1. XXXXXX Project
Sponsor Development Risk Assessment Report
Efforts to develop solar projects in the United States require the accomplishment of a number of
critical milestones which define the development process and eventually lead to a successful
project. Efforts to achieve these milestones face a number of obstacles that require careful
planning, risk assessment and mitigation efforts in order for the project sponsor to achieve
success. A broad categorization of these critical milestones and phases in project development
are as follows:
• Land Lease and Leasehold Matters
• Project Approvals and Permits
• Interconnection and Transmission Feasibility
• Power Purchase Agreement
• EPC and Construction
• Sponsor Financial Exposure prior to Financial Closing
• Project Financing and Financial Closing
Each of these phases of project development has unique risks associated with them. A successful
development of the XXXXX Project (the “Project”) requires an assessment of these risks and
plans on how to mitigate them.
Risk assessment and mitigation typically occurs in two stages. The first stage is the initial
identification of risks in the development plan which is the purpose of this report. The second
stage is more of an ongoing process of risk assessment as the Project progresses through the
development process and changes are made to the Business Execution Plan (BEP) and or new
business opportunities or alternatives present themselves for consideration.
One thing is certain in project development: there will be surprises, some good and some bad.
When a bad surprise happens the key for handling it is to have as many alternatives and options
available as possible to deal with it coupled with an understanding of what the long term
implications are of each of these alternatives and options on the overall development of the
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2. XXXXXX PROJECT
SPONSOR DEVELOPMENT RISK ASSESSMENT REPORT
XXXXX current risk management strategy is to assess risks in each of the respective phases of
development outlined above and to develop strategies to address, mitigate or abate those risks.
1. Land lease and Leasehold Matters.
Risks in the land lease and property matters reside in four areas:
• Risks of the City’s or XXXXX default under the terms and conditions of the lease,
resulting in the loss of the beneficial use of the land to XXXXX. This risk can be
controlled and mitigated by monitoring the Parties compliance with the essential
terms and conditions of the Lease and maintaining on-going dialogue with the City
not only through the development cycle of the plant but continuing on into the
operation phase of the Project.
• The risk that XXXXX will be unable to secure clear lessee’s title to the Leasehold,
thereby rendering the project non-financeable. Obtaining lessee property title
insurance from a reputable title insurance company will mitigate this risk. As of the
publication of this report XXXXX has secured an American Land Title Insurance
(ALTA) policy for the Property.
• The risk is that there are hazardous materials on the Leasehold that would render it
unusable for the construction and operation of a utility scale solar facility. XXXX
has secured a Phase 1 Environmental Site Assessment for the Leasehold and no
evidence of recognized environmental conditions that would prohibit the
development or financing of the proposed Project were found.
• The risk that there are biological (desert tortoise as an example) or archeological
(Native American cultural remnants) finds on the Project property or along its
proposed transmission ROW that could cause a delay, a lengthy and expensive
remediation plan, or even worse, a shutdown of the site or a re-routing of a ROW.
To date XXXXX, through its subcontractors, has conducted biological and
archeological surveys of the Project site and the ROW to the XXXX substation with
no material or significant findings. A biological survey still needs to be completed
for the XXXXX transmission ROW but it is not expected to have any material or
significant findings given the numerous surveys that have already been conducted
throughout the XXXXX. This biological survey is expected to be completed in the
spring of 2013.
• The risk that the costs of property and other use taxes will render the Project
economically unfeasible.
Pre-Operation: XXXXX was previously in a dispute with the XXXX County Tax
Assessor regarding tax assessment of the Project’s land prior to commercial
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operation. XXXX and XXXX with the assistance of counsel, XXXXX, were able to
reduce the current assessment of property value to a more reasonable valuation that
reflects the pre-operational value of the land for property tax assessment purposes.
Operation Phase: The next stage of property tax assessment during the operational
life of the Project will be of particular importance since this future assessment will
take into account the value of personal property (building and structure) that is
installed on the site during construction. The amount of personal property that will be
established on the site during the construction of the Project will significantly
increase the property tax basis of the Project and hence the amount of property tax the
Project will be required to pay. A careful interpretation and application of the
property tax law for solar projects in XXXX will be of great importance since the
property tax assessment will end up being one of the largest on-going expenses of the
Project during its operational life.
2. Project Approvals and Permits.
There are several risks associated with the permits and approvals for the proposed
Project. These risks are generally associated with the costs and time required to apply for,
process and receive approval for the permits with the various federal, state and local
agencies involved in granting permits and approvals for the Project. However, given that:
• The Project is located on land owned in fee by the City of XXXXX.
• The other solar developments in the XXXXX are also located on City owned land and
none of them have had a problem to date with permitting or environmental issues.
• All exiting and proposed EHV transmission in the XXXXX crosses land claimed by
the BLM, a federal agency. The BLM requires crossing permits for all ROWs across
claimed federal lands. These crossing permits must be granted in conformance with
the National Environmental Policy Act (NEPA).
