Project financing basics in the power sector

1. Project financing basics in the power sector presentation to School of Engineering Columbia University A.J. Goulding New York, NY October 24th, 2014

2. Speaker background My career, both before and after SIPA, has largely focused on the energy industry Joined ICF Resources, focusing on natural gas resource base and Section 29 tax credit for non-conventional fuels production Worked with top ten power marketing company on asset restructuring Set up private equity firm Control 16 MW of hydro at 11 sites Commenced studies at SIPA 1991 1993 1995 1996 1997 1998 2000 2003 2014 Moved to New Delhi, ultimately joined USAID working on bagasse cogeneration and clean coal technologies Summer associate at London Economics International Joined London Economics International as senior consultant Led management buyout of North American operations of London Economics International LLC

3. Speaker background Ampersand has been targeting one acquisition per year

4. Intro to project finance 4 Principles of project finance focus on risk isolation and financing efficiency Project Finance is a subset of the global financing markets designed to finance large infrastructure projects • Somewhat independently of changes in global financial markets, project finance maintains its own framework of terms and conditions that set long-term expectations among project finance lenders • Project Finance is a specialized practice served by dedicated bankers and lawyers with subject matter expertise Project Finance is structured to depend solely on the cash flows from the project, and is thus “non-recourse” or “limited-recourse” financing • This means that the lenders have limited recourse to the owner of the infrastructure project if the project is unable to meet its financial obligations Project Finance supports the development of new infrastructure projects • Reduces the cost of capital for new projects with no operating history • Allows developers and lenders to take calculated and managed risks in new or uncertain markets that require a large upfront investment

5. Intro to project finance 5 Project Finance is available in many forms from a range of sources With so many different forms and sources of project finance, how do we choose? Project Finance is available in many forms: • Senior Debt • Mezzanine Financing • Preferred Equity • Tax Equity • Project Equity and from many different sources: • Commercial Banks • Life Insurance Companies • Pension Plans • Multilateral Institutions • Export-Import Banks • Taxable Bond Markets • Municipal Bond Investors • Infrastructure Funds • Hedge Funds Q The goal is always to reduce financing costs and maximize the return to the Developer The optimal structure depends on the project’s details A

6. Intro to project finance 6 IPPs are essentially a stack of interrelated contracts • Typically there will be a special purpose company formed to house one or potentially many projects • Generally non-recourse financing is sought for the special purpose entity • The project itself must be creditworthy • Engineering, Procurement and Construction Contract for the supply of the equipment and construction • Consider direct purchase of equipment and performance guarantee coordination as part of this process • Direct purchase may be more economic but potentially sets up developer to be at risk for non-performance • Requires very close coordination • Operations and Maintenance (O&M) contract • Possible to self-perform some or all of the maintenance • Economies of scale, geographic presence or specific expertise • Negotiate site control: land lease or purchase • Interconnection agreement with utility or grid • Utility agreements for water and other site infrastructure • Power Purchase Agreement (PPA) • Financing Agreements • Key terms of all of these agreements need to be closely coordinated Loan agreement Power Purchase Agreement Site control agreement SPV EPC contract Manufacturerwarranties O&M agreement Permits

7. Intro to project finance Engineers play an important role in project financing • New projects lack operating history, leaving lenders unsure of performance • Engineers opine on two key aspects: • Opinions are critical in terms of new technologies or uncertain resource quality • Experience suggests that resource quality estimates can be dramatically wrong; data may focus on an impact (wind speed) without knowledge of conversion effectiveness • While equipment performance can be guaranteed, engineering report influences cost of insurance resource availability technical capability

8. Ampersand corporate structure reflects influence of project finance approach • Example project finance structure • All debt at SPV level • Operations separate from asset companies • PPAs at asset companies • Equity generally at holdco level • HOWEVER: holdco guarantee in place Ampersand Energy Partners LLC (“AEP”) controlling interest with AJG 100% Ampersand Operations Company LLC (“AOC”) Ampersand Hydro LLC (“AHL”)* 100% 100% 80.1% 55% 100% 100% 100% 100% ASLH ANHH AMH ANYH AGE*** ABMH ATIH ACH 100% 51% 100%**** AHI-P ABDH AMIH** AOHH AHDH AGH Notes: * shows only active subsidiaries ** AMIH has similar ownership structure to ANYH, but is owned directly by AHL *** AGE has other subsidiaries which hold the former paper mill buildings and associated land **** represents voting interest; partner holds residual 45% economic interest

9. Project life cycle and target returns Diversity of financing types available depends on stage of project development Target Return % Conceptualization PPA Signing Construction Operations Retirement Equity Preferred Equity Financing Type Mezzanine Equipment Senior

10. Project life cycle and target returns Example returns to investor classes for highly leveraged project by small developer Example returns to investor classes for highly leveraged project by small developer. (Note example uses simplified project returns and disregards investor-level taxes)

