Policy Analysis

1. Policy Analysis

2. Pricing Support • Various mechanisms can be used to support wind power: • a simple fixed tariff (usually set somewhere between retail and wholesale prices for electricity and paid for by the local electricity company to the wind farm) for a number of years; • "green certificates" provided to renewable energy producers and which can be traded - and which have value because producers of "dirty" electricity are forced by law to purchase growing amounts of such certificates each year to compensate for the polluting nature of their production; • investment subsidies (a one off amount paid at the onset of the project, or over a number of years) to compensate for higher initial investment costs.

3. Tax Depreciation Analysis • Review of Tax Depreciation Allowances • 5 Year MACRS • Incentive with Straight Line • Technical Issues • ½ Year Convention • Applicable Assets • Transfer of Tax Credits • Effects of Tax Depreciation on the Economics of Wind Projects • Best Case Effects • Worst Case Effects

4. Effect of Production Tax Credit and Accelerated Tax Depreciation • A principal reason for the use of private investors rather than municipal ownership is the possibility to use production tax credits and accelerated tax depreciation to offset taxes that would otherwise be paid. • Without the PTC and accelerated depreciation, private investors would require higher electricity rates to meet the rate of return requirements. • The tables on the next page use a rate of return of 9% and a debt service coverage of 40% to illustrate the effect of the tax benefits. The first case assumes the PTC and a five year depreciation is available, while the second assumes that the tax benefits are not available.

5. Value of Tax Benefits in Alternative Cases • Consider Extreme Cases: • If there is no energy production, there is no PTC. This implies that higher capacity factor projects have greater tax benefits. • If a project earns no income above the interest cost, there is not tax to pay and the advantage towns have in terms of tax payments do not exist. • If a project has a very low cost, there is a low base for tax depreciation and the accelerated tax depreciation benefits are not as important.

6. Summary of Tax Benefits and Costs • The graph below summarizes the components of costs and benefits of taxes in a private investor scenario. The benefits include the PTC and accelerated tax depreciation. The costs are that taxes must be paid on profits. This has a large negative effect in the later years of the project life.

7. Alternative Tax Cases • The analysis in the adjacent chart shows tax benefits in three alternative cases. • Case 1: • Base Case • Case 2: • Higher Capacity Factor, Lower Electricity Rate and Higher Cost • Case 3: • Lower Capacity Factor, Higher Electricity Rate and Lower Cost • Note the Significant swing in value

8. Components of Cash Flow for U.S. Project

9. Wholesale Power Rates and Net Metering Rates • Energy legislation known as the Green Communities Act was recently signed into law allows the energy produced at customer-sited generation facilities of up to 2 MW to be sold to the grid as if it were offsetting the energy used at the customer’s meter. • Previous Massachusetts law only allowed facilities of up to 60 kW to benefit from net metering while for larger facilities only the portion of the production that coincided with load could be credited at the retail rate. • Each municipality can net meter up to 10 MW of generating capacity, provided that no individual unit exceeds 2 MW. • According to the legislation, the net metering credit for generation used to offset load at a customer’s meter is credited at a rate equal to the “default service kilowatt-hour charge in the ISO-NE load zone where the customer is located.

10. Net Metering (Quincy) • Energy legislation known as the Green Communities Act was recently signed into law in Massachusetts that has made this on-site usage requirement moot. This legislation allows the energy produced at customer-sited generation facilities of up to 2 MW to be sold to the grid as if it were offsetting the energy used at the customer’s meter. Previous Massachusetts law only allowed facilities of up to 60 kW to benefit from net metering while for larger facilities only the portion of the production that coincided with load could be credited at the retail rate. Each municipality can net meter up to 10 MW of generating capacity, provided that no individual unit exceeds 2 MW. • According to the legislation, the net metering credit for generation used to offset load at a customer’s meter is credited at a rate equal to the “default service kilowatt-hour charge in the ISO-NE load zone where the customer is located.