• To date, the five completed projects have been granted ROWs by the BLM and the
four projects in the permitting process have all moved forward with the support of the
BLM and related federal and state agencies.
An issue did arise in the 1st
quarter of 2013 regarding a ROW request into the
XXXXX and XXXXX substations down the western side of the XXXXX. This is a
route that XXXX, XXXX and XXXX have all requested to connect their project
development sites with the two mentioned substations. It turns out that a large wind
developer in Wyoming, XXXXX , had previously applied for this ROW and claimed
that they control the rights to the whole corridor and asked the BLM not to grant any
further ROWs in this corridor. XXXX ROW request to the BLM went without notice
to XXXXX, XXXX request for the same path was opposed by XXXXX who claimed
they had pre-existing rights to the whole corridor based on an earlier application. It is
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4. XXXXXX PROJECT
SPONSOR DEVELOPMENT RISK ASSESSMENT REPORT
my understanding that a deal was worked out with XXXXX regarding this ROW,
although it is not known if XXXXX will be allowed to utilize this same path or will
be forced to choose an alternative path.
XXXX has now decided that its first choice of substation interconnect will be the
XXXX Substation which requires a ROW far from the XXXX ROW which is more
closely connected with the ROW to get into XXXX or XXXXX substations so this
has now become a moot point for XXXX. If in the future a ROW is contemplated by
XXXX into either the XXXX or XXXX substation an issue with the ROW
connecting the Project’s site to these two substations would be likely under the
original ROW XXXXX had proposed.
Given that XXXX preferred transmission route is to XXXX, the assessed risks to
permitting and approvals for this ROW is low. Continuing with the execution of the
Project’s plan for compliance with the BLM policies and procedures in regards to its
299 application, which includes the completion of the biological survey in spring
2013, will hopefully precede a Finding of No Significance (FONSI) and subsequent
NEPA approval and approval under Public Utilities Commission XXX Utility
Environmental Protection Act. The FONSI and NEPA/ PUXXXPA are considered
likely by early summer of 2013. These series of approvals will be the completion of
a major milestone for the XXXXX Project.
3. Interconnection and Transmission Feasibility, Costs and Timing.
The XXXXXX is considered one of the most attractive transmission corridors for energy
projects in the Western United States. There are currently five major substations
(XXXX, XXXXX, XXXXX, XXXXX and XXXXX) and over 30 extra high voltage
transmission lines entering and exiting the XXXX. Virtually every state and regional
balancing authority and IOU and POU in the Rocky Mountain and Pacific Coast region
own, all or in part, and operate transmission lines and substations in the XXXXX. There
are, however, concerns regarding the availability of bays in the various substations,
transmission capacity, and the costs and timing of network upgrades and improvement
plans.
The primary strategy for risk mitigation in the areas of interconnect and transmission was
to file separate interconnection applications and proceed with the requisite system impact
studies (SIS) and/or facility studies with the California Independent System Operator
(CAISO) for interconnect at the XXXX substation, XXXX for interconnect at the XXXX
substation, and the Los Angeles Department of Water and Power (LADWP) for
interconnect at the XXXXX substation. Although the extra cost of applying for three
different transmission options was unfortunate, by doing so XXXXX gave itself the
maximum flexibility to have options available in the case that transmission costs at one or
two substations would have economically unfeasible or that capacity improvement
schedules precluded timely commencement of power delivery to a power purchaser.
XXXXX received very good news in the 1st
quarter of 2013 in regards to the
interconnection at the XXXX substation which is the nearest to the XXXXX project of
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SPONSOR DEVELOPMENT RISK ASSESSMENT REPORT
the four substations in the XXXX. The SIS XXXX received at the end of January 2013
from XXXX indicated a very reasonable interconnect cost of XXXXX. Additionally,
XXXX indicated that they could establish interconnection with the Project within two
years (2015).
Further discussion with XXXX in February and March of 2013 has yielded even better
news regarding the on-going facilities charge that will apply to the XXXXX project. The
on-going facilities charge is expected to be in the neighborhood of XXXXX a year.
Initial feedback in January 2013 from XXXX was that the facilities usage charge would
be similar to that of a capacity usage charge versus a wheeling charge. The initial
estimate was over XXXXX a year for the Project if it were to use the XXXXX substation
as its interconnection point. At the end of March 2013 XXXX administrators reported to
XXXX that the on-going facility usage charge (facility maintenance charge) will likely be
XXXXX per annum. This is a significant cost reduction and makes the XXXX
substation by far the most attractive alternative for XXXXX in terms of total cost as well
as the ability to serve multiple off-takers out of this point of interconnect.
While given this very positive news from XXXX, the issue remaining is that the XXXX
process is not over and the process still requires a phase 2 Facility Study as well as the
actual interconnect agreement with XXXX needs to be documented and approved by
legal counsel for its completeness and ability to provide uninterrupted and economically
predictable service to energy off taker(s).