11. Project debt considerations Project Debt Covenants, default, and guarantee • Project debt is arranged under a core set of terms and conditions that are similar throughout the world • The details will vary from project to project, but certain key features remain consistent • All of the collateral sits within the four corners of the project company • The project company is fully secured, including assets, shares and assignability of key contracts to lenders • Limitations on modifying key contracts or taking actions outside the ordinary course off business without lender approval • Reserve accounts for debt service, major maintenance or other project risks • The loan provisions anticipate that an owner will “walk away” from a project once their resources are exhausted, but give lenders the time and tools to assume control of the project and continue operating it for the benefit of the lenders • Owners do in fact “walk away” from projects when prospects for a return on equity have been eliminated • As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive some return on their loans and ultimately for the project capital structure to be rearranged – original lenders may become the equity, with new lenders brought in

12. Project debt considerations There are six key drivers to optimizing Project Finance structures Local bankruptcy and foreclosure laws Tax laws Currency and regional markets • Lenders ability to enforce remedies drives view of project risk • Many jurisdictions provide tax incentives for debt over equity • Presence of tax incentives for renewable energy projects • Investors and lenders are different in different regions • Management of currency risk Global financial conditions Project type Project size • Different generation types have different risk profiles • Larger projects have more options because of the greater liquidity of corresponding financial securities • Changes in financial markets create swings in investor appetite • Euro crisis caused many prominent French project lenders to withdraw from senior debt market

13. Project debt considerations Closing mechanics and closing costs • Project Financing is a legally intensive process • Each class of financing generally represented by its own law firm • Attorney for Senior Lenders frequently coordinates documents, signature pages, and the project does not “close” (i.e. fund) until signatures are released by everyone’s counsel • A typical project financing will include several hundred pages of documentation • Legal fees alone can range from $250K to $1 million depending on complexity • Because legal fees do not change much with the size of the project, larger projects enjoy economies of scale • Lead financial arrangers also receive an upfront fee at close • Fees vary, but arranging senior debt can equal 2% of gross senior debt raised and mezzanine capital can be ~3-5% of gross subdebt • Upfront fees and legal bills are funded out of proceeds at close and thus indirectly increase the all-in cost of debt • If closing costs are 2% of total debt raised for a 20-year term, this drives up the all-in cost of debt by ~0.37-0.50% (37-50 basis points)

14. Project debt considerations Types of Project Finance available Mezzanine Financing • Subordinated Debt, often referred to as Mezzanine Financing, sits between senior debt and equity • “Mezzanine” is “an intermediate or fractional story that projects in the form of a balcony over the ground story1” • Similarly, mezzanine financing is paid after senior debt (the ground story in the analogy) but before equity • Mezzanine is used to finance cash flows with too much uncertainty for senior lenders but supported by enough collateral for debt financing • Funding sources are seeking higher financial returns and thus are willing to accept incremental risk • Cannot declare default without senior lender consent • During distress, senior debt often traps cash until project stabilizes or is refinanced • Mezzanine lender relies on likelihood of recovery in foreclosure process to protect downside risk and some sharing of upside economics • Lenders include specialized funds, hedge funds, insurance companies and some equipment manufacturers 1. Source: Merriam Webster Dictionary

15. Project debt considerations Project Debt Covenants, default, and guarantee • Project debt is arranged under a core set of terms and conditions that are similar throughout the world • The details will vary from project to project, but certain key features remain consistent • All of the collateral sits within the four corners of the project company • The project company is fully secured, including assets, shares and assignability of key contracts to lenders • Limitations on modifying key contracts or taking actions outside the ordinary course off business without lender approval • Reserve accounts for debt service, major maintenance or other project risks • The loan provisions anticipate that an owner will “walk away” from a project once their resources are exhausted, but give lenders the time and tools to assume control of the project and continue operating it for the benefit of the lenders • Owners do in fact “walk away” from projects when prospects for a return on equity have been eliminated • As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive some return on their loans and ultimately for the project capital structure to be rearranged – original lenders may become the equity, with new lenders brought in

16. Project debt considerations Project Debt Establishment of Debt Service Coverage Ratios • The Debt Service Coverage Ratio (“DSCR”) is one of the more heavily negotiated terms • Calculated over a 12-month period as the sum of (i) cash generated from operations net of any costs that are paid before debt service divided by (ii) payments to lenders • The “Total DSCR” will include all payments to lenders, including payments to mezzanine or other subordinated lenders • The ”Senior DSCR” only considers payments of principal, interest and fees to senior lenders • Debt is structured around Minimum DSCR and Average DSCR • There is generally a minimum DSCR before cash is trapped at the project and payments to equity or subordinated lenders are prohibited • There is also a minimum DSCR that can trigger an Event of Default (often a DSCR < 1.0) • The average DSCR is a measure of the degree of financial risk that the lenders are willing to assume • For projects with uneven project cash flows, the amortization of the debt can be shaped to ensure sufficiently high minimum DSCR throughout life of loan • Forecasted minimum and average DSCRs reflect amount of leverage project can support: • Highly stable and contracted projects, like Solar PV, might have minimum DSCR 1.125 and average of 1.5, which supports high debt proportion • Projects with higher technology or operating risk will have higher required minimum and average DSCRs and thus a lower proportion of debt (e.g. biomass could have a min DSCR of 1.4 and an average of 2.0)

