Adapting project finance to the new era of distributed energy projects
November 2015 | SPECIAL REPORT: ENERGY & NATURAL RESOURCES
Financier Worldwide Magazine
We have lived through a time period in which the project finance of renewable energy power plants became an important theme on the world energy and finance stage. That period is now fading away and renewable energy bankers will require new strategies to take advantage of the new emerging energy production and distribution markets which are emerging.
Let’s start by acknowledging that the development of renewables over the past decade has actually been the result of the confluence and interaction of four factors, only one of which was the practical, diverse applications of the ‘project finance’ tool, featuring non or limited recourse to project sponsors, significant leveraging of firm contractually-based cash flows, ‘de-risking’ of deal structures through contractual means to allocate risk among the parties and frequently some direct or indirect credit enhancers. There have always been three other factors at play which made its use practical and attractive.
First, governmental programmes and policies designed to financially incentivise renewables growth by enhancing the possibilities of project finance through types of federal tax credits, direct federal financial and credit enhancement programmes, and state specialised renewables supportive, market-based incentive programmes designed to reward renewables development and use. Second, electric utility regulatory ratemaking requirements which allowed third parties to tap utility credit built on rate basing, and utilities’ corporate structural realignment so they too could take advantage of ‘independent power’ financing possibilities. Third, perhaps above all, progressive technology improvements in the real world, economic competitiveness of renewable and related distributed energy uses (albeit only now approaching near non-artificially supported levels).
However, the fortuitous configuration of factors that produced this surge of renewables project finance may not be sustained because the factors themselves are each changing in ways that will affect the movement from renewables development to a more broadly distributed energy economy. Different types of public-private relationships may be required to effectively preserve profitable growth momentum. Simply put, new techniques may be required to finance new competitive alternatives which make contributions to ‘green’ ecological sustainability.
There are several changes which strategists will have to systematically account for. Some existing renewable energy technologies have begun to achieve competitive maturity and seem less to merit special regulatory treatment. With the increased focus on resiliency and productivity of the overall system of electric power production, focus on energy efficiency technologies, managed use of storage and microgrids has intensified, and self contained ‘circular economy’ wastes to energy producing applications, distributed energy processes are now receiving greater emphasis in part because of environmental concerns.
In the background, there remains a continuing conviction that newer breakthrough technologies are in the offing which are of a type that will result in more private capital attraction. Conversely, looming above it all is the prospect of partial competitive obsolescence due to the declining cost of conventional energy supply sources.
As the number of profitable operating renewables projects has proliferated, new structures for financing them are emerging that target public investor markets not previously important to project development. In part, this may represent a move to reap the yield of traditional project financing efforts before the predicable streams of cash flow run out. In part, too, it may reflect a recognition that the attractiveness to banks of emerging energy financing options may not be as great, and that other funding sources –including the great unwashed public – must be attracted to the game to sustain capital flows necessary for sustaining single unit renewable generation facilities.
Technology change is causing new management models for more readily and efficiently integrating electric distribution and transmission to emerge. Electric utility industry companies are now being goaded to restructure in response to new proposed regulatory changes, to re-examine their roles in the distributed energy business and even facilitation of certain community energy undertakings, and, as a consequence, are less oriented to acquisition of third party supplied project financed power. They are increasingly coming to the conclusion that the financing of negawatts, with or without project finance, undertakings, is a more attractive route to follow.
New types of governmental incentives are emerging for distributed energy or energy savings-oriented arrangements which, in many instances, emphasise government’s role not only as a stimulant to encourage private investment to facilitate sustainability, but as a major consumer of privately provided –on a cost effective basis – energy needs. In sum, overall regulatory policy objectives seem to be shifting to adapt to technological possibilities.
Thus, we are at an inflection point for re-evaluation of the continued efficacy of the still current formula: project finance for electric power distributed renewables generation; a patchwork of federal tax and state-administered market-based incentives designed to encourage it; glacial modification of the basic forms of private power production, transmission and distribution; and disjointed procurement by different federal agencies of different technologies using a mélange of traditional and what they believed to be an effective hybrid of private sector acquisition methodologies and their own.
Financial strategists, therefore, ought to be considering whether there are models which can be expanded upon which further the necessary flexible future compact between private capital markets and private entrepreneurial drive. And on the other, governmental responsiveness to the needs of the changing distributed energy economy to the overall well-being of the consumers of energy and available environmental resources.
Clearly, in this transitional time, that new balance has not been struck. We believe there are four starting point models, as outlined below, which public and private strategists may come to converge on, which would also be consistent with the national ability to evolve to enhance economically sound sustainability in the energy and environment arena. Each represents an effort not to destroy but to supplant and direct the vigour which once throbbed through the renewables project finance sector.
First, broadening capital markets for distributed energy resource investment through legislative facilitation of private power master limited partnerships and other mechanisms through which the public can invest. The fact that this raises the issue of the proper allocation of federal subsidies to different energy resources should not be allowed to obscure the partial benefits for the distributed energy industry to rely upon the risk assessments of a limited number of large financial institutions weighing up a large number of investments.
Second, partially federally capitalising state green bank-type institutions for selective and creative credit enhancement of private projects and provision of seed capital, to jump start new private innovations with reasonable prospects of success and contribution to the overall distributed energy economy. This is particularly suited because it would enhance the development and the partial private financing of distributed generation projects on a basis which was best shaped to the profile, not only of objective energy utilisation regional needs, but also with the structure of power and transmission ownership and governance in the region. IT would complement and facilitate other state-sponsored regulatory reform programs.
Third, creating the necessary legal infrastructure to permit private financial institutions to promote energy efficiency investment and capital raises directly with a sufficient level of confidence. The PACE programmes initiated in different states for different classes of customers with varying success should be scrutinised and assistance provided where applicable to revamp their legal form. Focus on financeable arrangements for building, campuses and industrial facilities promises to be another way to attract private capital to an area of distributed energy finance which clearly has enormous potential.
Fourth, facilitating the creation by utilities, private developers and municipalities of multi-consumer owned solar and other community energy projects. The possibilities for securitisation and pooling of revenues from distributed energy productive arrangements have not been adequately tapped.
In sum, it is a mistake to simply project past success in the project finance of renewables into the future. What was done was responsive to what could be done at one point of convergence of technology, public policy and electric utility operations with the use of a powerful financial tool previously applied primarily to natural resource industries. Effective strategic planning for the future should be predicated on a recognition that the time of distributed energy as an economic driver is arriving, that it presents different financing challenges, and that the key to strategic adaptation to will be different types of public-private partnerships which by broadening capital markets in ways which continue to attract private entrepreneurs, intelligent prototypes exist for reconciling the healthy relentless pressure of new technology development, new means to wring profit from change and new government policies to achieve their dynamic sustainability.
Roger D. Feldman is of counsel at Andrews Kurth LLP. He can be contacted on +1 (202) 662 3048 or by email: email@example.com.
© Financier Worldwide
Roger D. Feldman
Andrews Kurth LLP