While XXXX will undoubtedly decide to go forward with the XXXX interconnection at
Mead, as indicated in the previous paragraph, the XXXX interconnection agreement still
has several steps to go through before it becomes official. Therefore, in an abundance of
caution one could argue that it would be prudent to continue with a Phase 2 CAISO study
assuming XXXX as the primary point of interconnect. Doing this would give the Project
a second option if for whatever reason unforeseen problems came up with XXXX.
The primary arguments against this strategy are two-fold: 1) if the XXXX
interconnection does not work out the project would be faced with considerably higher
interconnect expenses by interconnecting at either XXXX or XXXX. It is not certain at
this point that the Project would be competitive in the market for a PPA if it was forced to
go to these other substations, and 2) In the case for the CAISO interconnect at XXXX,
having an immediately available second option for the Project might not matter given that
the three major investor owned utilities in California are not looking for renewable
energy until the end of the present decade (2018 – 2020). This extended time horizon
would give XXXX time to reapply to CAISO in this worst case scenario.
Given the economic costs of continuing on with the interconnect applications for XXXX
and XXXX and: 1) the higher interconnect costs if XXXX was forced to go to either of
these sites in the near term, and 2) the lack of sense of urgency for a PPA with the CA
IOUs, it is advisable that XXXX cease with the interconnection application for these two
interconnect points. Doing so will save XXXX from putting at risk a XXXX deposit or
LOC for the 2nd
phase of SIS for the XXXX application and an additional XXXX for an
interconnect study for XXXX with LADWP. Worst case for XXXX would be to reapply
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SPONSOR DEVELOPMENT RISK ASSESSMENT REPORT
CAISO and/or LADWP for interconnection studies if XXXX was unable to acquire an
interconnect agreement with XXXX.
Lastly, there is another issue regarding the potential scenario where the interconnect
agreement is ready to be signed before the PPA is ready. The potential risk under this
scenario is that XXXX would be put into a position to sign and commit capital to the
substation upgrades before knowing if they have a signed PPA with an off-taker. This is
a common problem faced by developers who are trying to get a PPA and an interconnect
agreement done at the same time, which is prudent project development.
According to legal counsel (XXXX) this problem is usually resolved through effective
communication with the Interconnect/ Transmission Authority, XXXX. Legal counsel
believes that XXXX would very likely give XXXX an additional few months to ensure
they have a PPA before they would be required to commit to the upgrades required at the
XXXX substation. The key to this strategy is communicating early and clearly with
XXXX about the intentions and time schedule of XXXX.
4. Power Purchase Agreement.
The risks associated with the PPA fall into two broad categories:
(1) XXXX will be unable to enter into an agreement to sell the power as the market for
energy from renewable will be phased out, or
(2) Terms and conditions for the purchase and sale of energy from the Project will be
such that it will render the Project uneconomical.
The first risk appears to be unlikely to materialize. The demand for power in the western
US and in particular California, and most of the states in the American Southwest are
expected to resume a positive growth rate as these economies emerge from the severe
recession of 2007 – 2010. Further all of the states in the American Southwest have RPS
goals to meet by 2020 – 2025, with California’s RPS requirements dwarfing that of all
other states.
Additionally, both IOUs and POUs are beginning the process of closing down and
decommissioning coal and nuclear power plants, resulting in the loss of large blocks of
base load generating capacity in the later years of this decade and into the next. What
this likely means is that natural gas and renewable energy will play an increasingly
important role for utilities well into the foreseeable future.
The second risk, being unable to structure a PPA that is economically beneficial to
XXXX, is more problematic. Over the last several years utilities have liberally signed
hundreds of PPAs, many of these have been with thinly capitalized and ill prepared
developers which have resulted in the widespread failure of proposed projects with PPAs
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from ever delivering energy to the grid. This trend has also resulted in a “race to the
bottom” for PPA prices where each year small developers have bid into the utility RFPs
with very aggressive PPA prices hoping to get a PPA with a utility. As mentioned, many
of these PPAs will never materialize into an operating project, but the problem it creates
is that it drives down prices to unrealistic levels.
It is well documented that from 2008 until now over 70% of the total MWs that have
been signed under PPAs have never achieved operational status. The reasons for this
widespread systemic failure come from: i) lack of development capital, ii) poor planning
and site selection of the project (particularly as it relates to permitting and
interconnection), and iii) inability to raise project financing.
While the IOUS in California are claiming that they do not need to enter into new PPAs
with renewable energy projects given their large backlog of signed PPAs, given the high
attrition rate of projects, most knowledgeable industry participants believe that California
IOUs and other utilities in the Western U.S. will need to continue to sign new PPAs for
the remainder of the decade to replace projects that have fallen out and to meet 2020 RPS
requirements, particularly after 2016 when utilities ability to use “bucket 2” and “bucket
3” power to meet RPS requirements is cut in half.
