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Project Finance in a Post-stimulus World

In the aftermath of the financial crisis in 2008, the United States and other countries took historic measures to promote investment and financing across chosen sectors of the economy. In the United States, the renewable energy industry was delighted to receive the benefit of several federal programs designed specifically to restore financing to the sector — these included the Treasury 1603 cash grant program and revitalized loan guarantee programs administered by the Department of Energy and the Department of Agriculture. The renewable energy industry also benefitted from the significant efforts made globally to restore confidence in financial institutions, including direct and indirect funding of banks by host governments.

How did the stimulus programs affect the renewable energy industry so significantly? Renewable energy businesses in the United States are oriented to the development, financing and operation of projects — special purpose entities combining equipment and contracts perfect for utilization of long-term debt and equity financing.  In the aftermath of the financial crisis, the project financing market was at death’s door.  Banks that had provided the bulk of debt financing were in disarray, having loaded up on toxic structured finance deals.  The tax equity market in the United States, the province of tax paying financial institutions before the crisis, had shrunk to a handful of still profitable players. 

The stimulus program resurrected both the debt and tax equity markets. On the debt side, governments flooded the banks with capital to lend.  The loan guarantee program became a principal means of financing projects that were too large for the markets to handle as well as those projects with technology considered too new by the banks to finance.  In the world of tax equity, the 1603 cash grant supplemented the regime of the investment tax credit and the production tax credit.  The result?  Project financing of renewable energy projects hit historic volume levels in 2011, and the tax equity market tripled from 2009 to 2011 — with over half of the tax equity being based on financing of the Treasury cash grants.

We are now at the precipice of a new age.  The stimulus programs have run their course.  The 1603 grant program requires commencement of construction (or at least the achievement of a “safe harbor” proxy for the same) by the end of 2011.  The DOE Section 1705 loan guarantee program required projects to have closed financing by September 30, 2011. In the wake of the debacle over the Solyndra and Range Fuels loan guarantees, and general Republican angst over a ballooning federal role in propping up the economy, stimulus related programs are unlikely to be renewed.  Another potential adverse change in the tax equity financing market is the pending expiration of the production tax credit at the end of 2012.

While the 2009 stimulus programs helped revitalize financial institutions globally, such support did not prevent (and indeed may have facilitated) the European debt crisis in 2011.  European banks laden with sovereign debt of the weaker EC members are shedding assets to survive.  A number of the prominent project finance banks have closed their doors to further transactions, and have put their portfolios up for sale.  The effect on the U.S. project finance market has been predictable — less, volume, higher prices and shorter tenors.

So what is the way forward for project financing in 2012?  At a minimum, we should expect the following:

The tax equity market may be chaotic as it deals with several competing influences.  Several tax equity investors have already indicated that they will not be open for business in 2012 if there is not a grant program.  What is not fully known at this point is the volume of projects that will qualify for the Treasury grant through the safe harbor mechanism.  The Treasury Department continues to fine-tune the safe harbor rules, potentially limiting the number of safe harbor qualifications.  In addition, demand for tax equity will be growing from at least three sectors.  Developers in the wind industry are pushing projects forward in 2012 to hedge against the expiration of the PTC at year-end.  Adding to the demand will be several large solar projects currently in construction and still seeking tax equity investors.  Finally, the rapidly declining price for PV solar panels is fueling a jump in distributed generation installations. All of those wind and solar projects undoubtedly will push up demand for tax equity.  While new investors are expected to emerge in 2012, demand may still exceed supply of tax equity, resulting in less favorable terms and pricing for developers. 

The debt market will continue to feel the effect of the European debt crisis, with tenors shortened and pricing increased over the terms in early 2011.  What remains to be seen is whether the remaining cadre of project finance lenders will increase the volume of loans.  Separate from the traditional bank lender market, the capital markets may be taking a greater share of the project finance market — as investment banks seek to connect the superb risk adjusted returns of project loans to a market of investors hungry for yield.  And, of course, if the loan guarantee programs are in their demise, what other sources of financing — equity or debt — might emerge to support newer technology projects?

At Renewable Energy World 2012 in Long Beach, we will have a panel of national experts addressing the prospects for the financing market of 2012.  Our panel includes Ben Cook of SolarCity, Greg Rosen of Union Bank, Todd Grenich of Grenich Capital, Kristian Hanelt of Clean Power Finance, and Stephen Tracy of Novogradac, and will be moderated by the author.  We will have a no holds barred exchange on the sources, terms and hot issues for project financing.  Be there!

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