner of a renewable energy generation system receives credit for a portion of the electricity that it generated. Net-metering is used primarily at the household level, but can also be used at larger scales. Essentially, the consumer's utility meter runs both forwards and backwards and the consumer is charged for only the net amount of energy used. Allowing surplus electricity to be sold back to the grid provides a financial incentive to those installing renewable energy systems. A net metering contract normally addresses interconnection with the utility and accounting for net excess electricity generated delivered to the utility.
Net metering is another important financial incentive in which the owner of a renewable energy generation system receives credit for a portion of the electricity that it generated. Net-metering is used primarily at the household level, but can also be used at larger scales. Essentially, the consumer's utility meter runs both forwards and backwards and the consumer is charged for only the net amount of energy used. Allowing surplus electricity to be sold back to the grid provides a financial incentive to those installing renewable energy systems. A net metering contract normally addresses interconnection with the utility and accounting for net excess electricity generated delivered to the utility.
6.4.2 Legislated Incentives
Various levels of government have the discretionary power to promote clean energy and improve its bottom line profitability. Legislated incentives (or mandates) help to create a positive environment for clean energy, thus indirectly contributing to the profitability of projects. Such legislative actions fall under the rubric of project finance because they can directly contribute to the financial viability of a clean energy project, and thus, must be carefully assessed before deciding to proceed.
For example, environmental attributes are often creatures of statute, whose value is a direct result of and depends on government fiat. Environmental attributes thus become project assets and can be traded as commodities; see discussion in section 4.8.3 (Environmental Attributes Trading Agreement). Similarly, emissions trading occurs under legislated or voluntary schemes, the commonality being that a price is assigned to commodities (in this case greenhouse gas and other pollutants) that do not have inherent economic value.
Various levels of government have the discretionary power to promote clean energy and improve its bottom line profitability. Legislated incentives (or mandates) help to create a positive environment for clean energy, thus indirectly contributing to the profitability of projects. Such legislative actions fall under the rubric of project finance because they can directly contribute to the financial viability of a clean energy project, and thus, must be carefully assessed before deciding to proceed.
For example, environmental attributes are often creatures of statute, whose value is a direct result of and depends on government fiat. Environmental attributes thus become project assets and can be traded as commodities; see discussion in section 4.8.3 (Environmental Attributes Trading Agreement). Similarly, emissions trading occurs under legislated or voluntary schemes, the commonality being that a price is assigned to commodities (in this case greenhouse gas and other pollutants) that do not have inherent economic value.
6.4.2.1 Renewable Portfolio Standards/Energy Efficiency Portfolio Standards
Renewable portfolio standards (also known as renewable energy standards) is a regulatory policy that requires the increased production of renewable energy and/or requires electric utilities to meet a specified percentage of their electricity purchases and sales with electricity produced from enumerated renewable sources. In some jurisdictions, a utility can also meet this obligation by purchasing renewable credits from other entities. Energy efficiency portfolio standards mandates energy providers to meet a portion of their energy demand or annual increase in energy demand through greater energy efficiency.
Renewable portfolio standards (also known as renewable energy standards) is a regulatory policy that requires the increased production of renewable energy and/or requires electric utilities to meet a specified percentage of their electricity purchases and sales with electricity produced from enumerated renewable sources. In some jurisdictions, a utility can also meet this obligation by purchasing renewable credits from other entities. Energy efficiency portfolio standards mandates energy providers to meet a portion of their energy demand or annual increase in energy demand through greater energy efficiency.
6.4.2.2 Feed-in Tariff
A feed-in tariff or renewable tariff is an incentive structure to promote renewable energy, whereby electrical utilities are required to purchase renewable energy at above-market rates. The fundamental objective of a feed-in tariff is to guarantee the owner of the renewable energy project a defined rate of return. The increased costs can be absorbed by government entities or passed on to the consumer, or a combination of both. Feed-in tariffs can serve as a means of stimulating the market for clean energy through positive financial incentives.
A feed-in tariff or renewable tariff is an incentive structure to promote renewable energy, whereby electrical utilities are required to purchase renewable energy at above-market rates. The fundamental objective of a feed-in tariff is to guarantee the owner of the renewable energy project a defined rate of return. The increased costs can be absorbed by government entities or passed on to the consumer, or a combination of both. Feed-in tariffs can serve as a means of stimulating the market for clean energy through positive financial incentives.
6.5 Public-Private Partnerships
Also known as PPP or P3, public-private partnerships can be an effective model for organising infrastructure development in both industrialized and developing countries. This hybrid approach to financing, as its name implies, involves a funding partnership between various levels of government and private sector companies. Possible approaches include joint ventures, co-financing, management and supply contracts, turnkey projects, leases, concessions, and outright private ownership of assets in schemes such as BOT and BOOT (discussed in section 4.6.1, BOT and BOOT Agreements). Often, a private sector entity enters into a contract with a government entity for the provision of certain services. In order to encourage private investment in such schemes, governments seek to minimize risk to the private investor through mechanisms such as offtake agreements containing revenue guarantees, grants, and tax concessions.
Sample Finance Agreements
Sample Emissions/Environmental Attributes Trading Agreements
Also known as PPP or P3, public-private partnerships can be an effective model for organising infrastructure development in both industrialized and developing countries. This hybrid approach to financing, as its name implies, involves a funding partnership between various levels of government and private sector companies. Possible approaches include joint ventures, co-financing, management and supply contracts, turnkey projects, leases, concessions, and outright private ownership of assets in schemes such as BOT and BOOT (discussed in section 4.6.1, BOT and BOOT Agreements). Often, a private sector entity enters into a contract with a government entity for the provision of certain services. In order to encourage private investment in such schemes, governments seek to minimize risk to the private investor through mechanisms such as offtake agreements containing revenue guarantees, grants, and tax concessions.
Sample Finance Agreements
Sample Emissions/Environmental Attributes Trading Agreements