Another trend that bodes well for the future of solar projects is the continuing
improvement in solar panel efficiencies and the rapid decline in unit costs. Solar panel
prices have fallen significantly since the mid-2000s to a point where true grid parity with
base load energy is not as far off as many thought only a few years ago. Utilities tracking
the costs of solar and alternative energy developments are likely negotiating PPAs in
anticipation of these trends continuing through the balance of the decade.
Mitigation of the risks outlined above is well within XXXX s capability.
First, XXXX needs to continue to carefully monitor and assess all aspects of Project costs
and expenses. Given the competition in the market for new PPAs and the rapidly
declining cost of utility scale solar PV projects, it is imperative for XXXX as a developer
to ensure that its costs and project layout maximizes economic value for the XXXX
Project site. This focus on maximizing economic value is ingrained in XXXX, XXXX’ s
corporate parent’s culture.
Given the recent positive developments with XXXX as a point of interconnect the Project
will probably remain very competitive in the market place on a pure cost basis with
almost any project in the market. This coupled with XXXX’s agnostic approach to using
the best equipment and XXXX’s development and utility experience and investment
grade rating should clearly give the Project a competitive advantage over most projects
competing in the market for a PPA.
Second, if at all possible, XXXX should try to open PPA discussions on multiple fronts
to avoid becoming hostage to any one customer for the sale of the Project’s power.
Ideally if the Project’s energy output can be marketed to multiple buyers then XXXX and
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its advisors will gain a much better appreciation of the terms in the market which will
allow them to realize the best possible PPA for the Project. The Project’s point of
interconnect at XXXX greatly enhances this opportunity. Often a project relies heavily
on a single power purchaser or group (CA IOUs) which restricts a developer’s capacity to
negotiate the best PPA for purchase and sale of a project’s energy. The existence of
alternative paths provide incentive to power purchasers to agree to reasonable, market
rate terms and conditions for the Project’s PPA.
Third, and perhaps most importantly, XXXX needs to increase its visibility to all of the
potential energy off-takers under consideration for the Project. One of XXXX s greatest
strengths is that it is a fully owned subsidiary of XXXX and through XXXX, part of the
XXXX family. Unlike many of its competitors, XXXX has the corporate experience,
financial strength and relationships with advisors, consulting, legal and engineering firms
and EPCs to plan, develop, finance and provide O&M to utility scale power generation
projects. XXXX’s sponsorship is a significant advantage for the Project.
A detailed and coordinated approach to promoting XXXX and the Project needs to be
conducted. This is often a “grass roots” effort, in that the marketing of XXXX and the
project needs to be conducted person by person in numerous organizations in a
systematic effort. Further, once XXXX and the project are introduced to individuals in
various organizations follow up correspondence needs to be maintained.
As part of its development plan XXXX and XXXX have agreed that a well connected
law firm and/or a PPA advisor (perhaps the same organization) would be critical in
assisting in a marketing of the project. Major law firms specializing in independent
energy and project finance typically have strong relationships with numerous utilities. It
is also very important that the law firm and/or the PPA advisor have good connections
and an abundance of experience in the local market where XXXX is hoping to get a PPA.
As an example, East Coast based lawyers and law firms may not have the local
experience needed to effectively direct a marketing campaign to promote XXXX and the
Project.
Securing an economically viable PPA is the cornerstone of a viable Project. Following
each of the above risk mitigation measures will ensure that the Project achieves this
objective.
5. EPC and Construction Risk
Construction risk, as is the case with most independent power projects, will be one of the
larger risks associated with the Project and therefore will need to be carefully reviewed
and structured around to minimize the impact to the Project, the capital providers to the
Project, and to the Sponsors themselves.
Often the greatest period of risk in financing a renewable power project is during the
construction and start up phase of the project. Construction lenders in a non-recourse
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transaction will not take this construction risk without a combination of “completion
guarantee” and/or other support mechanisms from the Sponsor(s) and/or the EPC
Contractor and/or other related parties, such as Equipment Suppliers (Solar Panel
Manufacturer).
Typically a completion guarantee is essentially a guarantee limited in time, since it
guarantees the project will be completed in a certain time frame and will perform at a
certain rate of efficiency. It expires not on completion of construction but after the
expiration of a period of time sufficient to ensure that the project will in fact perform as
represented. If the construction lender is otherwise satisfied with the projected cash
flows and the economics of the transaction, the completion guarantee may eliminate the
necessity for any other source of long term direct guarantee.
Construction risk is used in this context to mean the risk associated with the Project
achieving commercial operation by a date certain, with no cost overruns and meeting
certain performance measurements over a defined period of time after construction is
completed. While there are other risks that may delay the completion of the project or
adversely impact it, such as political risk, casualty risk, and acts of God, these risks are
not directly assumed by the Sponsor/ EPC Contractor and will typically be covered under
third party insurance for such occurrences.
