Introduction to Project Finance in Renewable Energy Infrastructure: Including Public-Private Investments and Non-Mature Markets

By Farid Mohamadi

What is project finance? What makes project or structured finance so relevant for large renewable energy infrastructure? Which vocabulary do I need to know in order to speak the same language during meetings with lawyers, investors, bankers and engineers?  These questions and many more are answered throughout this book, offering real world examples to bridge the gap between theory and practice.

The book details the role of each stakeholder in the development of renewable energy projects, the interconnection between all the agreements, the financial process from fundraising to financial close, the processes of due diligence, risk analysis, project investment valuation and much more. It also provides with an introduction to Portfolio Management using renewable energy assets and an explanation of the role of Climate Finance in green energy investments. The commented glossary enables readers to unpick the jargon used in project finance forrenewable energy, and the numerous creative figures and comprehensive tables aid with understanding.

Offering a complete picture of the discipline, Introduction to Project Finance in Renewable Energy Infrastructure will be of value to professionals, engineers and academics alike interested in understanding the process and components of project finance in renewable energy infrastructures, in both private and public-private contexts.

• Language: English
• Publisher: Springer
• Release date: Apr 20, 2021
• ISBN: 9783030687403

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© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021

F. MohamadiIntroduction to Project Finance in Renewable Energy Infrastructurehttps://doi.org/10.1007/978-3-030-68740-3_1

1. Introductory Concepts

Farid Mohamadi¹  

(1)

Bogota D.C., Colombia

Farid Mohamadi

Email: [e-mail]

Abstract

Most renewable energy plants are considered as infrastructure assets, mainly for their size and their capital-intensive nature but also because of their long-term lifespan. Some renewable energy sources such as wind power and solar power are considered as variable renewable energy (VRE) sources while others are to a certain extent excluded from this definition because they are able to provide a relatively constant energy to the grid. Renewable energy infrastructure can be either private assets or public–private assets which requires a cooperation between a public entity and one or several private parties (consortium). Depending on the jurisdictions and their stage of economic development, either developed countries or emerging countries, so-called public–private partnerships (PPP) in the renewable energy sector will be more or less common. Nevertheless, an emerging economy can be a mature market, for instance, because of the abundant availability of a given renewable energy source. And the other way around is true as well, a developed country could be a non-mature or new renewable energy market, for example, because it has historically invested and developed other non-renewable energy sources and has not started yet policies to incentive the implementation of renewable energy in its jurisdiction. Generally speaking, we could say that most countries have set goals for the contribution of VRE, in particular, to achieve climate change mitigation. The global renewable energy market is diverse and even though most of the world’s countries embraced clean energy, these infrastructures are being developed and installed at different paces and with different levels of difficulties.

Project finance is a form of structured finance used for medium to large non-social infrastructures such as highways, airports, transmission lines, bridges, and power generation to which belongs renewable energy infrastructure. This book describes project finance applied to renewable energy projects such as on and offshore wind, grid-scale photovoltaic solar projects, concentrated solar power (CSP), and hydropower in general although this form of renewable energy could be categorized as conventional non-fossil-fuel-based energy. Also, many insights refer to non-mature markets, i.e., markets where the renewable energy industry has recently started or is just starting. A chapter is also dedicated to public–private projects, public procurement, and to a broader extent to investments where the public sector is involved as a stakeholder.

1.1 Renewable Energy Infrastructure

Renewable energy is a form of energy based on natural and not finite sources such as wind, sun, soil warmth, waves, and river flows. It is considered as a clean energy form because this infrastructure does not generate carbon emissions unlike fossil fuel-based power plants (such as coal or gas power plants). The most common types of renewable energy include on and offshore wind, solar (photovoltaic and thermal concentrated), geothermal, biomass, marine (ocean tidal and wave), small hydropower, and depending on the jurisdiction large hydropower (Fig. 1.1). Indeed, renewable energy is sometimes referred to as Non-conventional Renewable Energy, this is because large hydropower could be considered as a conventional renewable energy source. This classification is due to the maturity of the hydroelectric market which does not require any policy or support to incentive its development (i) and to the social and environmental impact (ii) generated by large dams for their construction and operation (ex. Three Gorges Dam in China). There is still a significant market for hydropower however, the issues of resilience have reduced its attractiveness in the past years and the focus today is more on repowering, efficient retrofit, or regular maintenance of the existing plants (some models could easily exceed 50 years of lifetime). Its contribution to the stability of the grid, in general, is important to balance the effects of the variable renewable energy (VRE) described above.

