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NREL is a national laboratory of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy operated by the Alliance for Sustainable.

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Presentation on theme: "NREL is a national laboratory of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy operated by the Alliance for Sustainable."— Presentation transcript:

1 NREL is a national laboratory of the U.S. Department of Energy Office of Energy Efficiency and Renewable Energy operated by the Alliance for Sustainable Energy, LLC Michael Mendelsohn Sr. Financial Analyst Paul Schwabe Energy Analyst February 1, 2012 NREL Renewable Energy Finance Basics

2 Agenda NREL Finance Team Financing Background Project Financial Structures Financial Modeling Metrics National Renewable Energy Laboratory Innovation for Our Energy Future 2

3 NREL Finance Team National Renewable Energy Laboratory Innovation for Our Energy Future 3

4 RE Project Finance Team – overview 4

5 DATA: RE Finance Tracking Initiative (REFTI) 5 REFTI collects and disseminates wide array of project and financial info including cost of tax equity and LCOE

6 CREST Models: Solar, Wind, Geo 6 Primary: Levelized Cost of Energy (LCOE), Yr. 1 Cost of Energy Secondary: Rolled up and Detailed Cash Flows

7 7 NATIONAL RENEWABLE ENERGY LABORATORY Visualization - RE Project Finance Website Feature Analyses: Unique NREL analysis about policies, innovations and market conditions that impact RE project financing UserLogin:registeredusers cancomment,ratecontent Flexible Search: by keyword, or by filters (single/multi-) by sector, tech, size, policy, financing structure, and/or content type Blog Analyses: Credible, objective policy and market observations from NREL analysts

8 Financing Background National Renewable Energy Laboratory Innovation for Our Energy Future 8

9 Key Metrics Levelized Cost of Energy (LCOE) {or Levelized Cost per Mile (LCPM)} = Discounted sum of costs / Discounted sum of energy produced {or miles driven} Return on Equity (ROE) = Discounted sum of returns to investor / initial investment Internal Rate of Return (IRR) = Discount rate necessary to make returns to investor equal $0 Weighted Average Cost of Capital (WACC) = A calculation of a firm’s cost of capital in which each category of capital (e.g. debt and equity) is proportionally weighted Payback = number of years of benefits to recover initial investment National Renewable Energy Laboratory Innovation for Our Energy Future 9

10 Project IRR impact on LCOE National Renewable Energy Laboratory Innovation for Our Energy Future 10 Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “ Lower risk = lower required return = lower LCOE Every 1% reduction in target equity IRR results in $4/MWh for wind and $8/MWh for PV

11 Sources of Investment Capital Investor ClassRisk ToleranceMetrics DebtLowDebt service coverage ratio (DSCR), Margin or Interest Rate Mezzanine Finance Medium. Will bear some operational risks but not completion risks. Includes “tax equity” common in U.S. IRR, IRR target year, Default Probability (for Fixed- Income Instruments) Balance-sheet Equity High. Bears all project risks.IRR, Payback, other metrics relevant to internal decision- making Project Finance Equity High. Willing to concentrate project risk by increasing project leverage. Project IRR, Levered IRR National Renewable Energy Laboratory Innovation for Our Energy Future 11

12 Financing Risk Factors National Renewable Energy Laboratory Innovation for Our Energy Future 12 RiskExplanationFin. cost impact Technology Risk Any operational experience?High Completion Certainty Developer experience & balance sheet? Medium - perceived risk can lead to high reserve or guarantee requirements Revenue Certainty Is buyer credit-worthy? Are prices firm? Medium - high Duration of Revenue Support Debt duration (tenor) no longer than PPA minus 2 years, shorter based on risk perception Very high Cost Certainty Are components already purchased? Or subject to significant re-pricing? Low

13 Financing Risk Factors, cont’d National Renewable Energy Laboratory Innovation for Our Energy Future 13 RiskExplanationFin. cost impact InsuranceIs contractor / operator properly insured? What if something happens during construction Medium Site controlDoes developer own the development location? High in U.S. Resource Certainty Are long-term, quality measurements available? Variability in historic data? “P” rating will impact debt service coverage ratios Transmission Access Who controls interconnection & dispatch? Proper oversight? Medium – High. Prior operational experience will be assessed Political RiskAre national / local governments stable; court action possible? High Currency RiskAre costs / revenues in desired currency? Is currency stable against the dollar / euro / yuan? Low – can be hedged with currency swaps