As stated above, in non-recourse project financings, construction lenders will require the
Sponsor and/or EPC Contractor to provide a completion guarantee or some other form of
support or some combination of the two. The combination of support and guarantees
from the Sponsor(s), EPC Contractor and other Equipment Suppliers can be as diverse as
there are projects in the market.
As an example, the support from the Sponsor could be in the form of a completion
guarantee in lieu of the EPC Contractor supplying a completion guarantee and/or a date
certain for funding some portion of the Project. Sometimes this is more acceptable to a
Sponsor then negotiating a completion guarantee with the EPC Contractor who may be
unwilling or unable to provide for such a guarantee. Given the relatively low-tech nature
of the Project, it seems more than reasonable that such completion guarantees will be
available from most large EPC Contractors. Where this could be potentially problematic
is with the choice of the panel manufacturer or equipment supplier that has limited
market presence and the EPC Contractor is asked to “wrap” (see below) the solar panel
performance risk.
The requirements of the construction lenders will be based on many different factors,
including, but not limited to: i) the reputation and credit worthiness of the EPC
Contractor, ii) the reputation and credit worthiness of the Sponsor(s), iii) the experience
of both the Sponsors and the EPC Contractor in building and operating a power plant
similar to the one that is being project financed, iv) the amount of installed equipment of
the panel manufacturer, v) the economics of the Project and the amount of projected
coverage assumed in cash flow projections.
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In many project financings the EPC Contractor is asked to provide for a completion
guarantee that is limited to a specific period of time and a capped amount. Since the
EPC Contractor is often the project party that has the most understanding and control of
managing construction and performance risk, the EPC Contractor will often be the
project participant that is asked to assume this risk. If the EPC Contractor is the party
supplying the completion guarantee then the lenders will usually ask that the EPC
Contractor “wrap” the risk of all subcontractors including the panel manufacturer so that
the EPC contractor becomes the focal point of responsibility for the performance of the
project. Therefore it is typically important that the EPC Contractor accepts the
warranties and performance guarantees of the panel manufacturer and makes these
warranties and performance guarantees their own.
As an example, a EPC Contractor will provide a “wrap” of the construction of the Project
that will cover i) completion, ii) performance, iii) cost over runs, and iv) delays. This
wrap of the Project will fall off after a period of time following COD (90 days as an
example). After the completion guarantee falls off the lenders and equity participants
will typically rely on the reps and warranties provided by the various equipment suppliers
such as the panel manufacturer.
The form of the completion guarantee will need to be acceptable to the construction
lenders. For large, well know and highly rated EPC Contractors a corporate guarantee
may suffice, but often EPC Contractors will provide a completion guarantee (also
sometimes called a performance bond) that will be backed by a “standby” letter of credit
(LOC) for the amount that the EPC Contractor is at-risk. Another arrangement that is
sometimes used in conjunction with a LOC is for the construction lenders to hold back
the full amount of the EPC Contract until a period of time following COD to ensure that
the project is operating according to agreed upon specifications.
If construction lenders are not comfortable with the “wrap” of the Project by the EPC
Contractor or the EPC Contractor is unwilling or unable to provide for such a guarantee
then the construction lenders will look to the Sponsors to provide such credit support.
As to the amount of the Completion guarantee that a construction lender will seek from
an EPC Contractor, as noted above this amount can vary depending on a number of
different factors, including but not limited to, the technology employed, the track record
of the EPC Contractor and the Sponsor(s), as well as the robustness in the economics of
the project. For planning purposes, a 30% liquidated damages cap can be assumed,
assuming the application of well known technology, well known EPC Contractor and
Sponsors. If less well known technology is used the amount of liquidated damages can
approach 100%. Bottom line is that since the amount of guarantee sought by the
construction lender can be based on so many factors it is best that the dialogue with a
construction lender is established early on in the process regarding what they would
require with any combination of equipment, EPC Contractor and Sponsor(s) so as to
eliminate unpleasant surprises.
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While it is perhaps somewhat misleading to suggest a specific amount of completion
guarantee that lenders will seek without us knowing the details of the Project, a typical
term sheet of these concepts can illustrate what lenders would typically find acceptable:
Project Construction Loan Amount: $400,000,000 – This would represent 100%
financing during the construction phase of the
Project and typically include a 10% contingency in
the budget that is over and above the Liquidated
Damages offered by the EPC Contractor.
Project cash flow model and assumed debt service
coverage amounts would assume the full $400
million construction price which incorporates a 10%
cost over-run contingency.
Completion Guarantee: EPC Contractor will provide Completion Guarantee
with liquidated damages capped at 30% of the total
construction amount for: i) completion of the
Project with specific performance requirements
over a defined period of time that is deemed by
Lender’s Engineer to be acceptable in assuring long
term performance of the Project, ii) cost-over runs
over the budgeted amount of the Project, and iii) a
date certain for completion of the Project.
