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The Impacts of Policy on the Financing of Renewable Projects : A Case Study Analysis. Uday Varadarajan, David Nelson, Brendan Pierpont, Morgan Hervé-Mignucci Climate Policy Initiative USAEE - October 12, 2011. Why study the financing of renewable projects?.
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The Impacts of Policy on the Financing of Renewable Projects:A Case Study Analysis Uday Varadarajan, David Nelson, Brendan Pierpont, Morgan Hervé-Mignucci Climate Policy Initiative USAEE - October 12, 2011
Why study the financing of renewable projects? • Policies such as Feed-in-Tariffs or Investment Tax Credits affect renewable energy outcomes in large part through their impacts on investor behavior. • Understanding how policy affects investment and financing decisions can help policy makers diagnose how and why renewable policies are working or not. • As a first step, we developed a project cash flow modeling tool and analyzed six renewable projects in the U.S. and Europe in order to assess how policy impacts: • Project economics • Cost of financing • Ability to attract capital
Summary and Conclusions • Project Economics • The projects would not have attracted investors without policy support. • Except for the Italian PV facility, financing and project costs are in line with published benchmarks for renewable projects. • Cost of Financing • For all projects: • The duration of revenue support had the largest impact on financing costs. • Revenue certainty is the second most important factor. • Investors’ perceptions of risk also impact project financing costs. • For less mature or more innovative projects: • Protection against losses is critical due to higher perceived risks of project failure. • Construction and completion risk can usually be covered through commercial arrangements • Ability to Attract Capital • Institutional investors with the expertise to evaluate renewable projects will invest in renewable projects if there is revenue certainty and arrangements to insulate them from policy and completion risk.
Outline • Which projects did we look at and why? • How did policy affect project costs and revenues, and returns? • How can policy impact the cost of financing these projects? • How could policy help attract capital?
Which projects did we look at and why? Draft - For Internal Purposes
How did policy affect project returns? Equity Returns (IRR) Relative to Benchmark Range for Similar Projects Range of Benchmarks Expected Equity IRR
How could policy impact the cost of financing these projects? • Goal: Assess the potential importance of each policy impact pathway on financing costs in each of our cases. • Method: We compare the modeled financing costs of the project in various hypothetical scenarios, reflecting changes in the policy regime and project circumstances associated with a given pathway (adjusting revenues as needed to meet investor requirements). • Metric – Financing Component of LCOE: This is the contribution of cash and tax flows to and from investors and debt providers to the project’s LCOE. We present the change in this component as a percentage of the LCOE without supports.
How could policy impact the cost of financing these projects? • Example: Revenue Certainty & the U.S. Wind project • Start with optimized financing with a fixed-price 20 year PPA, which allows allows for 77% leverage. • Compare to scenario with a 20 year fixed-price contract for RECs at a price sufficient to deliver the same benchmark equity return (12.5%). • With RECs, energy sales are subject to market price uncertainty and P90 revenues are much lower, allowing only 59% leverage (at the same assumed debt interest rate). • This leads to an increase in the financing component of LCOE of 7 USD / MWh, which is roughly 6% of the LCOE without Supports for the project (110 USD / MWh). • Thus, we say that moving from fixed-price to the fixed-premium policy increased financing costs by 6% of the LCOE without Supports.
How could policy impact the cost of financing these projects? Policy Impact Pathways Potential Impact on Financing Costs Duration of Revenue Support • 10 Year reduced duration Revenue Certainty • Move from fixed tariff to fixed premium • High equity return req’d Risk Perception • More debt security req’d Completion Certainty • 1 year construction delay Cost Certainty • 5 % Cost overrun Additional Financing Costs as a Percent of Total Costs (Before Price Supports) US Wind Risk Distribution US PV US Power Tower Spanish Wind Development Risks Italian PV 10
How could policy help attract capital? • Institutional investors invested in projects with: • Significant & stable revenues from revenue support policies • Partners insulating them from completion and policy risks. • In-house capacity to assess and manage renewable investments • Ivanpah attracted private capital for first-of-a-kind at-scale facility – it featured: • Cost and revenue supports that enabled equity returns consistent with the risks of first-of-a-kind project. • Government debt that reduced financing costs by 11% relative to utility financing and included: • Financing conditions that distributed cost & completion risks. • A loan guarantee which partially socialized risks of project failure.