17. Role of offtake agreement 17 Are PPAs necessary? • Greenfield merchant plant is very difficult to finance, unless on balance sheet • Project financing is non-recourse to sponsors; if non-recourse, need something to prove credit-worthiness • current market will support 5 to 7 year contracts; is this in turn enough to support new construction? • depends on whether equity will accept back-ended returns • Question of whether contracts are necessary depends on what bank will accept and whether you believe that prices will be allowed to signal supply shortages • Plenty of other capital intensive industries show massive capital investment without long term contracts • Clearly, however, larger facilities are less likely to proceed without some sort of long term contract backing • So called “gentailer” models pairs retailer with IPP; retailer load may substitute for PPA Key PPA clauses • parties involved • output guarantees • length of contract • cost allocation of interconnection facilities • tariff rate • billing, invoice, and payment terms • force majeure conditions • settlement of disputes and arbitration • termination of contract

18. Role of offtake agreement 18 Well designed PPAs effectively allocate risk and reward in an administratively straightforward fashion TABLE OF CONTENTS TABLE OF CONTENTS (continued)

19. Role of offtake agreement 19 Structure of the PPA incorporates number of key terms • PPAs can be lengthy – upwards of 60-80 pages (including schedules) • Two parties: Buyer and Supplier (Developer) • Payment period length varies between different jurisdictions, but typically in the range of 20-25 years r Buyer’s eligible renewable technologies • PPA length is intended to match up with expected useful life of equipment and repayment period for project financing • In Ontario, the length of all renewable power PPAs is 20 years, except for hydroelectric power which has a 50-year payment period (better aligning to the life of hydro assets) • Main objective is to establish price paid to the Supplier for electricity • PPA also defines the allocation of risks and responsibilities between Buyer and Supplier Language from draft PPA: 20-year length: “ending at the beginning of the hour ending 24:00 hours (EST) on the day before the 20th (twentieth) anniversary of the date that is the earlier of (A) the Milestone Date for Commercial Operation and (B) the Commercial Operation Date” Energy-only structure: “For each hour in a Settlement Period, the Contract Payment shall be an amount expressed in $US and equal to the Hourly Delivered Electricity multiplied by the Indexed Contract Price applicable during the corresponding calendar year” Examples of PPA length

20. Project financial modeling 20 Initial screening model evolves into project pro forma to support financing Initial Screening Model • Develop estimates of all project parameters based on experience, industry data and vendor quotations • Multiple sites and technologies will be considered at this stage • Narrow alternatives through iterative process Project Pro Forma • Discounted cash flow model that assists project team from initial screening through project financial close and even into operation • All projects contain common risks • Capital cost overruns • O&M cost overruns • Production shortfalls • Force Majeure risks • Schedule delays • Conversion efficiency • Evaluate what resources should be expended to mitigate risk • Communicate to investors key aspects of the project

21. Project financial modeling 21 Pro forma underpins range of contract negotiations INPUTS OUTPUTS • Project Specific • Capacity • Capacity Factor • Degradation Factors • Finance • Leverage Ratio • Debt Rate / Term • ROE • Reserve Req’t • Taxes • Income Tax Rate • Foreign Owner’s • Depreciation Levelized Cost of Energy First Year Contract Price • Construction • Term • Debt Cost • Capital Costs • Pre-construction • Construction • Technology Cost Improvement Rates Debt Service Coverage Ratios Weighted Average Cost of Capital • Operating Costs • Fixed O&M • Variable O&M • Fuel Costs, inc. Start-up • Contract • Term • Escalation • Post-Contract • Asset Life • Terminal Value

22. Project financial modeling 22 Such models can be extremely detailed, and examine the project from a variety of perspectives Indicative Snapshot of the Output Sheet of a Solar PV Financial Model • Discounted cash flow model • Main cost inputs are the capital, O&M and financing costs • Updated iteratively as inputs change from assumptions to actual numbers • Coverage ratios are critical element • Primary output is expected bid price • Can be calculated for different sensitivity scenarios (contract term, technology, and size of project) • Accounts for relevant taxation regimes Indicative Snapshot of the Output Sheet of a Solar PV Financial Model Indicative Snapshot of the Output Sheet of a Solar PV Financial Model

23. Conclusion Concluding remarks • Project finance is the norm rather than the exception for new infrastructure projects • When markets are liquid, sponsors can achieve greater amounts of non-recourse financing • Unexpectedly low gas prices caused many merchant project financings to fail; rising interest rates will pose refinancing risk • Successful project financings require creativity and flexibility from participants • Teams of bankers, lawyers, engineers, and developers with strong working relationships help to reduce costs