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Renewable Energy Finance Basics. Michael Mendelsohn Sr. Financial Analyst Paul Schwabe Energy Analyst February 1, 2012 NREL. Agenda. NREL Finance Team Financing Background Project Financial Structures Financial Modeling Metrics. NREL Finance Team. RE Project Finance Team – overview.

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renewable energy finance basics

Renewable Energy Finance Basics

Michael Mendelsohn

Sr. Financial Analyst

Paul Schwabe

Energy Analyst

February 1, 2012

NREL

NREL is a national laboratory of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy operated by the Alliance for Sustainable Energy, LLC

agenda
Agenda
  • NREL Finance Team
  • Financing Background
  • Project Financial Structures
  • Financial Modeling Metrics

National Renewable Energy Laboratory Innovation for Our Energy Future

slide3
NREL Finance Team

National Renewable Energy Laboratory Innovation for Our Energy Future

data re finance tracking initiative refti
DATA: RE Finance Tracking Initiative (REFTI)

REFTI collects and disseminates wide array of project and financial info including cost of tax equity and LCOE

crest models solar wind geo
CREST Models: Solar, Wind, Geo
  • Primary: Levelized Cost of Energy (LCOE), Yr. 1 Cost of Energy
  • Secondary: Rolled up and Detailed Cash Flows
slide7

Visualization - RE Project Finance Website

http://financeRE.nrel.gov

http://financeRE.nrel.gov

  • Feature Analyses: Unique NREL analysis about policies, innovations and market conditions that impact RE project financing

User Login: registered users can comment, rate content

  • Flexible Search: by keyword, or by filters (single/multi-) by sector, tech, size, policy, financing structure, and/or content type
  • Blog Analyses: Credible, objective policy and market observations from NREL analysts

NATIONAL RENEWABLE ENERGY LABORATORY

slide8
Financing Background

National Renewable Energy Laboratory Innovation for Our Energy Future

key metrics
Key Metrics
  • Levelized Cost of Energy (LCOE) {or Levelized Cost per Mile (LCPM)}
  • = Discounted sum of costs / Discounted sum of energy produced {or miles driven}
  • Return on Equity (ROE)
  • = Discounted sum of returns to investor / initial investment
  • Internal Rate of Return (IRR)
  • = Discount rate necessary to make returns to investor equal $0
  • Weighted Average Cost of Capital (WACC)
  • = A calculation of a firm’s cost of capital in which each category of capital (e.g. debt and equity) is proportionally weighted
  • Payback
  • = number of years of benefits to recover initial investment

National Renewable Energy Laboratory Innovation for Our Energy Future

project irr impact on lcoe
Project IRR impact on LCOE

Lower risk = lower required return = lower LCOE

Every 1% reduction in target equity IRR results in $4/MWh for wind and $8/MWh for PV

Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “

National Renewable Energy Laboratory Innovation for Our Energy Future

sources of investment capital
Sources of Investment Capital

National Renewable Energy Laboratory Innovation for Our Energy Future

financing risk factors
Financing Risk Factors

National Renewable Energy Laboratory Innovation for Our Energy Future

financing risk factors cont d
Financing Risk Factors, cont’d

National Renewable Energy Laboratory Innovation for Our Energy Future

slide14
U.S. Federal Tax Incentives & Tax Equity

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tax incentives designed to spur re investment
Tax Incentives Designed to Spur RE Investment
  • Two Primary Federal Incentives Available:
    • Investment Tax Credit (ITC) / Production Tax Credit (PTC)
    • Accelerated Depreciation
  • Together, ITC/PTC and accelerated depreciation count for approx. 50-55% of a project’s capital investment

National Renewable Energy Laboratory Innovation for Our Energy Future

tax incentives only good if you can use them
Tax Incentives: Only Good if You Can Use Them
  • Renewable energy projects and their developers don’t have sufficient taxable income (aka “tax appetite”) to utilize fully
  • Without sufficient tax appetite, the tax incentives have to be “carried forward”
    • Greatly reduces the present value of the tax incentives, and thus their ability to induce investment
  • Credits and depreciation must be claimed by the owner
  • Benefits are nonrefundable and non-transferable
simplified financial structure representation
Simplified Financial Structure Representation

Corporate Parent

Project Company

Power, RECs, Tax Ben.

2)Equity Partnership

3)Equity Partnership With Debt

  • 1)Single Developer / Investor

Senior Lender

Developer

Tax Investor /

Govt.

Developer

Tax Investor / Govt.

Project Company

Project Company

Power, RECs, Tax Ben.

Power, RECs, Tax Ben.