11. Benefits of Private Ownership with and without Tax Incentives • The two adjacent graphs show the effects of tax incentives on the cash flow and rate of return earned in a private investor scenario. The rate of return declines from 9.15% to 3.07% • In the example, the price in the PPA contract would have to increase from $141/MWH to $191/MWH

12. Structuring

13. Flip Structure

14. Details of Tax Flip • This flow will only arise IF EPIC applies/receives approval to receive credit under Section 48B. • As proposed by CSI, the $$ flow of ITC (to Master Tenant) and corresponding investment (from Master Tenant to Landlord) would occur annually; • the $11MM investment would not be paid as a lump sum before the ITCs are created. There are other ‘flip’ structures (equity investors) that make the investment on the front-side of project. • For FY2008, $337MM was available for Section 48B projects. • The submission date for 2007-2008 funding closed 10.31.07, with notification of awards targeted for mid-2008. • In June 2007, the Treasury Department and DOE released revised guidance on the procedures for awarding the tax credits authorized under EPAct 2005 for qualifying advanced coal projects and qualifying gasification projects. Under the revised guidance, applications for • DOE certification received before October 31, 2007, will be acted on in 2008. • DOE received five applications for projects in five different states before the October 31 deadline. Two applications, requesting $258 million in tax credits, were received for qualifying advanced coal projects costing $4.1 billion, while three applications, requesting $390 million in tax credits, were received for qualifying gasification projects costing $5.0 billion Due to some (potentially conflicting) language regarding the application deadline in IRS 2007-53, I am investigating if there is still a window of opportunity to submit an application for FY2008 funds. • Otherwise, an application could be submitted for FY2009 funds (by 10,31,08), if deemed worthy to do so for either the EPIC-HES Ethanol Project (HGL) or other EPIC client projects. To ensure qualification for a future Section 48B award, EPIC would need to both be carbon capture ready and capture/dispose of its carbon emissions as part of the project. • Consortium Investments is interested in making an EPIC investment if/when tax credits can be exchanged for an equity investment.

15. Different Structures for Renewable Projects

16. Reasons for Hybrid Analysis • General Structure • Partnership between private investors and town • Not typical partnership with percent of contributions and percent of dividends • Different contributions and dividends paid at different time periods • Tax Benefits and Tax Costs • Tax Investors in Wind Farms • Flip structure • Returns to tax investors • Alternative Structures

17. Modeling of Hybrid Structure PTC Tax Dep Partnership Contributions Dividends and Financing Requirements of Partnership Private Entity Town Dividends Debt Service Dividends Debt Service

18. Example of Hybrid Structure • Contributions to Partnership • Private 80% • Town 20% • Dividends from Partnership before year 11 • Private 99% • Town 1% • Dividends from Partnership after year 10 • Private 1% • Town 99% • Derive the town partnership contributions through working with the contract level and with private IRR similar to private investor case

19. Length of Pre-Flip Period Ten Year Flip • An issue arises in structuring a hybrid analysis as to whether the first pre-flip period should be 10 years to cover the PTC payments or should it be 5 years to cover the accelerated depreciation (in which case some of the PTC benefits are given up). • The adjacent charts demonstrate that a five year flip structure has more value than a ten year flip structure. Five Year Flip

20. Considerations in Developing Hybrid Structure • Building from principles in earlier discussion, the amount of contributions to the partnership should consider: • The project IRR for the town portion must be greater than the municipal interest rate, otherwise it is not possible to repay loans • The equity IRR should be just sufficient to induce investment and the debt coverage should be aggressive. This can be accomplished by adjusting the contract price • After making the structuring adjustments, evaluate the savings relative to town savings on a standalone basis.

21. Example of Hybrid Structure • Contributions to Partnership • Private 80% • Town 20% • Dividends from Partnership before year 11 • Private 99% • Town 1% • Dividends from Partnership after year 10 • Private 1% • Town 99% • Derive the town partnership contributions through working with the contract level and with private IRR similar to private investor case

22. Considerations in Developing Hybrid Structure • Building from principles in earlier discussion, the amount of contributions to the partnership should consider: • The project IRR for the town portion must be greater than the municipal interest rate, otherwise it is not possible to repay loans • The equity IRR should be just sufficient to induce investment and the debt coverage should be aggressive. This can be accomplished by adjusting the contract price • After making the structuring adjustments, evaluate the savings relative to town savings on a standalone basis.