Liquidated Damages are usually further broken
down into categories for cost overruns, performance
and delays, collectively the Liquidated Damages
associated with these two main sections will
collectively total 30%. As an example only, cost
overruns may be 10% of the LDs, performance
related issues may represent 10% of the LDs and
construction delays may represent 10% of the LDs,
paid out in a daily penalty to be paid for every day
that the Project fails to meet completion by a
specified date. Often when there are complications
associated with construction of a project all three
categories are often tripped.
Sponsors: Sponsor(s) will agree to fund its portion of the
equity in the project at a Date Certain or when
Lender’s engineer deems project has achieved
successful completion, whichever occurs first.
Lenders will require that the Sponsor’s commitment
to fund the Project be established at the financial
closing of the construction loan. This commitment
is often met by the Sponsor’s posting a LOC or
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posting a corporate guarantee that the Lenders find
acceptable. The other alternative is for the
Sponsors to fund their equity in the project pari-
passu with the Lenders during the construction
phase. Typically the Sponsors would rather post a
LOC for their commitment so as not to employ their
capital during the non-cash generating construction
phase due to the higher cost of equity capital.
Tax Equity: Tax Equity will also be looked upon to fund on the
earlier of a Date Certain or when the Project meets
its completion milestones.
With that said, typically Tax Equity Investors will
not assume construction risk. They will only fund
once the project has met its completion milestones
.
Take Out Funding Requirement: What is certain is that Lenders to the Project will
require a take-out funding of the construction loan
to be contractually agreed upon prior to the closing
of the construction loan. Typically this will include
the senior lenders assuming a percentage of the
construction loan as the long term loan, and an
agreement among the Tax Equity Investor(s) as well
as the Sponsor(s) as to the amount of capital that
they will fund.
Over the last several years Lenders have given full credit for the 1603 credit (30% of the
project cost) as a portion of the guaranteed amount due from Sponsor(s) and Tax Equity
Investor(s). Giving full credit to the 1603 credit significantly reduced the “take-out”
amount that the Sponsors would need to guarantee since tax equity investors would not
assume construction risk. With the expiration of the 1603 credit in December 2011, the
last of the 1603 deals were done in 2012.
In 2013 there have been few data points in the market to determine with certainty how
Lenders will respond in giving credit or even partial credit to the Investment Tax Credit
(ITC) that is also equal to 30% of the project cost. With the tax equity investor not
committing to COD this may have the effect of increasing the amount of the “take-out”
guarantee that the Sponsor(s) will need to guarantee during the construction period.
This scenario and ways to mitigate the amount of the “take-out” guarantee will need to be
further explored with our, to be named, financial advisor and legal counsel. The other
item of consideration is how this guarantee would be measured and accounted for by the
Sponsor(s) on their own balance sheet. Clearly the guarantee for the take-out equity
funding requirement is a conditional or contingent one, in that the EPC Contractor will
likely be offering a guarantee for the on time completion and performance of the Project,
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and the Tax Equity Investor will offer a guarantee that they will fund if the completion
milestones of the Project are met. Given those two guarantees by the EPC Contractor
and the Tax Equity Investor the way the guarantee will be characterized and accounted
for by the Sponsor will not be the same as if they offered an unconditional guarantee with
no counter guarantees in place.
6. Sponsor Financial Exposure Prior to Financial Closing.
Sponsors typically take on additional financial risks during the development cycle of the
project by providing a capital bridge that is required for providing a LOC, cash deposit or
corporate guarantee for performance under the PPA and Interconnect Agreement,
ordering equipment, and mobilizing legal, financial and engineering personnel whom
require payment prior to financial closing of the construction and permanent financing.
It can be thought of as a capital bridge since the financial guarantees and expenses will be
reimbursable to the developer at the closing of the construction and long term financing.
Unfortunately the risk of providing this capital bridge on a deal that is not 100% certain
to achieve financial closing is hard to avoid given that the PPA and Interconnect
Agreements are required to be signed before financial closing, the long lead times
expected for certain types of equipment (which require ordering sometimes a year in
advance) and the significant amount of professional services that are required to move a
project through financial closing.
One of the ways to minimize this risk is to wait until there is a high degree of certainty
that the project will achieve financial closing. Typically this means that a developer will
wait until a PPA and Interconnect Agreement is signed or in advance stages of
documentation before ordering equipment or spending heavily on legal, financial and
engineering services.
When ordering equipment, often a down payment will be required by the manufacturer
when the order is placed to cover the working capital requirements of the order. It is
important that this down payment is properly negotiated with the manufacturer and
reviewed by XXXX’s legal counsel to ensure maximum protection for XXX of a down
payment being made to a financially weak manufacturer. XXXX will likely want to ask
for some protection from default by the equipment manufacturer by asking for collateral.
Often this collateral for the down payment will be a first lien on the raw materials and
unfinished goods that the project developer has ordered. In addition to this collateral
assignment, more protection may be needed, depending on the state of the manufacturer,
in the form of covenants and a guarantee, similar to what would be found in a loan
agreement, which is essentially what a series of down payments on an equipment order
becomes.