National Renewable Energy Laboratory Innovation for Our Energy Future

commonly used financial structures
Commonly Used Financial Structures
  • Partnership Flip (PF) structures
    • All Equity PF
      • Cash and tax benefits allocated to tax investor (primarily) until TI receives pre-defined IRR (flip point). After, allocations flip from TI to developer
    • Leveraged PF
      • Similar to AEPF but debt at project level increases required yield by tax investor by approx. 2%, often alters allocation schedule
  • 2. Lease structures
    • Sale Leaseback
      • Developer sells project to an entity (lessor) who then leases it back to the developer to operate and garner revenue
    • Inverted lease (a.k.a. lease pass-through)
      • ITCs passed via Master Lease; Tenant operates equipment and makes lease payments to Owner (not simulated in SAM)
  • 3. Single-owner (balance sheet)

National Renewable Energy Laboratory Innovation for Our Energy Future

leveraged partnership flip
Leveraged Partnership Flip

Senior Lender

Developer

(1% of equity)

Tax Investor

(99% of equity)

Project Company

(equity + PPA/cash debt)

Tax incentives can lead to complicated financial structures

Power (and REC) Sales

Federal Incentive

ITC/Cash Grant

Cash Revenue

 1% / 0%

99% / 100% 

less

Operating

Expenses

less

Tax-Deductible Expenses

(including MACRS and interest on debt)

less

Debt Service

equals

Taxable Losses/Income

(which result in

Tax Benefits/Liabilities)

equals

Distributable Cash

 1% / 90%

99% / 10% 

 1% / 90%

99% / 10% 

detailed financial structures in sam
Detailed Financial Structures in SAM
  • Four Financial Structures Recently Added to SAM
    • All Equity Partnership Flip
    • Leveraged Partnership Flip
    • Sale Leaseback
    • Corporate (Single Owner)
  • Allows For:
    • More realistic evaluation of RE costs
    • Information transfer from finance and legal RE experts to and new industry participants
    • National lab analytic capability
    • Examination of complex support
    • policies

National Renewable Energy Laboratory Innovation for Our Energy Future

slide21
Financial Modeling Metrics: Capital Recovery Factor and Fixed Charge Rate

National Renewable Energy Laboratory Innovation for Our Energy Future

the fcr method is one of many standard approaches used to represent finance in lcoe equations
The FCR method is one of many standard approaches used to represent finance in LCOE equations
  • FCR equation is a representation of a cash-flow model and determines the amount of revenue needed to cover investment and operating cost.
    • Defined as the amount of revenue per dollar of investment that must be collected annually to pay the carrying charges on that investment as well as taxes

FCR equation, as we generally present it, combines a standard amortization equation (Capital Recovery Factor) and an equation that accounts for the additional revenue required to meet tax obligations.

This method was adopted by all program areas during the EPRI/DOE Technology Characterization from 1995/996 and the wind program has used it ever since

d(1+d)n

1- (T*PVdep)

(1+d)n - 1

(1-T)

Capital Recovery Factor

Value of Taxes and Depreciation

Fixed Charge Rate

the use of different fixed chare rates can result in lcoes that measure different cost aspects
The use of different Fixed Chare Rates can result in LCOEs that measure different cost aspects
  • FCR calls for an after-tax discount rate (d) and can be either nominal or real (depending on discount rate input). WACC method generally used to estimate d
  • Fixed Charge rates can represent different scenarios:
  • No-tax Investment Scenario:
  • Cost After Tax Deductions Scenario:
  • Before Tax Revenue Required Scenario:

d(1+d)n

d(1+d)n

d(1+d)n

1- (T*PVdep)

(1+d)n - 1

(1+d)n - 1

(1+d)n - 1

Determines cost of energy that will allow investor to recover costs and achieve target ROR without considering tax obligations

(1-T)

FCR

Determines after-tax cost of energy that will allow investor to recover costs and achieve target ROR assuming full monetization of tax benefits

FCR

[1- (T*PVdep)]

Determines before-tax cost of energy that will allow investor to recover costs, meet tax payments, and achieve target ROR

FCR

thank you
Thank you

Michael Mendelsohn

Paul Schwabe

National Renewable Energy Laboratory Innovation for Our Energy Future

slide25
Extra Slides

National Renewable Energy Laboratory Innovation for Our Energy Future

tax equity a critical component to re financing
Tax Equity a Critical Component to RE Financing
  • To take advantage of tax incentives, often a separate investor with tax appetite is brought into the project
  • Generally referred to as “tax equity”
  • Currently very small pool of tax equity investors (investment banks, insurance companies known as institutional investors)
    • Continued tax appetite required (MACRS 6 year recovery period)
    • Complexity of the project structure
    • Wide array of risks perceived:
      • Technology
      • Developer
      • Off-taker (utility or commercial entity) credit rating and contract duration
      • Regulatory (e.g., can regulators alter the PPA contract?)
      • Site access
wind project development process
Wind Project Development Process
  • Entire process can take 3-4 years to reach operational phase
  • Pick any two: “Fast, cheap, or good”

Source: Holland & Hart, RE Project Development & Finance

risk factor mitigants
Risk Factor Mitigants

National Renewable Energy Laboratory Innovation for Our Energy Future

project irr impact on lcoe1
Project IRR impact on LCOE

How do we de-risk projects in order to lower required return?

Deutsche Bank calls it TLC:*

How do different policies impact financing and transaction costs?

* Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “

National Renewable Energy Laboratory Innovation for Our Energy Future

u s wind investment in response to policy
U.S. Wind Investment in Response to Policy

National Renewable Energy Laboratory Innovation for Our Energy Future

feed in tariff design considerations
Feed-In Tariff Design Considerations

National Renewable Energy Laboratory Innovation for Our Energy Future