23. Length of Pre-Flip Period • Issue: Should the repayment period be 10 years to cover the PTC payments or should it be 5 years to cover the accelerated depreciation

24. Complexities

25. Periodic Cash Flow Modeling • Monthly versus Annual Periodic Modeling • Need to model with years on a vertical rather than a horizontal basis because you run out of room. • Use look-up tables to find inputs from annual workings analysis and monthly construction etc. • Adds accuracy where • Debt service is quarterly etc. • Scrapping occurs at specific points

26. Dates and Length of Period • Standard IRR and NPV calculations in Excel assume that the cash flows occur at the end of the period • To be consistent with this, one would make the formulas for interest, depreciation and other items use the opening balance rather than the average or the ending balance • To be careful, explicitly show the beginning day of the period and the ending day of the period and use XIRR and XNPV • It is helpful to explicitly show how many months are in each period so the EDATE function can be used

27. Step by Step Process for Setting up Dates • Step 1: Input months per period for various phases of the project – typically one month for construction period and six months for operating period. • Step 2: Develop period code – this is an essential part of the process, the last date before operation is period zero and the project begins its life in period one. • It does not matter at all that the length of some periods is different than other periods. The start period of construction is the negative of the number of construction months minus one. For example if the start date of construction versus the completion date yields 40 months, the first period is negative 39. Then, the first period of construction will be zero as desired. (Note: it is a good idea to hide remaining columns) • Step 3: Develop switches (TRUE/FALSE) for different phases and important dates – construction period, operation period and terminal period. • Step 4: Correspond the months per period from the switches. For example, for the construction period, the months per period is one. • Step 5: Enter the dates using the EDATE function. Show both the beginning date and the ending date. The first beginning date is the established date and the ending date is the EDATE function with using the months per period. The beginning period in the second period is the ending period plus one day. • Step 6: Compute the number of days per period and the days in 360 day year (first period next year)

28. Tip for Computing Months of Construction • To set-up a model that accounts for different project phases, a few excel techniques are helpful. First, the total construction period should be defined by subtracting the completion date from the date at which construction begins (the construction start date and the completion date should be defined in the model along with the number of periods per year for construction and the number of periods per year for operation.) Through defining dates in this manner, the model can be flexible enough to account for delays in construction of the project. • To compute the start date in this manner on a monthly basis, use the DAYS360 function in excel and enter the start date of construction and the completion date (DAYS360(start date, completion date), then divide this number by 30. To illustrate this process consider the following example: • Start date of construction: 1-March-2010 • End date of construction: 1-December-2015 • DAYS360(begin,end) : 270 • Divide by 30 : 69

29. Modeling the Financial Structure • Model Structure • Sources and uses • Debt financing • Depreciation Schedule • Financial statements • Time Periods • Construction • Debt module • Operating • Financial statements • Returns

30. Annualizing with Fiscal Year It is simple to annualize periodic cash flows once the fiscal year has been established. This can be accomplished by listing the year below the date and then using the SUMIF function to sum the periodic cash flows within the year. To demonstrate the process, the establishing the fiscal year is discussed and then the process of using the conditional sum is described. Establishing the fiscal year can be demonstrated by considering the example of Microsoft Corporation. For this company, the fiscal year 2007 ends at June 30, 2007 and covers the period July 2006 through June 2007. Here, one would define the fiscal year as June. For programming purposes, January through June correspond to the current calendar year (2007) and the later months, July through December, correspond to the prior fiscal year. In project finance models, for convenience, the fiscal year should in the month just before commercial operation. For example, if construction ends in May and the project begins in June, the fiscal year should end in May. Once the month of the fiscal year is established, use the YEAR function along with the MONTH function and an if statement to determine the fiscal year. For the case where the fiscal year is ending in May, if the month is less than to June, the fiscal year equals the calendar year. On the other hand, when the month is greater than June, the fiscal year is the calendar year plus one. • Step 1: Compute Fiscal year • If the month of the opening date is less than the fiscal month, (e.g. June) then the fiscal year is the same of the calendar year (e.g. 2007). (For example, for months of January through May, the year is 2007.) • If the year of the opening date is greater than or equal to the fiscal month (e.g. July), the year is the calendar year plus one (e.g. 2007+1). (In the example above, June through December are set to 2008.) • Step 2: Copy titles to a separate section: Once the fiscal year is established, copy the cash flow titles to a separate section, or a separate sheet. • Step 3: Apply the SUMIF function, where the initial range is the fiscal year definition, the criteria is the year and the sum range is the cash flow item. To make this work shade the entire row and use fixed references for the fiscal year, and relative references for the criteria.