14 U.S. Federal Tax Incentives & Tax Equity National Renewable Energy Laboratory Innovation for Our Energy Future 14

15 Tax Incentives Designed to Spur RE Investment Two Primary Federal Incentives Available: 1.Investment Tax Credit (ITC) / Production Tax Credit (PTC) 2.Accelerated Depreciation Together, ITC/PTC and accelerated depreciation count for approx % of a project’s capital investment National Renewable Energy Laboratory Innovation for Our Energy Future 15

16 Tax Incentives: Only Good if You Can Use Them 16 Renewable energy projects and their developers don’t have sufficient taxable income (aka “tax appetite”) to utilize fully Without sufficient tax appetite, the tax incentives have to be “carried forward” Greatly reduces the present value of the tax incentives, and thus their ability to induce investment Credits and depreciation must be claimed by the owner Benefits are nonrefundable and non-transferable

17 National Renewable Energy Laboratory Innovation for Our Energy Future 17 Simplified Financial Structure Representation 1)Single Developer / Investor 2)Equity Partnership 3)Equity Partnership With Debt Power, RECs, Tax Ben. Corporate Parent Project Company Developer Project Company Power, RECs, Tax Ben. Tax Investor / Govt. Senior Lender Developer Project Company Power, RECs, Tax Ben. Tax Investor / Govt.

18 Commonly Used Financial Structures 1.Partnership Flip (PF) structures All Equity PF Cash and tax benefits allocated to tax investor (primarily) until TI receives pre-defined IRR (flip point). After, allocations flip from TI to developer Leveraged PF Similar to AEPF but debt at project level increases required yield by tax investor by approx. 2%, often alters allocation schedule 2.Lease structures Sale Leaseback Developer sells project to an entity (lessor) who then leases it back to the developer to operate and garner revenue Inverted lease (a.k.a. lease pass-through) ITCs passed via Master Lease; Tenant operates equipment and makes lease payments to Owner (not simulated in SAM) 3.Single-owner (balance sheet) National Renewable Energy Laboratory Innovation for Our Energy Future 18

19 Leveraged Partnership Flip Tax incentives can lead to complicated financial structures Senior Lender Tax Investor (99% of equity) Developer (1% of equity) Project Company (equity + PPA/cash debt) Power (and REC) Sales Cash Revenue ITC/Cash Grant less Operating Expenses less Debt Service less Tax-Deductible Expenses (including MACRS and interest on debt) equals Taxable Losses/Income (which result in Tax Benefits/Liabilities) equals Distributable Cash 99% / 100%  99% / 10%  1% / 90% 99% / 10%   1% / 0% Federal Incentive

20 Detailed Financial Structures in SAM National Renewable Energy Laboratory Innovation for Our Energy Future 20 Four Financial Structures Recently Added to SAM All Equity Partnership Flip Leveraged Partnership Flip Sale Leaseback Corporate (Single Owner) Allows For: More realistic evaluation of RE costs Information transfer from finance and legal RE experts to and new industry participants National lab analytic capability Examination of complex support policies

21 Financial Modeling Metrics: Capital Recovery Factor and Fixed Charge Rate National Renewable Energy Laboratory Innovation for Our Energy Future 21

22 NATIONAL RENEWABLE ENERGY LABORATORY The FCR method is one of many standard approaches used to represent finance in LCOE equations 22 FCR equation is a representation of a cash-flow model and determines the amount of revenue needed to cover investment and operating cost. –Defined as the amount of revenue per dollar of investment that must be collected annually to pay the carrying charges on that investment as well as taxes FCR equation, as we generally present it, combines a standard amortization equation (Capital Recovery Factor) and an equation that accounts for the additional revenue required to meet tax obligations. This method was adopted by all program areas during the EPRI/DOE Technology Characterization from 1995/996 and the wind program has used it ever since Fixed Charge Rate d(1+d) n (1+d) n - 1 Capital Recovery Factor Value of Taxes and Depreciation 1- (T*PVdep) (1-T)

