Finance for renewable energy


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Presented by Colin McNaught, AEA 19 September 2012

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Finance for renewable energy

  1. 1. Financing Renewable Energy Session 1 Colin McNaught
  2. 2. Aim Introduction of main finance options and key concepts How finance options shape a project Increase your fluency in finance matters In short: How would you like to pay for that? 2
  3. 3. Scope Focus is on renewable energy – Solar, Wind, Hydro, Biomass etc. – Investment up to around £10 million:  Wind: Up to 7 MW  Solar: Up to 6 MW (small projects)  Hydro: Up to 3 MW Key concepts also apply to energy efficiency 3
  4. 4. My Background Energy sector experience over 20 years Energy efficiency, CHP & renewables Financial models for wind, solar, anaerobic digestion Background in engineering – so presenting finance from a different perspective 4
  5. 5. Your Background Renewable Energy? Internal Finance? External Finance? Mortgage? 5
  6. 6. Agenda for Part 1 The Drivers – why invest and finance a project? Risk and Reward Finance Options Decision Tree 6
  7. 7. Types of Drivers Reduce energy bills Invest capital and generate financial returns Reduce greenhouse gas emissions Improve corporate image Enhance energy security Address fuel poverty 7
  8. 8. See Copy of Guide: Page 4Motivation Main benefits Influence on the set up of the project Finance option which maximises and retains the value of energy Reduction in energy bills generation potential should be selected.Energy bills Hedging against future rises Finance must be set up so that developers can use the energy for their in energy costs own use. Projects that supply onsite energy demand will inherently offer this. Finance option which maximises the rate of return on investment Financial returns should be selected.Investmentreturns Greater rate of return than Different financing options and choices of incentive should be explored investment in core activities to determine the option that maximises such returns, without incurring significant risks. The selected finance option, and any incentives claimed, will need toGreenhouse Reduction in greenhouse gas allow the carbon value of the renewable energy generated to begas emissions claimed.emissions Reduction in carbon footprint Energy from waste or biomass electricity projects that recover heat as well as generate electricity may offer this. Finance option needs to allow the developer sufficient control over real Improved public perception of or perceived environmental risks.Corporate environmental values of the Finance should be setup so that local benefits are easily discernibleimage organisation and communicated in an appropriate manner. Wind or solar PV projects may provide this opportunity. Reduction in dependence on If energy security required on site, systems should be engineered so fossil fuels and electricity that they can operate without a grid supply. This will add capital costsEnergy supplies and should be weighed against the cost of energy supply interruptions.Security Reduction of UK imports of For biomass and energy from waste this will require on site storage of energy sufficient fuel. Energy security for poorer Finance set up should allow benefits of the project, e.g. lower energy communitiesFuel poverty prices or a profit share, to be passed on to the communities in need. Reduction in energy costs For example, the roll out of solar PV to housing stock. and impact of price rises 8
  9. 9. Types of Drivers Reduce energy bills Invest capital and generate financial returns Reduce greenhouse gas emissions Improve corporate image Most of these drivers are based on the Enhance energy security income that can be earned Address fuel poverty 9
  10. 10. Income from renewables Feed in Tariff (FIT)  Electricity systems up to 5 MW  Solar PV, Wind, Hydro, Anaerobic Digestion…  Tariff for 20 years  Inflation indexed once registered  But reduces for new schemes in future years  Export tariff 10
  11. 11. Income from renewables Feed in Tariff – Non domestic schemes (since April 2010) 11
  12. 12. Current FIT Technology Band (kW) Tariff (p/kWh) ≤15 21Subject to 15-≤100 19.6 Hydro 100-≤500 15.5change 500-≤2000 12.1depending 2000-≤5000 4.48on rate of ≤1.5 21market >1.5-≤15 21growth >15-≤100 21 Wind >100-≤500 17.5Solar PV >500-≤1500 9.5needs to be >1500-≤5000 4.48on a building ≤4 15.44with an EPC >4-≤10 13.99of D or >10-≤50 13.03better to Solar >50-≤100 11.5earn > 7.1 p >100-≤150 11.5 >150-≤250 11 >250-≤5000 7.1 Standalone 7.1 Export All 4.5 12