31. Cash Sweep • Cash sweeps mean that if the project is successful, we get repaid faster, by taking ("sweeping") a portion of the surplus to reimburse the loans. • Banks always use more conservative revenue estimates than investors to have a higher certainty that such revenue levels will always be reached - and make it possible for the debt to be paid. • If thing go well, of even just as expected, there will be more revenue than the banks plan, and the investors will make a lot more money. • So in this case, we have a right to a portion of these extra revenues in the "better-than-the-pessimistic-scenario" cases. That means that it is actually quite likely that we be repaid faster than we expect. • We don't earn more, but we take risk over a shorter period, and it does lower the rate of return of the investors (as their own income is delayed by these payments).

32. Debt Schedule

33. Debt Schedule Discussion • Basics • Debt Draws come from sources and uses; debt repayments come from inputs • Debt Corkscrew with Opening and Closing Balance • Use of Minimum Function (rather than if statement) to assure that repayments do not exceed the opening balance • Other Issues with Debt • Grace period • Level payment • Customized repayment using solver • Include Debt Service Reserves in this Section

34. Setting-up the Debt Schedule • The fundamental part of a debt schedule is defining the balance of debt outstanding and computing the interest rate from the balance of the debt. The debt outstanding should be computed from explicitly showing the opening balance, the new debt issues, the debt repayments and the closing balance on distinct rows of the model. These debt balance schedules should be listed for every single existing and prospective debt facility that will be present during the forecast period. In the case of project finance models, the debt issues include all of the different tranches of debt that are issued to finance construction. In addition, project finance models should be set up to include debt issues that will in a re-financing. • New debt draws are computed from the source and use statement and from some criteria that defines how re-financing will occur. • The manner of repaying debt depends on the type of debt issue. In general, the repayment calculation uses the opening balance of the debt. For example, in a subordinated debt issue with repayment at a single date – bullet repayments – a TRUE/FALSE test can be created from the repayment year and this is used to assure that repayment only occurs on the repayment date. (The programming involves (year = repayment year) x opening balance.) • It is generally a good idea to show the total accumulated amount of the debt on a separate line item above the debt balance. This accumulated balance can then be multiplied by the repayment percent or a tailored repayment schedule to establish the periodic repayments. In this case, the MIN function should be used to assure that the amount being repaid does not exceed the opening balance of the debt.

35. Example of Debt Module in Actual Models • The debt schedule can be much more complicated than an opening balance, with drawls and closing balance as illustrated below Note the items for cash sweep, interest capitalization, scheduled amortisation, refinancing

36. Debt Repayment Structure and Risk • A project's debt amortization schedule often influences the rating, more so than the degree of leverage. • Front-loaded principal amortization schedules that capitalize on the more predictable project cash flows in the near term may be less risky that those with whose delayed amortizations seek to take advantage of long-term inflation effects. • Flexible re-payment structures can be developed where the project has irregular cash flows.