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Engineering and Design personnel (XXXX) need to be cognizant of this risk window and
recognize when developing a critical path for engineering and construction of the Project
that ordering of equipment and advanced negotiation with an EPC Contractor will not
likely be done in earnest until after a PPA and Interconnection Agreement is signed or at
least in very advanced stages to minimize risk to the developer.
As explained in the section discussing interconnect issues, often a developer will be in
the predicament where an interconnect agreement is completed before the PPA or vice
versa. In either of these situations the developer is faced with a risk of committing
capital to the upgrades required on interconnection or committing capital to performance
under the PPA before knowing with certainty that the other agreement is going to get
done. This is a common problem because developers try to get both documents
completed at or near the same time. In order to avoid making such commitments
without knowing if the other agreement will be completed the developer can typically
buy themselves some time by effectively communicating their situation to the utility or
interconnect authority they are dealing with. Typically if the developer communicates
their position they will be allowed time before they need to commit capital required under
the agreement. During this time they will be able to get the other agreement signed.
Once these documents (PPA and Interconnect Agreement) are both signed the developer
will need to commit to a rather large performance guarantee under both contracts. This
performance guarantee (under a PPA it is a performance guarantee that the project will
deliver power as defined in the contract for the interconnect agreement it is typically a
financial guarantee that the Project will cover the expense of system upgrades required
for transmission of the power unto the grid) is made before financial closing and
therefore will add to the developers at risk capital until financial closing occurs.
As for legal and financial services the developer needs to exercise caution with
professional service providers until the PPA and interconnect are either completed or
very near completion. While law firms and banks may defer the actual billing of
services to the back end of the deal, this deferral, if it is offered, does not eliminate the
cost and liability of professional service providers which can grow quite large as the
Project nears financial closing.
7. Project Financing.
Failure to achieve a successful project financing is typically related to: i) the lack of a
suitable PPA, ii) a PPA that produces a low return on invested capital, iii) a weak and
thinly capitalized sponsor, iv) poor planning and understanding of the project finance
market, v) use of equipment that is lacking historical field experience combined with an
inadequate performance warranty or a balance sheet not able to back up the warranty, and
vi) a project that is missing a critical contract or permit or has a contract or permit that is
discovered to be flawed and deemed not suitable for non-recourse financing.
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Assuming that XXXX is successful in acquiring all the required permits and contracts as
well as an economically viable PPA, the one risk that remains and is difficult to manage
is the cost of capital in the market.
The cost of capital is among the most significant costs for a project and unfortunately is
often a function of the supply and demand forces in the financial markets, and to a large
extent outside the control of XXXX. One thing to keep in mind is that when the supply
of capital becomes scarce, capital will flow to the best projects first. Also some sub
sectors of the financial market will be more active than other sectors, for instance the
commercial bank market may be retrenching but the institutional market (life insurance
companies) may be expanding. It is important that all sectors of the market are
understood and explored as financing alternatives. Financial consultants need to have a
broad understanding of the market and alternative options.
Therefore one of the ways to best manage the risk of changes in the financial markets is
to ensure that the project compares favorably with others in the market and that XXXX
and its advisors thoroughly understand what the various sub market are looking for in a
project and make sure that the XXXX Project has these same attributes and marketed
accordingly.
Additionally, it is important that a methodical, systematic and timely approach is taken in
approaching the market. Approaching the market in this manner with personnel and
advisors that are well versed in project finance and with a thorough understanding of
market conditions in all sub-markets will make a material difference and lead to a
successfully financed project.
XXXX has already taken many steps in the right direction for the successful financing of
the XXXX Project. XXXX has a solid understanding of the economics in the Project,
developed a comprehensive financial model, will have explored a number of financial
market alternatives prior to entering into the market, and their financing plan assumes the
naming of a financial advisor as soon as it is practical, likely soon after the signing of a
PPA.
To recap, the path to a successful project financing for the XXXX Project will likely look
very similar to the following schedule of activities, the one caveat being if XXXX hires a
Financial Advisor late in the PPA process. If a Financial Advisor is hired they will likely
follow a similar path that is shown below.
Path to Financial Closing:
1. Financial Modeling of the Project – The financial modeling of the Project will certainly
be an ongoing process up until financial closing and even beyond to the commercial
operation date as the project emerges from construction and goes on-line. Hopefully, the
changes to the financial model of the Project will be more fine tuning (small changes in
equipment prices or small changes to energy output due to changes in site layout and
configuration) than anything else.
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The important financial modeling exercises will likely be in the early stages of
development (August 2012 – late 2013) when project configuration and equipment
choices are being matched to a power purchase agreement and an interconnect
agreement.