  13. 13. Income from renewables Renewable Heat Incentive (RHI)  Heat systems  Biomass, Ground Source Heat Pumps, Solar thermal...  Tariff for 20 years  Inflation indexed 13
  14. 14. Current RHI Technology Band (kWth) Tariff (p/kWh) ≤200 Tier 1 8.3Tier 1: ≤200 Tier 2 2.1 Commercial< 1314 > 200 < 1000 Tier 1 5.1 Biomasshours full > 200 < 1000 Tier 2 2.1 > 1000 1.0load Ground Source ≤100 4.7 Heat Pumps > 100 3.4Tier 2: Solar Thermal all 8.9> 1314 Biomethane/biogas all 7.1hours 14
  15. 15. Income from renewables RHI – Non domestic schemes (since Dec 2011) 15
  16. 16. Risk & Reward Risk increases the cost of finance, restricts the options for finance and adds to the cost of obtaining finance. Identifying and managing risk will improve all these finance issues. Risk management may involve a partnership approach. 16
  17. 17. Types of Risk Financial risks, capital costs, energy prices, credit risks and inflation Development risks, the costs of undertaking feasibility and the risk of planning Construction risks, construction costs and long lead in times Technology risks, particularly around efficiency and reliability of the technology Operational risks, operational and maintenance costs, fuel availability Policy risks, changes to renewable energy policy and incentive structures = investment returns 17
  18. 18. Risk Description Capital costs higher than budgetSee Copy Operational costs higher than budget (including maintenance, interest rates and insurance) Cost of finance higher than expectedof Guide: Economic / Borrowing conditions breached and associated risksPage 5 Risks associated with energy price fluctuations Financial Carbon prices reduce New competitors in the market Rate of inflation Currency risks (if cross-border projects, or if purchasing components in other currencies) Cost of resource assessment and feasibility studies Cost of environmental impact studies, EIA reports etc. Cost of grid connection assessments Development Planning time longer – delay in generation income / possible lower incentive value received Failure to gain planning consent Development partners disagree and part company Planning consent requires cost to comply with conditions Construction costs higher than budget Construction Construction time longer, delaying income from generation Connection to energy networks delayed Costs of impact assessment (often a legal requirement) higher than budgeted Environmental Issues identified during impact assessment delay or prevent project development / social Costs of mitigation actions higher than budgeted Technology less efficient than predicted, so less energy produced Technology Technology less reliable than expected, less energy produced and higher maintenance costs Renewable energy resource is lower than predicted (e.g. lower wind speed) Access to site prevents repair or maintenance Replacement parts required Delays in supply or installation of spare parts Operational Fuel costs higher than expected (e.g. biomass fuel costs higher or there is an increase in price of electricity for heat pump projects) Fuel supply problems, (poor quality or interruptions in delivery) Site energy use falls, reducing the value of avoided energy costs Planning requirements changed Capital grants removed or oversubscribed Revenue incentive removed or reduced in value Policy Eligibility for capital grants or revenue incentives changed Finance sector regulatory changes, reducing availability, and cost, of finance Tax treatment changed 18
  19. 19. Assessing Risk For each type of risk: – How could your project be affected? – How significant are the impacts? – How could you reduce the risks? – How could someone else reduce the risks? 19
  20. 20. Financing optionsType Examples – Internal fundingOwn – Debt financedevelopment – Equity finance – Leasing – Partnership – majority controlPartnership – Partnership – equal splitstructures – Partnership – minority control – Land lease agreementsThird party – Service concessions – Energy Service Companies (ESCOs) 20
  21. 21. Own Development Greatest control + Rewards + Risks Internal Funding – Business Case and internal reviews – May not be deemed core business External Funding – Grants or low cost loans – May be incompatible with income from the FIT or RHI etc 21