37. Debt Repayment - Sculpting • When working on a project finance model, you sometimes would like to compute the debt capacity through “sculpting” the debt repayments such that the debt service coverage ratio achieves a targeted ratio. This is accomplished using the solver and the following steps: • - Setting the both debt leverage and the repayment for each period. • - Add a constraint that the computed debt service ratio equals the target debt service coverage ratio • - Add a constraint that the final debt balance must be zero. • It is helpful to set-up a macro to re-do the solver with a macro. Unfortunately, this is a bit complex because the visual basic must be adjusted to allow the solver to work. This process involves: • Step 1: Press the Alt-F11 key to get the visual basic menu • Step 2:Go to the tools and references option and then click on the solver option. • Step 3:After beginning to record a macro, re-set the solver • Step 4: Make sure the first part of the solver is not blank • Step 5: Re-do the solver • Step 6:Add a TRUE statement after solver solve to automate

38. Modelling Defaults on Debt • In order to evaluate the credit spread, it is useful to determine at what point an investment experiences a loss on a loan. When a loss occurs, the interest rate realized by lenders is less than promised interest rate and attempts to restructure the debt have not allowed temporary defaults to be repaid. Modeling defaults on debt is important in credit analysis because the ultimate task in credit analysis is to measure the probability of default as well as the loss given default. The following process can be used to compute defaults on debt and shows how to model defaults: • Step1: Set up the debt balance with line items to incorporate defaults and re-payment of defaults. • Step 2: Fill in the default row from a sub-total line in the cash flow waterfall that computes the default on debt from the inability to meet debt service (this should be computed using the formula MAX(-cash flow,0). • Step 3: Set the re-payment of default to be the previous year’s default amount implying that all defaults are paid of in the subsequent year. This means the model attempts to fully repay the default in the year immediately following the default. If there is no cash flow to repay the default, the default increases by the amount of the default. • Step 4: Enter the repayment of default as a cash outflow item in the cash flow waterfall. • Step 5: Assure that the repayment of default is less than the opening balance of the debtless the scheduled repayment so that too much debt is not repaid in the final year of the model. • Step 6: Compute the cash flow realized by lenders through deducting defaults and adding re-payment of defaults to the scheduled debt service.

39. Relationship Between Debt Schedule and Cash Flow Schedule in Structured Finance • This shows the linking of the debt schedule and the cash flow statement Debt Schedule Opening Balance New Issues Repayments Default Repayment of Default Repay after default Cash Flow Statement Operating Cash Flow Plus Interest Cash Before Financing If negative during construction , feeds into financing needs If positive, used for repayment of debt If insufficient cash after construction, default

40. Default Mechanics • Steps in computing default and repayment of default • Compute default in cash flow statement by structuring a cash flow waterfall • Assume all defaulted debt is paid in subsequent period, before any other debt service • If cash is insufficient to pay debt service and re-payment of default, default will be larger and will attempt to repay larger default • Example • Default Year 1 100 • Cash Flow Year 2 -50 • Year 2 • Cash flow (50) • Repayment of Default from year 1 (100) • Total Cash Flow (150) • Default in year 2 150

41. Modelling Defaults on Debt - Procedure • The following illustrates the modelling process for defaults. • Note how the default comes from the cash flow statement • The if statement in the cash flow statement • The repayment of default from the prior default

42. DSCR Covenants and Risk Mitigation • Covenants will not come into play if everything is working in a base case scenario. • Covenants cannot change an un-economic project into an economic project – they cannot prevent the inevitable • Effective covenants can allocate more of the free cash flow to debt holders and less to equity holders in a project that is marginally economic. • A project model should be able to: • Measure which covenant is most effective in reducing risk • Measure the level of the covenant that will materially reduce risk • Evaluate whether a covenant does not do much in assisting in risk reduction for the economics of a project

43. Investors Need Some Dividends Before All Debt is Paid Off • The timing of debt service (i.e. loan interest payments and principal repayments) is one of the biggest factors that drives the rate of return for equity holders in a project. If the debt service is structured to allow no dividends until all debt is paid, return will be lower. This will generally be unacceptable to sponsors. • The faster investors in a project are paid dividends, the better their rate of return. • Investors therefore do not wish cash flow from operations of the project to be devoted to lenders at the expense of these dividends. • Lenders, on the other hand, generally wish to be repaid as rapidly as possible. Striking a reasonable balance between these conflicting demands is an important part of loan negotiations. • ER Yescombe, Principles of Project Finance

