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HomeMy WebLinkAboutLBNL - Wind project financing structures analysus Sep 2007Electricity Markets and Policy Group • Energy Analysis Department1Wind Project Financing Structures:A Review & Comparative Analysis~ Report Summary Presentation ~John Harper(Birch Tree Capital, LLC)Matt Karcher(Deacon Harbor Financial, L.P.)Mark Bolinger(Lawrence Berkeley National Laboratory)September 2007 Electricity Markets and Policy Group • Energy Analysis Department2Introduction• The financing of wind projects varies from that of conventional power projects due to the different characteristics of each:- Wind projects have higher capital costs but lower operating costs (e.g., no fuel costs)- Whereas Federal tax support for conventional power is distributed throughout the entire fuel cycle (from exploration/extraction through emissions controls), Federal tax support for wind power is concentrated primarily at the power generation stage• The two principal Federal tax incentives available to wind projects are the production tax credit (“PTC”) and accelerated depreciation deductions (together, known as “Tax Benefits”)• Tax Benefits provide a significant value to wind projects, but also complicate wind project finance, since most wind project developers lack sufficient Federal income tax liability to use the Tax Benefits efficiently• In response, multiple financing structures have emerged to attract investors, manage risks, and allocate Tax Benefits to entities able to use them efficiently• These financing structures are the underlying focus of this report Electricity Markets and Policy Group • Energy Analysis Department3Purpose of ReportThe purpose of the report is three-fold:1) To survey recent trends in the financing of utility-scale wind projects in the United States2) To describe the seven principal financing structures through which most utility-scale wind projects (excluding utility-owned projects) have been financed from 1999 to the present3) To analyze the potential impact of these seven structures on the levelized cost of energy from wind powerThe year 1999 is used as a starting point because it marks the advent of the recent expansion in wind power growth in the U.S. Electricity Markets and Policy Group • Energy Analysis Department4History of Modern Wind Finance1999-2002: Dominated by “Strategic Investors”• Tax-motivated investors (“Tax Investors”) with a long-term strategic interest in the wind sector (e.g., FPL Energy)• Smaller developers unable to use Tax Benefits often had little choice but to sell their projects to a Strategic Investor2003-2006: Rise of the “Institutional Investor”• More-passive Tax Investors (e.g., JP Morgan) get involved• New structures allow ongoing ownership stake for developer2003-2006: Declining cost of equity and debt capital• New investors attracted to the wind sector creates competition• Increasing competition and comfort with financing structures reduces cost of both debt and equity capital Electricity Markets and Policy Group • Energy Analysis Department5Seven Structures Examined Financing Structure Name Project Capital Structure Likely Equity Investors Brief Description of Structure Mechanics Corporate All equity Developer (corporate entity) Corporate entity develops project and finances all costs. No other investor or lender capital is involved. Corporate entity is able to utilize Tax Benefits (no flip). Strategic Investor Flip All equity Developer and Strategic Investor Strategic Investor contributes almost all of the equity and receives a pro rata percentage of the cash & Tax Benefits prior to a return-based flip in the allocations. Institutional Investor Flip All equity Developer and Institutional Investor Institutional Investor contributes most of the equity and receives all of the Tax Benefits and, after the developer has recouped its investment, all of the cash benefits, until a return-based flip in the allocations. Pay-As-You-Go (“PAYGO”) All equity Developer and Institutional Investor Institutional Investor finances much of the project, injecting some equity up-front and additional equity over time as the PTCs are generated. Includes a return-based flip in the allocations. Cash Leveraged Equity and debt Developer and Institutional Investor Based on the Strategic Investor Flip structure, but adds debt financing. Likely involves Institutional Investors, rather than Strategic Investors. Loan size/amortization based on the amount of cash flow from power sales. Cash & PTC Leveraged Equity and debt Developer and Institutional Investor Similar to the Cash Leveraged structure, but the loan size and amortization profile are based on the cash flow from power sales plus a monetization of the projected PTCs from the project. Back Leveraged All equity (but developer uses debt outside of the project) Developer and Institutional Investor Virtually identical to the Institutional Investor Flip, but with the developer leveraging its equity stake in the project using debt financing. Electricity Markets and Policy Group • Energy Analysis Department6Corporate Structure• All-equity structure with one investor• Corporate parent funds 100% of the costs of the project as equity in the project company • 100% of each benefit stream flows to parent:–Distributable cash–Tax Benefits: (a) taxable losses and gains, and (b) PTCs• With just one investor, there is no “flip” in the allocation of cash and Tax BenefitsCorporate Parent(100% of equity)Project Company(100% equity)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessTax-Deductible