  22. 22. Own Development Debt Finance: – Full ownership of rewards and risks – Likely to be part of capex (so need internal funds) – Added costs of interest payments – Capital repayments – May be step in-rights 22
  23. 23. Partnership Development Many different forms of partnership Different structures, benefits and risks Majority control – You closely control risks – Partners bring niche skills or assets Minority control – Driver is not financial – reward share is low – Partner controls – Can you gain what you hope for without control? 23
  24. 24. Third Party Transfer of almost all aspects Best when you lack the skills and capital Small income – e.g. land rent 24
  25. 25. Service Concessions Useful for the public sector Grant a right to develop and exploit a resource Often long term (25 years) Payments made to public authority – (fixed + revenue elements) Used for energy from waste contracts and other renewables 25
  26. 26. Choosing an Option What are your drivers and expected outcomes? Does the arrangement provide these outcomes? Which risks are retained? 26
  27. 27. Own Development Partnership Third Party Financial risksSee Copy Rate of inflation / Capital Will depend on which partyof Guide: costs / Operational costs / All risks typically held by All risks typically held by has access to the lowest Cost of finance / Borrowing the developer. the third party. cost of capital. conditionsPage 11 Construction risks All risks typically held by All risks typically held by Longer planning time / the developer. the third party. Will depend on which party Planning consent difficulties Potential to include some has responsibility for Potential to include some or costs / Construction risks (e.g. construction construction of the project. risks (e.g. construction costs / Construction delays time) in the contracts let. time) in the contracts let. Environmental / social risks Impact assessment costs / Will depend on which party Delays due to impact All risks typically held by All risks typically held by has responsibility for assessment / Costs of the developer. the third party. construction of the project. mitigation Technology risks All risks typically held by Will depend on the setup All risks typically held by the developer. arrangements for the the third party. project. Who has the Lower technology efficiency Potential to manage these experience of the Potential to manage these / Lower technology through warranty with the technology and the through warranty with the reliability equipment supplier and allocation of benefits (in equipment supplier and through performance terms of energy savings through performance contracts with the and revenue streams from contracts with the equipment supplier. generation)? equipment supplier. Operational risks Lower levels of resource / Will depend on which party Repair or maintenance has responsibility for issues or delays / Higher All risks typically held by construction of the project, All risks typically held by fuel costs / Lower site the developer. as well as on the setup the third party. energy use falls / Carbon arrangements for allocation prices / Market competition of benefits. Policy risks Planning requirements Policy risks are out of the All risks typically held by changed hands of the developer or a the third party. Changes in requirements or All risks typically held by third party. Neither can the developer. manage these. So, Some tax benefits for the eligibility for: Capital grants appropriate to share these third party – e.g. enhanced / Revenue incentives / Tax risks. capital allowances. treatment 27
  28. 28. Sources of Finance Two main options – but many variants On Balance Sheet: – Part of normal activities of the organisation Off Balance Sheet: – Separate company who owns the asset 28
  29. 29. On Balance Sheet Balance Sheet Debt – Usually through a bank as a loan – Banks have the first claim on the assets of a business (senior debt). – Bank loans are lower risk = lower returns – Two main types of bank debt:  Non recourse  Recourse 29
  30. 30. On Balance Sheet Non recourse debt: – Loan is secured on the value & income of the asset – Bank focuses on the value and income of the asset  Will it perform? Will it break down? – Added scrutiny on the asset – Not as suitable for higher risk projects – Lender will limit the risk e.g. 75% debt – Fixed at outset, all consents etc. needed – Often needs special purpose company – Higher costs to set up – Typically larger projects (> £25 million) 30