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Fig. 1.1

Installed wind and solar capacity and targeted evolution (numbers: REN21 2020)

The differences between the types of renewable energy listed above are punctual in the context of this work. For instance, in the losses for solar and wind infrastructure, you need to consider losses due to shading in solar energy while wake effects are estimated for wind energy. As to biomass plants, we actually can better predict the future cash flow because the quantity of energy (heat or power) depends on the inputs which are not subject to weather variability. We, therefore, do not use P-tables (probability levels) and refer to equivalent full load hours (FLH) when talking about quantities scenarios. The generation of hydropower plants, in spite of possible seasonality effects, is also relatively predictable and reliable because it depends on the flow of rivers or the size of the dams.

In general, there are sources of energy that are more mature than others such as hydropower, onshore wind, solar, and to a certain extent biomass. The rest such as offshore wind, geothermal, CSP, and especially ocean energy is less developed and thus this immaturity could be reflected in the technological risk and in a certain way in the project costs and competitiveness. For the sake of simplicity, we will assume in the next chapters that they are equally mature.

Infrastructure

I would not dare to try to define by myself infrastructure, but I assume that it is a mix of different definitions depending on which perspective we see this entity. Infrastructure is everything in the built environment that is distinct from the natural environment, and essential to the economy, the quality of life, to communities, to high standard of living (Grigg Neil 2010). We distinguish public infrastructure that is owned by the government or any public entity and that serves the public interest, i.e., benefiting the citizens, from infrastructure that is owned by a private entity and serves the same purpose (cf. Public–private partnerships), and from infrastructure owned by the private sector and serving the private sector. It encompasses roads, telecommunication systems, railways, subways, tunnels, bridges, airports, water supply and treatment, waste management, heat and power systems, etc. Most of the infrastructures are large and capital-intensive and their investments often require decades to break even. So why are we talking about infrastructure? We refer to infrastructure because the power generation industry and the power industry, in general, provides a service on a large scale to private companies but also and in particular to all citizens (Fig. 1.2).

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Fig. 1.2

General view of an electrical grid system

The renewable energy infrastructure belongs to a larger system that goes from sourcing and generating electricity on a large scale to making it available in every home. This system includes centralized or decentralized power generation plants (whether from renewable sources or not), transmission lines and high voltage substations (transformers that make the connection between a high voltage grid and transmission lines and between a medium voltage grid and distribution lines), and distribution lines (that connect to individual homes) (Fig. 1.3).

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Fig. 1.3

Schematic representation of distribution versus transmission grid

1.2 Non-mature Markets

There is no definition for non-mature renewable energy markets. Although developing markets tend to be non-mature markets, it is not always true. Indeed, a developing country could have started early to implement renewable energy and thus have reached a certain market maturity and a developed country that has not started a market yet could also be considered a young or non-mature market.

In the following chapters, the term non-mature will essentially refer to Latin American and Caribbean markets and to a certain extent Africa, and will encompass Mexico, Brazil, South Africa, and Morocco despite their relative market maturity. The reason for that is that these countries are still experimenting policies and their local manufacturing industry is unstable compared to large European countries or to the United States of America. We might refer to Asia, but it is important to distinguish markets such as China and India, countries that manufacture their own equipment, from Vietnam or Taiwan for instance.

In general, the fact that the industry is not mature is reflected in an increased level of country risk and/or commercial risk and/or macroeconomic risk.