Expenses(including MACRS)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash100% Æ100% ÆÅ100% Electricity Markets and Policy Group • Energy Analysis Department7Strategic Investor FlipStrategic Tax Investor(99% of equity)Developer(1% of equity)Project Company(100% equity)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessTax-Deductible Expenses(including MACRS)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash99% Æ99% / 10% ÆÅ1% / 90%Å1% / 90%99% / 10% ÆÅ1%• All-equity structure with two owners• Tax Investor (“TI”) provides vast majority (e.g., 99%) of equity • Each party receives a pro rata share of the cash and Tax Benefits until TI IRR target (“Flip Point”) is reached • After Flip Point is reached, virtually all allocations go to developer • Note, the first percentage figure in each box is the pre-flip allocation, the second is the post-flip allocation Electricity Markets and Policy Group • Energy Analysis Department8Institutional Investor FlipInstitutional Tax Investor(60% of equity)Developer(40% of equity)Project Company(100% equity)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessTax-Deductible Expenses(including MACRS)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash100% Æ100% / 10% ÆÅ0% / 90%Å100% / 0% / 90%0% / 100% / 10%ÆÅ0%• All-equity structure with two owners• TI provides a majority (e.g., 60%) of equity • Pre-Flip Point, there are bi-furcated allocations:–Cash: initially 100% to developer until return of investment; then 100% to TI–Tax Benefits: 100% to TI • After Flip Point is reached, virtually all allocations go to developer Electricity Markets and Policy Group • Energy Analysis Department9Pay-As-You-Go (PAYGO)Tax Investor(55% of equity)Developer(45% of equity)Project Company(100% equity)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessTax-Deductible Expenses(including MACRS)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash100% Æ100% / 5% ÆÅ0% / 95%Å30% / 95%70% / 5% ÆÅ0%Å85% ofPTC value• All-equity structure with two owners• TI provides a majority (e.g., 55%) of equity up-front• TI makes additional payments as PTCs are generated, based on value of PTCs (e.g., 85%)–Most often payments are made directly to the developer• Pre-Flip Point, TI receives all of the Tax Benefits and a majority (e.g., 70%) of the cash• Post-Flip Point, virtually all allocations go to developer Electricity Markets and Policy Group • Energy Analysis Department10Cash LeveragedSenior Lender(PPA/cash debt)Tax Investor(99% of equity)Developer(1% of equity)Project Company(equity + PPA/cash debt)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessDebt ServicelessTax-Deductible Expenses(including MACRS and interest on debt)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash99% Æ99% / 10% ÆÅ1% / 90%Å1% / 90%99% / 10% ÆÅ1%• Two equity owners and project-level debt based on cash generated• Lenders have first lien on project assets• TI provides vast majority (e.g., 99%) of equity • Each party receives a pro rata share of the cash (after debt service) and Tax Benefits until Flip Point • After Flip Point is reached, virtually all allocations go to developer • Note: interest payments are tax-deductible, thereby decreasing taxable income Electricity Markets and Policy Group • Energy Analysis Department11Cash & PTC Leveraged• Two equity owners and project-level debt based on cash and PTCs generated• Lenders have first lien on project assets• Equity parties guarantee additional annual equity contributions, if necessary, to cover shortfall caused by PTC debt• TI provides vast majority (e.g., 99%) of equity • Each party receives a pro rata share of the cash (after debt service) and Tax Benefits until Flip Point • After Flip Point is reached, virtually all allocations go to developer • Note: interest on both tranches of debt is tax-deductibleSenior Lender(PPA/cash debt + PTC debt)Tax Investor(99% of equity)Developer(1% of equity)Project Company(equity + PPA debt + PTC debt)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessDebt ServicelessTax-Deductible Expenses(including MACRS and interest on debt)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash99% Æ99% / 10% ÆÅ1% / 90%Å1% / 90%99% / 10% ÆÅ1%contingentequitycontingentequity Electricity Markets and Policy Group • Energy Analysis Department12Back Leveraged• All-equity structure with two owners, similar to Institutional Investor Flip structure• TI provides a majority (e.g., 60%) of equity • Developer funds part of its equity with debt borrowed at its company-level, outside of the project• Pre-Flip Point bifurcated allocations:–Cash: initially 100% to developer until return of investment; then 100% to TI–Tax Benefits: 100% to TI • After Flip Point is reached, virtually all allocations go to developer Senior Lender(back leverage)Tax Investor(60% of equity)Developer(40% of equity)Project Company(100% equity)Power (and REC) SalesCash RevenueProduction Tax Credits (PTCs)lessOperatingExpenseslessTax-Deductible Expenses(including MACRS)equalsTaxable Losses/Gains(which result inTax Benefits/Liabilities)equalsDistributable Cash100% Æ100% / 10% ÆÅ0% / 90%Å0%Å100% / 0% / 90%0% / 100% / 10%Æ Electricity Markets and Policy Group • Energy Analysis Department13Choosing a StructureScenario Developer can use Tax Benefits Developer can fund project costsDeveloper wants to retain stake in project ownership / ongoing cash flows Developer wants early cash distributions Project has low projected IRR Project already exists (refinancing / acquisition) Most suitable financing strategy or structure: 