  31. 31. On Balance Sheet Recourse debt: – Loan is secured by the borrower – Bank focuses on the credit status of the borrower – May suit higher risk projects – May not suit borrowers with high levels of existing borrowing 31
  32. 32. Practical example Non recourse finance – Large wind investments typically need 1 year of on site wind measurements + detailed analysis – Cautious use of wind data – Adds to development cost – Adds to development timescale – May miss higher incentives Recourse finance – Farmers securing loan for 1 MW wind turbines against the farm – No met mast = saving 18 months + costs 32
  33. 33. Lessons from Non Recourse The tests are tougher because they are external Debt Service Cover Ratio: The operating cash flow compared to the debt payments? – Aim for at least 1.3 : 1 in any operating year Loan Life Cover Ratio: The operating cash flow compared to the debt payments over the entire term of the loan? – Aim for at least 1:5 : 1 33
  34. 34. Lessons from Non Recourse Debt Service Reserve: The cash kept to cover debt payments: – In Project Finance – typically 6 months debt payments Maintenance Service Reserve: The cash kept to cover maintenance: – Often at least 3 months P90 output: The output which will be exceeded 90% of the time. 34
  35. 35. Output and Cash Flow Three hydro schemes in Argyll Use bank thinking in the business case 35
  36. 36. Balance Sheet Equity Raise funds by creating and selling new shares Shareholders gain via: – A share of the operating profits (dividends) – Capital value in price of shares – Must be possible to sell share – all investors need an exit strategy 36
  37. 37. Mezzanine loans Think of buildings = Half way between bank debt and equity Can take higher risk Do not have highest call on assets Short duration Higher cost Used to fill a funding gap Replaced with lower cost finance once risks reduced? 37
  38. 38. How much will financecost? Guide Page 14 Debt Equity Bank Senior Bank Mezzanine InfrastructureType of finance Pension Funds* Private Equity* Debt Debt* Funds* Proven Demonstrator / ProvenType of risk technology proven Proven technology Demonstratortypically taken Established technology technology Private technology companies New Companies companiesTypical level ofreturn expectedby the various ~5.5% to 6% ~7.5% to 10% ~15% IRR ~7% IRR ~35% IRRtypes of lender /investor** Only an indication:• Your project, your risks, your security, all influence the cost 38
  39. 39. Guide Page 15: Decision Tree 39
  41. 41. BREAK 41
  42. 42. Financing Renewable Energy Session 2 Colin McNaught
  43. 43. Agenda for Part 2 Illustrations of the income and finance options for a renewable energy projects More on incentives Short case studies Short exercise 43
  44. 44. Own Development Risks – Planning risk – upfront costs / 60% failure rate – Requirement for equity can be as high as 30% – Understanding project finance – Selecting bankable technology –big issue under FIT Benefits – ‘Guaranteed’ income stream from electricity generation – regardless of use – Energy Security – Generation of your own electricity for use on site 44
  45. 45. Debt example Single Enercon E-48 0.8MW Wind Turbine Bank provided Debt by way of : – Stage Payment facility – Term Loan – Working Capital facility – VAT bridge 45
  46. 46. Debt example (cont’d) 45 Documents to sign including : – Banking documents – Turbine Supply & Maintenance documents – Land / Lease documents – Grid Connection documents – Planning documents (Section 75) / Decommissioning Bond – Insurance documents – Civils construction documents 46
  47. 47. Debt example (cont’d) 18 weeks to reach financial close 3 sets of lawyers (Bank, SPV and Landowners) 18 different Parties Involved – Lawyers, Accountants, Technical Advisors, Insurance Advisors, PPA off takers, Turbine Suppliers, Civil Engineering Companies, Grid Connection provider, Project Manager /Planning Consultants, Wind Report Assessors. Turbine/ project performance to be monitored continually Which type of debt finance is this? 47
  48. 48. Project Finance Example Bank will typically lend 70% - 90% of the project cost (dependant on technology ) Landowner will need to invest the remainder Term of up to 15 years Lend of between £1m and £25m Lent against the forecast future cash flows Bank will require legal, technical, financial and insurance overview These costs to be met by the SPV – part of equity investment 48