Directions for Future Work • Several areas of immediate interest include: • Extending the analysis to other geographies – do these insights apply to emerging economies and why or why not? • Exploring a greater set of policy design options – how do variable price support incentives such as RECS impact financing costs? How do we compare the impacts of cost vs. revenue supports? • Evaluating the impact of changes in design features – for example, how sensitive are financing costs to the level of a price collar? • Analyzing the tradeoffs with lower financing costs – do the lower financing costs of FiTs justify the additional social costs & risks? • Understanding portfolio effects – how does increasing development uncertainty impact willingness to invest in renewable projects?
Contacts • We welcome any and all inquiries, thoughts, questions, and comments! • You can reach me at: • Uday Varadarajan • uday@cpisf.org • (512) 466-3149
How did policy affect project costs, revenues, and returns? • Except for the Italian PV facility, financing and project costs are in line with published benchmarks for renewable projects. • The Italian PV facility had both high returns (estimated 27% equity return) and a high cost of electricity (more than double that of the U.S. PV facility). • The high Italian Feed-in-Premium (FiP) made such returns possible. The rush to qualify for the premium prior to its expiration appears to have driven up equipment and installation costs. • The projects would not have attracted investors without policy support. • Policy supports provided 36 to 81% of the cost of electricity from these projects. • Tax-related incentives cover roughly 41-45% of levelized project costs for U.S. projects, revenue support through price premiums implicit in long term PPAs cover an additional 10-37% of project costs. • European projects rely primarily on a single revenue support policy – either a FiT or a FiP – which provides between 36-79% of levelized project revenues.
How could policy impact the cost of financing these projects? • The duration of revenue support had the largest impact on financing costs. • Revenue support over a shorter duration means projects must pay down debt faster to adjust for lower cash flows in later years. • This effect increased financing costs by 11-15% of the cost of electricity when revenue support was reduced by 10 years (while increasing the level of support to reach required debt and equity returns). • Revenue certainty is the second most important factor. • In all six cases, the uncertainty of electricity prices is a much greater source of revenue risk than the uncertainty surrounding the wind or solar resource. • A shift from fixed electricity prices to a combination of a premium plus market prices (normalized to maintain equity returns) leads to additional financing costs of 4-11% of the cost of electricity. • Revenue certainty is more important to projects that require the lowest premium and to projects with either high equity costs or low-cost debt • Investors’ perceptions of risk also significantly impact project financing costs. Higher risk perceptions lead equity and debt investors to require increased returns or demand greater margins of error. The upper range of investor requirements would increase financing costs by 3-9% of the cost of electricity.
Policy Impact Pathways • Through the course of interviews with project stakeholders and investors, we identified seven key pathways for the influence of policy on the cost and availability of financing: • Duration of Revenue Support • Revenue Certainty • Risk Perception • Completion Certainty • Cost Certainty • Risk Distribution • Development Risks • In order to assess how important each pathway could be, we compared the financing costs for the projects in varying policy and project scenarios reflecting the impact pathways.
Financing Cost Methods II • Modeling Assumptions: We fix the basic cost and operational features of the project, but determine optimized financing in each scenario as follows: • Equity returns are fixed to benchmarks by adjusting revenue supports to remove any dependence on the particular risk and reward profile of the specific investors involved in the project. • Equity investors make decisions on expected returns using annual revenues which are likely to be met or exceeded 50% of the time for each year. • Debt cost is taken from actual project, but amount is optimized to meet benchmark DSCR requirements (1.3 for onshore wind and 1.4 for other technologies) published ratings agencies as needed to achieve investment grade for renewable projects. • Debt providers decide on the level of debt using annual revenue levels which are likely to be met or exceeded 90% of the time for each year (based upon conversations with rating agency staff). • Thus, the impact of production or market price uncertainty (when applicable) on financing is captured through providers’ use of more conservative estimates of annual revenues than equity investors.
Financing Cost Methods III • We are making the approximation that achievable leverage is the driving force behind cost of capital. • We neglecting further impacts a scenario may have on expected equity returns or debt characteristics. • The change in financing cost metrics between the optimized base case and the alternative scenario is entirely driven by a change in the achievable leverage – the amount of capital a debt provider is willing to commit to this project.