44. Cash Sweeps and Cash Traps • Cash sweep mechanisms. That simply means that if the project is successful, we get repaid faster, by taking ("sweeping") a portion of the surplus to reimbursethe loans. Banks always use more conservative revenue estimates than investors to have a higher certainty that such revenue levels will always be reached - and make it possible for the debt to be paid. If thing go well, of even just as expected, there will be more revenue than the banks plan, and the investors will make a lot more money. So in this case, we have a right to a portion of these extra revenues in the "better-than-the-pessimistic-scenario" cases. That means that it is actually quite likely that we be repaid faster than we expect. We don't earn more, but we take risk over a shorter period, and it does lower the rate of return of the investors (as their own income is delayed by these payments).

45. Example of Financial Covenants • SECTION 6.15 Financial Covenants. •      (a)  The Borrower shall not, as of the end of each fiscal quarter, permit the Ratio of Cash Flow to Fixed Charges to be less than 1.5:1.0. •      (b)  The Borrower shall not, as of the end of each fiscal quarter, permit the Ratio of Debt to Capitalization to be greater than 0.6:1.0. •      (c)  The Borrower shall not, at the end of each fiscal quarter, permit (i) Consolidated Net Worth to be less than the Minimum Consolidated Net Worth and (ii) Non-Trading Consolidated Net Worth to be less than the Minimum Non-Trading Consolidated Net Worth.

46. Cash Flow Restrictions (Reference) • Covenants can restrict the amount of dividends paid to sponsors during good time and bad time periods. Covenants that restrict cash flow in bad time periods are known as cash traps. Covenants that limit cash payments when cash flow is high are known as cash flow sweeps. These covenants are explained as follows by Standard and Poor’s: • A project’s credit is generally strengthened by covenants that limit, or even preclude, distributions to sponsors unless both robust historic and projected DSCRs are met, and reserve funds are fully funded. • The reason for dividend restrictions in time periods when cash flow is low is because when financial results are worse than expected, it is essential to assure that cash flow is kept for the debt holders and not “leaked” out of the project as dividends. A cash flow trap operates by limiting any dividend payments if the debt service coverage is below a debt service ratio criteria. If the dividend restriction is tied to a relatively high level of the debt service coverage such as 2.5x, the dividend restriction will occur more often than if the dividend restriction is set to a relatively low level such as 1.2x – the “bad” time periods occur more often with the higher covenant. Since the covenant limits dividends, cash flow traps mean that something must be done with the cash flow that is not distributed to sponsors. Cash either can be used to payoff debt early or be put into a debt service reserve to protect debt holders.

47. Cash Flow Sweeps and Cash Flow • A cash sweep covenant applies in periods when cash flow is high rather than when cash flow is low. The reason for restrictions on dividends in good time periods is because when prices higher than normal, cash flow can be kept for the debt holders to protect against default in later periods when cash flow and prices may be below normal. • Cash flow sweeps operate by computing the amount of dividends that will just limit the debt service coverage to the covenant – for example, dividends cannot be paid above a level that implies a DSCR of 2.0x. • Unlike the cash traps, if the cash sweep covenant is set to a low level it is more restrictive (the cash flow trap covenant described above was more restrictive with a higher level). If the cash sweep is tied to a relatively low level of the debt service coverage such as 1.5x, the dividend restriction will occur more often than if the dividend restriction is set to a relatively low level such as 3.5x.

48. Cash Trap Mechanics • Set up Cash Reserve Account and Relate to the Cash Flow Statement Cash Reserve Opening Balance Cash Inflows Cash Outflows Ending Withdrawls Interest Income Cash Flow Statement Operating Cash Flow Add: Cash Balance Add: Interest Income If positive cash and debt outstanding, trap cash If negative cash and positive cash balance, use cash If paid off debt and positive cash flow, withdraw all cash Subtract: Cash Balance

49. Fixed Assets and Depreciation

50. Items Included in Fixed Asset and Other • Plant Balance • Book Depreciation Expense • Accumulated Depreciation • Tax Depreciation Expense • Accumulated Unamortized Debt Financing Fees • Amortization of Debt Financing Fees • Operating Reserves