23 NATIONAL RENEWABLE ENERGY LABORATORY The use of different Fixed Chare Rates can result in LCOEs that measure different cost aspects 23 FCR calls for an after-tax discount rate (d) and can be either nominal or real (depending on discount rate input). WACC method generally used to estimate d Fixed Charge rates can represent different scenarios: 1.No-tax Investment Scenario: 2.Cost After Tax Deductions Scenario: 3.Before Tax Revenue Required Scenario: d(1+d) n (1+d) n - 1 FCR d(1+d) n (1+d) n (T*PVdep) (1-T) FCR d(1+d) n (1+d) n - 1 FCR [1- (T*PVdep)] Determines before-tax cost of energy that will allow investor to recover costs, meet tax payments, and achieve target ROR Determines after-tax cost of energy that will allow investor to recover costs and achieve target ROR assuming full monetization of tax benefits Determines cost of energy that will allow investor to recover costs and achieve target ROR without considering tax obligations

24 Thank you Michael Mendelsohn Paul Schwabe National Renewable Energy Laboratory Innovation for Our Energy Future 24

25 Extra Slides National Renewable Energy Laboratory Innovation for Our Energy Future 25

26 Tax Equity a Critical Component to RE Financing 26 To take advantage of tax incentives, often a separate investor with tax appetite is brought into the project Generally referred to as “tax equity” Currently very small pool of tax equity investors (investment banks, insurance companies known as institutional investors) Continued tax appetite required (MACRS 6 year recovery period) Complexity of the project structure Wide array of risks perceived: Technology Developer Off-taker (utility or commercial entity) credit rating and contract duration Regulatory (e.g., can regulators alter the PPA contract?) Site access

27 Wind Project Development Process Identify New Market Select Sites Acquire or Control Land Assess Wind Resource Acquire Permits Obtain Transmission Negotiate PPA / Offtake Agreement Design ProjectTurbine Supply Negotiate Turbine / BOP Installation Contracts Finance Project Install Infrastructure Install Turbines Testing & Commercial Operations Operate & Maintain Project Source: Holland & Hart, RE Project Development & Finance Entire process can take 3-4 years to reach operational phase Pick any two: “Fast, cheap, or good”

28 Risk Factor Mitigants National Renewable Energy Laboratory Innovation for Our Energy Future 28 CategoryExamples Private (Market) Long-term contractingPPAs, leases InsuranceConstruction, operation, debt obligation Advanced financial structuresPartnership flips, sale leasebacks SecuritizationN/A (none currently for RE industry) Public (Government) Investment support structures Tax credits (ITC, PTC, MACRS) Loans or loan guarantees Grants Foreign exchange risk mitigation First loss reserves Securitization underwriting (FNMA, GNMA) Market support structures Demand targets (RPS) Guaranteed prices (FIT) Guaranteed markets (e.g. military contract) Net metering policies Indirect support structures Transmission build-out Labor education Infrastructure development (roads, shipping)

29 Project IRR impact on LCOE National Renewable Energy Laboratory Innovation for Our Energy Future 29 * Source: Deutsche Bank Climate Change Advisors, “Get Fit Plus: Derisking Clean Energy Business Models in a Developing Country Context “ How do we de-risk projects in order to lower required return? Deutsche Bank calls it TLC:* PolicyFinancing Impact Transaction Costs LCOE Impact Tax CreditsGoodHighTBD Loan GuaranteesExcellentVery highTBD Cash GrantsGood-excellentLowTBD Production GrantsGood?Moderate?TBD How do different policies impact financing and transaction costs?

30 U.S. Wind Investment in Response to Policy National Renewable Energy Laboratory Innovation for Our Energy Future 30

31 Feed-In Tariff Design Considerations National Renewable Energy Laboratory Innovation for Our Energy Future 31 Design IssueOptions EligibilityWhat resources? Solar, wind, biomass, geothermal, etc.? Contract Length10 years? 20 years? Rate-Setting BasisCost-based? Value of power? Payment StructureFixed or variable with power production? Tariff DifferentiationBased on project size, resource? Interconnection & Purchase Requirements Utility required? Cost allocation? Purchasing EntityPublicly-traded (and rated) entity? Political longevity? Payment AdjustmentsDeclining or increasing payments? One- time adjustment after bond repayment? Purchase CapsLimited by total expenditure or per project expenditure


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