Renewable Energy Installed Capacity in Developing Countries (IRENA 2020)

Furthermore, it is more interesting in my opinion to look at the situation of countries considered as high-potential attractive countries because this is where investments will be made and cash will flow in the coming decades. Among them, we could mention Chile, Argentina, Egypt according to the Renewable Energy Country Attractiveness Index (EY 2020) (Table 1.1).

Table 1.1

Renewables attractiveness: developing countries ranking (based on EY 2020; REN21 2020)

1.3 Public–Private Context

What is meant in this work with public–private is the inescapable relationship with or implication of public institutions in renewable energy projects. In fact, the majority of power generation infrastructure is linked to a public institution not only contractually (e.g., through connection agreements, concession agreements, licenses, etc.) but also physically because even projects developed by private companies, the so-called independent power producers (IPPs) to generate power and sell it to private companies, for example, to a cement plant, very often use the national grid infrastructure. Indeed, the power sector being a strategic sector for many jurisdictions, governments tend to always have a hand on the electrical infrastructure. Furthermore, historically, large transmissions and power plants were built and owned by the state. Last but not least, the renewable energy industry is highly depending on public policies. This is because, unlike other types of conventional energy, renewable energy is variable and until the past decade needed a support from governments in order to thrive (cf. Renewable energy policy).

We also refer to public–private context, because in non-mature markets governments are in the processes of deploying more infrastructure through partnerships with the private sector. And in some jurisdictions, the involvement of public entities contribute to the bankability of the projects when they, prima facie, might not be easily financeable without this contribution (cf. Blended finance) but on the other hand, the bureaucracy and the extended tender times create further challenges to private companies that are not used to do business in this context (cf. Public–private partnerships and Public tendering).

In a short report of the International Renewable Energy Agency, Scaling up renewable energy investment in emerging markets: Challenges, Risks and Solutions, experts concluded that despite low prices, the market alone proved insufficient to spread the benefits of renewables beyond the large established markets and that intervention by governments, international financing institutions working in partnership with the relevant industry would help the pace and scale of investment (IRENA 2018).

References

Ernst, Young: Renewable energy country attractiveness index (2020). https://​assets.​ey.​com/​content/​dam/​ey-sites/​ey-com/​en_​gl/​topics/​power-and-utilities/​power-and-utilities-pdf/​ey-recai-55-country-index.​pdf?​download

Grigg Neil, S.: Infrastructure finance: the business of infrastructure for a sustainable future (2010). ISBN 978-0-470-48178-3, https://​www.​wiley.​com/​en-us/​Infrastructure+F​inance%3A+The+Business+​of+Infrastructur​e+for+a+Sustaina​ble+Future-p-9780470481783

IRENA: Global Renewables Outlook (2020). ISBN 978-92-9260-238-3, https://​www.​irena.​org/​publications/​2020/​Apr/​Global-Renewables-Outlook-2020

IRENA: Scaling up renewable energy investment in emerging markets: challenges, risks and solutions (2018). https://​coalition.​irena.​org/​-/​media/​Files/​IRENA/​Coalition-for-Action/​Publication/​Coalition-for-Action_​Scaling-up-RE-Investment_​2018.​pdf

REN 21: 2020 global status report (2019). ISBN 978-3-948393-00-7, https://​www.​ren21.​net/​wp-content/​uploads/​2019/​05/​gsr_​2020_​full_​report_​en.​pdf

Footnotes

1

Based on the author personal judgment and knowledge of the market.

2

The objectives are unclear: they are expressed in different units (capacity or percentage of consumption) depending on the jurisdiction and they sometimes include hydropower which creates distortion when comparing the values.

3

In the IRENA report dated July 2020, the value is 758 GW for China and 128 GW for India. This is because the methodology might differ from a data collector to another (ex. commissioning date vs. COD).

