Investigate Financing Implications and Project Bankability

The return on investment of each procurement method is likely a key determining factor for your organization’s willingness to invest. Therefore, understanding the costs associated with each method is crucial.

It is also important to appreciate the cost of finance, as it has a large impact on the cost of renewable energy procurement – for both turnkey purchases and third-party PPAs. Turnkey purchases require upfront financing to build the project, and third-party developers must have financing secured to build the power generation asset for the PPA.

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Main Points

• Procuring electricity through a third-party PPA enables the corporate buyer to avoid upfront investment. However, the corporate buyer must seek a bankable project – one in which the developer is able to secure lending to build the project.
• For a turnkey purchase, corporate buyers must invest significant upfront capital. They commonly utilize debt financing through either corporate financing or project finance.

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First, Understand The LCOE

The levelized cost of electricity (LCOE) is the total cost of an asset based on its electricity output and investment and operating costs.

Realizing the LCOE for certain renewable options will help you to compare the cost of renewable procurement versus continuing to pay a standard utility tariff. The LCOE is an important calculation for both turnkey purchases and third-party PPAs–though with different inputs. The LCOE will also vary between commercial scale solar assets, rooftop solar PV, and wind.

Next, Read About Bankability

Corporate buyers interested in engaging in a PPA must understand what lenders look for in a bankable project. This might impact what issues might arise during PPA negotiations between the developer (or independent power producer) and the corporate buyer.

And Read This

Commercial banks and equity providers evaluate corporations’ credit worthiness and ability to pay before lending to corporations or developers involved in a third-party PPA.

The most obvious financiers are banks. Both private and public sector banks engage in both corporate and project finance. However, regulatory changes in the last decade in many parts of the world have made it harder for banks to grant long-term loans. Consequently, banks have been reducing their long-term lending to energy and infrastructure projects, although they still engage in providing short-term liquidity (typically during the construction period).

Development finance institutions (DFIs) are another, special type of financier. DFIs typically have a public-sector or supranational nexus and engage in granting various types of finance that contribute to economic development. Examples of DFIs include the World Bank, the Asian Development Bank (ADB), the Indonesia Infrastructure Finance (IIF), or Kreditanstalt für Wiederaufbau (KfW). Climate change is considered a development issue and therefore many DFIs are active in financing renewables. DFIs typically act as primary lenders (or guarantors) on projects but also often partner with local finance institutions to achieve scale. The financing granted by DFIs can have attractive terms and in some cases also comes with useful technical assistance programmes; however, they can also come with specific development and political requirements.

Institutional investors, such as insurance companies, pension funds and sovereign wealth funds, also participate in financing renewables. Those investors typically buy the debt of operational projects (often in bond format). This constitutes an attractive investment proposition for them because the long-term (and sometimes inflation-linked) nature of this debt matches the cash flow profile of life insurance and pension liabilities well, and also because in some cases they provide returns that are uncorrelated with traditional credit and listed stock market returns.

Read Excerpt: Module 4.1 from ‘Corporate Renewable Energy Procurement: India’ course by Imperial College London and Confederation of Indian Industries.

Next, Understand Project Finance

Project developers and corporate buyers investing in turnkey purchases have two primary options for financing: project financing and corporate financing. While project financing can be complex with several legal and financing parties, it offers the benefit of larger amounts of debt with longer maturities. On the other hand, corporate financing, while simpler, could be more expensive, have a shorter tenor than the renewable asset, and could simply not be available if a company’s credit is not high enough.

Note that an SPV refers to a special purpose vehicle, or a legal entity created by a parent organization to isolate financial risk.

Read: Excerpt from A Primer on the Project Finance Industry by Corporate Finance Institute.

Financing for renewable energy generally takes the form of project finance, where the cash flow and assets are isolated from the firm.

Read: Excerpt from A Primer on the Project Finance Industry by Corporate Finance Institute.

Now, See This

The cost of renewable energy lies mostly in the capital expenditure, with low operating expenditures as compared to fossil energy. With a brand new project under a turnkey purchase or third-party PPA, financing structures differ.

See: Table 3 from Renewable Energy Procurement Guidebook for Colombia by CEIA.

Finally, Consider Green Bonds

Some regions have increased green bond issuances as an instrument for investment. Corporate buyers investing in a turnkey purchase could take advantage of green bonds to finance their project.

Suggested Actions & Next Steps

• Investigate: Talk to your finance department about the various financing options available in your region, your company’s credit worthiness, and potential for upfront financing. Research risk mitigation instruments (e.g., guarantees, currency-hedging instruments and liquidity reserve facilities) available by local governments and public financial institutions.
• Investigate: Talk to colleagues or peers who have procured energy or search online to find financing institutions available in your operating region. Make a list of these institutions and pros and cons of working with each one.