2. Financial Modeling of the Special Purpose Company – Similar to the financial modeling
of the Project, the financial modeling of the Special Purpose Company will be an ongoing
process that will likely continue right up until financial closing as financial terms and
conditions are agreed to as a normal part of the negotiations that occur in project
financing.
As with the financial modeling of the project, much of the financial modeling of the
Special Purpose Company (SPC) will take place concurrently with the financial modeling
of the Project with the intent that XXXX will have a solid understanding of the best
financial vehicle for the SPC prior to launching the RFP to lenders and tax equity
investors. Feedback from XXXX’s Financial Advisor and RFP respondents will provide
input on the pricing and terms and conditions for their investment in the Project and will
further refine the modeling of the SPC prior to financial closing.
3. Prepare Comprehensive Project Financial Feasibility Report – This report will be written
with recommendations as to which financial structure for the SPC and the Sponsors will
maximize their respective financial goals and objectives (as an example: IRR, NPV,
minimize equity investment, etc.). This report will also be a comprehensive survey of
the financial markets and provide likely pricing and terms and conditions of the various
capital providers to the Project. It is currently assumed that this report will be done by
me and prior to the hiring of a financial advisor.
4. Prepare Information Memorandum for Project – This report will be prepared to provide
potential financial investors (debt and equity providers) with a comprehensive view of the
Project, complete with a detailed summary of all of the material contracts, permits and
licenses. The information memorandum will provide a complete economic analysis of
the project, typically with an economic model for investor review and analysis. The
Information Memorandum and all of its exhibits will become the primary document that
will be used by investors to determine whether or not they have an interest in investing in
the Project. A well written, informative and comprehensive document will be
instrumental in attracting investors’ attention to the Project. As a rule of thumb, the
more investors that are interested in the Project the better terms and conditions the
Sponsors will be able to negotiate and the lower the cost of capital they will be able to
employ in the Project.
5. Distribute Information Memorandum to Project Capital Providers – The timing of this
event will very much depend on when and how far along negotiations are with a utility on
the Project’s power purchase agreement. Most financial institutions will not want to
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begin work on preparing a bid on a project financial proposal until they are confident that
a power purchase agreement is going to be signed. The date that the Information
memorandum is distributed should roughly coincide with the end of negotiations with the
utility on the power purchase agreement. The distribution of the Information
Memorandum in many respects represents the beginning of the project financing process.
The distribution of the Information Memorandum will be done with a person to person
meeting of various financial institutions. It is anticipated that the distribution of the
Information Memorandum will coincide with an approximate week-long visit to financial
institutions in New York to introduce the Project in person.
6. Receive Feedback and Choose Lead Capital Providers – The Sponsors will decide during
this time on lead capital providers who will be chosen to represent the banks and tax
equity investors. It may be that a sub-debt provider will also be chosen if that is a viable
financial structure alternative. During this time period, financial institutions will be
given time to analyze the project, prepare bid submittals of which the Sponsors will chose
on which proposals best match the financial objectives they desire.
7. Negotiate Preliminary Terms and Conditions with Capital Providers – This process will
provide Sponsors and Capital Providers Terms and Conditions of their financing
proposals of which they will take to their respective investment committees for final
approval.
8. Lead Capital Providers conduct due diligence and finalize terms – This period is provided
for Capital Providers to complete all of their due diligence and seek approval from their
respective investment committees. By the end of this process the lead Capital Providers
will have provided binding commitments to the Sponsors for the XXXX Project, subject
to changes that may occur during the financial documentation closing process or any
other material change to a contract or permit or license.
9. Negotiate Inter-creditor Agreement – The Inter-creditor Agreement can be a difficult
agreement to negotiate since it governs the relationship between each class of the capital
providers in the Project. Often the lenders, tax equity investors and the Sponsors will all
want and expect certain rights and privileges to protect their investment in the Project.
Often these demands and expectations of each class of investor are in conflict with one
another. The Inter-Creditor Agreement is the document that will govern over these
conflicts and make them cohesive with one another. It is not anticipated that an Inter-
Creditor Agreement will be finalized at the end of this period but at a minimum a general
framework will be agreed upon prior to bank market syndication.
10. Syndication of the Bank Deal – The lead banks selected and/or the Financial Arranger
will syndicate the senior construction loan and senior term loan to a wider market of
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18. XXXXXX PROJECT
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interested financial institutions. Often banks that bid to be a lead bank will be interested
in being a member of the syndicated bank group. During this process the bank market
will receive the deal in the form of the Information Memorandum and a bank meeting
(often in New York to get the most banks interested and involved) and take the bank deal
that has been largely formulated by the lead bank(s) to their respective investment
committees for approval to participate in the debt financing.
11. Lender and Tax Equity Documentation Completed. This is typically a two to three
month process between bank approvals and completing all documentation on behalf of
lenders and tax equity. Tax equity will provide a conditional commit to fund based upon
the Project achieving COD at the end of the construction period.
12. All Conditions Precedent for Financial Closing Completed.
13. Project Financial Closing.
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