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2021

F. MohamadiIntroduction to Project Finance in Renewable Energy Infrastructurehttps://doi.org/10.1007/978-3-030-68740-3_2

2. Developing Renewable Energy Projects

Farid Mohamadi¹  

(1)

Bogota D.C., Colombia

Farid Mohamadi

Email: [e-mail]

Abstract

Renewable energy infrastructure, just like real estate for instance, can take years sometimes even decades for some technologies (e.g., offshore wind, large hydropower) to be developed. The development is a crucial and complex phase that, very often, requires significant investment without a guarantee of success. Yet the promoter, the utility, or the public entity developing the project has to rigorously work on all complex aspects of the permitting, with a specialized team, that would contract experts and consultants to carry out feasibility studies, environmental impact assessments, resource measurements, land purchase or lease negotiation, public relations with the municipalities and social communities. The competitiveness of the financing as well as the project’s attractiveness toward investors will depend on the level of perfection of the development. A proper development leads in principle to a bankable project. Now, when promoters develop projects in non-mature markets, things can get even more complicated and the licensing processes even longer. This is often due to bureaucracy, the lack of administrative structure in place to deal with the requests but also with the poor knowledge of the promoters of the written and unwritten local rules, in particular when the promoters are international players. Whether in existing markets or non-mature markets, understanding the stages of a renewable energy project is worthwhile, especially when it comes to assessing risks. For example, the development stage has a low cost or investment value but also represents low chances of success, a permitted project has higher value but also higher chances to be constructed and thus to generate return, etc. There are stages in the life of renewable energy infrastructure, and each one has a specific risk-and-return profile that attracts different types of investors.

The development of renewable energy infrastructure is an important step in the lifetime of a wind farm, solar farm, or biomass plant. It is at this stage that the right location is identified, the natural resources such as wind speed or solar radiation are measured, land leases are negotiated, grid connection studies and thorough feasibility studies are realized in order to file requests for grid connection, environmental license, and operating permits. This is a relevant phase for the future structuring of the project before presentation to the creditors. Therefore, the more the project development is carried out from a finance structuring perspective the easier it will be to obtain funding. In public projects, sometimes, part of the development is done by the public entity, and in this case, the more they include the structuring perspective, the less changes and corrections it will require the private entity to do in order to have a bankable development.

2.1 Simplified Project Development Timeline

Like any large-scale project development, the development of renewable energy projects requires a multi-disciplinary team (engineering, legal, financial, tax, environment, etc.) as well as some patience and resilience. But beyond that, one aspect is key for the success of the development, it is the project finance mindset. Developers need to think from the very early stage of the project as a future single purpose vehicle (SPV), i.e., a project company with all the requirements related to a structured finance (such as documenting the process, allowing its constant revision by potential lenders, bylaws of the SPV, contracts negotiations that comply with future project finance structure, etc.). We see often cases in non-mature markets of projects that have not considered enough the heavy level of requirements of project finance and face bottlenecks once they start (re)structuring (ex. projects that have been granted permits free of recourse but under the name of the sponsor, once the change of ownership from the sponsor to the SPV is requested, and the permits are publicly presented, they are being challenged, and removing the recourse could take years!).

The development phase including the permitting in general takes between 3 and 7 years depending on the size of the projects and on the country (Fig. 2.1). Once all due diligences have been successfully terminated, to reach financial closing, it takes (also depending on the size and the maturity of the market) between 1 and 2 years. If a cover from an Export Credit Agency is required, or if development banks are involved in the financing, this time can be easily extended due to the amount of requirements these entities need to see fulfilled to approve the loan. And if certain multilateral banks are involved, the review of the fulfilment of environmental requirements (cf. Equator Principles) could also lead to an extended financing process.

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Fig. 2.1

Simplified project development timeline of a wind farm

2.1.1 Business Development in Non-mature Markets

Part of the process of developing projects of renewable energy infrastructure in new markets is the identification of opportunities and their qualification. Often referred to as business development it consists, in the energy industry, in opening new markets either domestic in the own country or internationally. The discipline encompasses from desk researches and analysis of specialized press to fact-finding trips and lobby