1 No No No Yes N/A No Sell project to a Strategic Investor 2 Yes Yes Yes No No No Corporate 3 No Limited Yes No No No Strategic Investor Flip 4 No Limited Yes Yes No No Institutional Investor Flip 5 No Limited Yes No Yes No Cash Leveraged or Cash & PTC Leveraged 6 No Limited Yes Yes No Yes Institutional Investor Flip 7 No Yes Yes Yes N/A Yes Pay-As-You-Go 8 No Limited Yes Yes Yes No Back Leveraged • Developers decide which financing structure best meets their needs for a given project based on multiple considerations• The table below lists several non-exhaustive scenarios with differing combinations of these developer considerations Electricity Markets and Policy Group • Energy Analysis Department14Modeling Approach• Constructed a simplified Excel-based pro forma financial model to create a template of an indicative wind project as the common basis for illustrating the effects of each financing structure• Input assumptions to the model fall within three categories:–Market:reflect the broad market conditions experienced by most utility-scale wind projects developed and financed in the last several years (e.g., long-term PPA, credit-worthy counterparty, proven technology)–Common:project-specific characteristics common to all financing structures (e.g., capacity factor, O&M costs, hard project costs)–Structure-Specific:assumptions specific to each structure (e.g., equity contribution levels, cost of debt and equity, benefit allocations)• For each structure, the model calculates a 20-year levelized cost of energy (“LCOE”) that enables the project to cover its operating costs and satisfy the return requirements of lenders (if any) and equity providers Electricity Markets and Policy Group • Energy Analysis Department15Key Modeling Inputs and Results Cash & PTC Leveraged Cash Leveraged Institutional Investor Flip Back Leveraged PAYGO Strategic Investor Flip Corporate Assumed Installed Project Costs Hard Cost ($/kW) 1,600 1,600 1,600 1,600 1,600 1,600 1,600 Soft Cost ($/kW) 229 215 183 183 183 183 125 Total Cost ($/kW) 1,829 1,815 1,783 1,783 1,783 1,783 1,725 Tax Investor After-Tax Return (The 10-year target IRR is a model input, while the 20-year IRR is a model output) 10-Year Target IRR 9.25% 9.00% 6.50% 6.50% 6.50% 6.50% N/A 20-Year IRR 9.67% 9.29% 7.12% 7.12% 7.02% 7.02% N/A Assumed Loan Terms All-in Interest Rate 6.70% 6.70% N/A 6.70% N/A N/A N/A Tenor (maturity) 15 years 15 years N/A calculated N/A N/A N/A Developer After-Tax Return (Except for the Corporate 20-year IRR, the developer returns are all model outputs) 10-Year IRR 9.25% 9.00% 0.00% -10.08% 5.75% 6.50% 6.64% 20-Year IRR 33.15% 30.58% 10.44% 11.91% 11.52% 37.44% 10.00% 20-Year NPV ($000 @ 10%) 7,208 7,540 1,578 4,673 7,811 20,745 0 20-Year Levelized Cost of Energy (LCOE) Nominal $/MWh 48 50 53 53 59 61 63 Electricity Markets and Policy Group • Energy Analysis Department16Model Results – Discussion• The comparative nature of the analysis means that these results are best considered relative to one another – i.e., to illustrate the relative impact of financing structures – rather than individually or on an absolute basis. Note: the LCOE figures will change under different assumptions.• The two structures with the lowest LCOEs use project-level debt– However, debt is not widely used in the current market – Reasons include both factors in favor of other structures (perceived simplicity, standardization, speed) and factors against using debt (perceived cost, complexity, loss of control, little-improved IRR)• Variations in the LCOE across financial structures (assuming the same underlying template project) are driven by the different assumptions made regarding the required equity returns and the cost of debt– Although these assumptions are intended to reflect current market conditions, in practice these parameters are often project-specific and highly negotiated.• Section 4.2 of the report provides more-detailed modeling results Electricity Markets and Policy Group • Energy Analysis Department17Observations and Future Trends• Financing structures have evolved to meet specific developer needs and investor requirements, and this evolution will continue as long as the sector attracts new investment capital• After being out of favor, leveraged structures seem to be gaining popularity– Rising turbine costs put pressure on returns (need leverage boost)– Longer-term PTC eligibility window allowing for the time needed to close– Tax Investors gaining comfort with bringing on lenders• Recent developer consolidation trend will have several implications:– Creates larger developers with greater financial resources who can de-link project financing from construction deadlines, thereby allowing the use of new financing tools such as portfolio finance– Influx of foreign capital with little U.S. tax liability means passive Tax Investors will still be required to monetize Tax Benefits• In some markets (e.g., Texas, New York), investors are becoming increasingly comfortable with commodity hedges in lieu of long-term PPAs• Utility (both IOU and POU) ownership is increasing; POUs requirespecialized structures (not reviewed here) to capture Tax Benefits• Portfolio financings are gaining popularity Electricity Markets and Policy Group • Energy Analysis Department18For More Information1) Download the full report at:http://eetd.lbl.gov/ea/emp/reports/63434.pdf2) Contact the authors:John Harper (jharper@birchtreecapital.net, 617-803-7338)Matt Karcher (karcher@deaconharbor.com, 972-739-0242)Mark Bolinger (MABolinger@lbl.gov, 603-795-4937)