  49. 49. More on Incentives FIT & RHI – Covered in Part 1 Renewables Obligation – generally for projects > 5 MW CCL – Renewables is exempt worth £4.85/MWh for electricity CRC – Can be avoided – but better to claim FIT 49
  50. 50. More on Incentives EU-ETS – Large sites only, renewable heat would avoid purchase of fossil fuel and need fewer EU- ETS allowances CCA – Larger sites – Cant claim if earn FIT or RHI Public Capital Grants – Cant claim FIT or RHI – Some expenditure is eligible (development, heating network) – Private sector grants are OK 50
  51. 51. More on Incentives Enhanced Capital Allowances – a benefit against corporation tax paid. Not available if FIT or RHI is earned Business rate relief – Stepped by scheme size, 100% relief for small schemes, to 2.5% 51
  52. 52. Example 300 kW wind turbine 27% load factor = 710 MWh pa 372 tonnes CO2 pa Capex £450k Operating & Maintenance £13.2k 52
  53. 53. Example Interest of 6.5% pa Deprecation of 10% Corporation tax 30% 53
  54. 54. Example – Scenario 1 Earn CRC at £12/tonne CRC worth £4.4k Electricity used on site worth £64k Payback in year 14 IRR 9.6% 54
  55. 55. Example – Scenario 2 Earn FIT at 17.5p/kWh + 3.1p export* FIT worth £124k Export worth £22k Payback in year 6 IRR 25.2% * Guide and its examples were drafted when export tariff was 3.1 – this is now higher at 4.5p 55
  56. 56. Example – Scenario 4 Earn FIT at 17.5p/kWh + 9 p/kWh on site use FIT worth £124k On site use worth £64k Payback in year 5 IRR 38.9% 56
  57. 57. Guide Page 22 Scenario 1 Scenario 2 Scenario 3 Scenario 4Electricity used on site 100% 0% 40% 100%Electricity exported 0% 100% 30% 0%Electricity wheeled 0% 0% 40% 0%CRC savings £4,467 - - -Electricity savings on site £63,860 - £25,544 £63,860FIT - £124,173 £124,173 £124,173Export - £21,996 £6,599 -Extra for Wheeling - - £20,455 -Exempt Services - - -£1,500Total revenue (Year 1) £68,327 £146,169 £175,271 £188,033Payback by: Year 14 Year 6 Year 5 Year 5IRR 9.6% 25.2% 30.5% 32.9%NPV £104,875 £727,786 £957,422 £1,058,483ROI 12.3% 29.5% 36.0% 38.9% 57
  58. 58. Finance Options Own Development (as per Scenarios 1 to 4) Partnership 50:50 Third Party: Land lease: – £3,200/MW + 6% of electricity sales 58
  59. 59. Guide Page 23 Partnership Land lease Own development with development with 50-50 arrangement with third debt finance split of risk and reward party developerAnnual turbine output 710 MWh 710 MWh 710 MWhFIT value (generation & export) £206/MWh £206/MWh £206/MWhFIT £124,173 £62,087 -Export £21,996 £10,998 -Land rent per MW - - £3,200Percentage of electricity sales - - 6%Land rental income - - £13,673Total revenue (Year 1) £146,169 £73,085 £13,673Payback by: Year 6 Year 6 N/AIRR 25.2% 25.2% N/ANPV £727,786 £363,893 N/AROI 29.5% 29.5% N/A 59
  60. 60. Worked Example Company plans to build a 1 MW wind turbine on their warehouse site costing £1.5 million Expect to generate 2,600 MWh pa. The relevant FIT is 9.5 p/kWh generated The export tariff is 4.5 p/kWh generated Operation costs are 1.7 p/kWh generated They are offered a finance on 75%:25% debt equity basis at 7% pa. 60
  61. 61. Knowledge Review How much did they borrow? What was the annual interest payment? How much income (£/yr) from the FIT is due? What is the net annual income? 61
  62. 62. Knowledge Review How much did they borrow? – £1.125 million (75% x £1.5 million) What was the annual interest payment? – £78.8k pa (7% x £1.25 million) How much income (£/yr) from the FIT is due? – £247k pa (9.5 p/kWh x 2,600,000 kWh) What is the net annual income? – (FIT + Export – Interest – O&M) – (£247k + £117k) – (£78.8k + £44.2k) – (£364k) –(£123k) = £241kNB this is a Simple Example which did not include:• Repayments, Insurance, Business rates, Land rent , P90 Output etc. 62
  63. 63. Further Resources Co-operative Bank; project case studies Financing renewable energy projects; A guide for developers Financing Renewable Energy Projects for Farmers Private Financing of Renewable Energy; A Guide for Policymakers West Midlands Local Authority Low Carbon Economy Programme; Local authority funding guide Scottish Future Trust; Report on the Commercial Aspects of Local Authority Renewable Energy Production 63
  64. 64. Questions3.5 32.5 21.5 10.5 0 00:00 02:00 04:00 06:00 08:00 10:00 12:00 14:00 16:00 18:00 20:00 22:00
  65. 65. T: 0870 190 6191E: 65