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Ontario's FIT Raises Lender Interest

Ontario's Feed-in Tariff (FIT) program, introduced in 2009 by the Ontario Power Authority (OPA) following passage of Ontario's Green Energy and Green Economy Act (the Act), has captured the attention of the global renewable power development community and manufacturers of utility scale generation equipment. The global lending community is just now waking up to the opportunities this program represents: to date there have been two utility-scale wind projects that have been financed under FIT and there are two more on the way.

With approximately 1,300 MW of solar and 2,300 MW of wind already under contract or with contract offers, the Ontario market is now squarely on the renewable energy map.

A well designed FIT program is an efficient and effective means of supporting renewable energy development. Most notably used in Europe, the FIT is a proven model and several states in the U.S. and other provinces in Canada have hinted at adopting it. Given the track record in Europe, European investors have a natural comfort with the Ontario program.

(Left, Jonathan Weisz) 

A FIT program offers relative simplicity and a guaranteed revenue stream in comparison to other incentive frameworks. No tax appetite is required as is the case for U.S. renewable projects, although for certain investors in Ontario FIT can offer accelerated depreciation benefits. It's not necessary to combine complicated federal, state and local incentives, which makes for easier logistics and financial modeling. The Act also implements a streamlined permitting process known as the Renewable Energy Approval (REA), which is intended to cut down on the cost and time of navigating the myriad of approvals required for these projects. The OPA has proven to be a pragmatic and accommodating off-take counterparty which enhances the comfort developers and lenders take in participating in projects backed by an OPA contract.

While Ontario's FIT program is clearly attractive to the financial community, it does come with some issues to consider.

Domestic Content - Solar projects coming online must have 50 percent Ontario content, rising to 60 percent in 2011. Wind projects must have 25 percent Ontario content rising to 50 percent in 2012. The domestic content requirement is not a value based formula but rather a "check the box" system comprised of nine line item boxes for solar projects and 18 line item boxes for wind projects with each box given a certain point score. The purpose behind this system is to try to ensure that certain manufacturing and service activities are developed in the province (hence the "Green Economy" part of the Act). The delicate aspect of the FIT domestic content requirement is that the test for determining compliance is not undertaken by OPA until after project completion. If a project is found to have failed the domestic content test, the only remedy available to the OPA is termination of the FIT contract. This is a critical issue for lenders looking to finance these projects.

An ad hoc committee of lenders was organized to discuss this issue with the OPA. This committee proposed a variety of solutions including pre-approval of projects by the OPA, pre-approval of suppliers and the addition of a damages remedy in place of contract termination. The OPA has already adopted a process of pre-approving domestic content plans prior to NTP as a mechanism to provide lenders with comfort that a project will meet the domestic content requirement. This has resulted in several successful wind financings; however, it remains to be seen if this will be enough to finance future projects when the domestic content requirements increase in the coming years.

Warranty Coverage - The domestic content requirement under FIT means that new manufacturing facilities must be set up in Ontario. As such, these facilities have no track record for producing reliable equipment; although the equipment design may be of financeable quality, much depends on demonstrating that the manufacturing plant itself can perform. It is necessary for developers to provide lenders with product warranties backed by a financially strong counterparty. In the relatively new solar industry, there are a limited number of panel suppliers with large balance sheets. Developers' choices are to find manufacturers that can provide sufficient warranty protection, find a wrap EPC contractor with a strong balance sheet that can warranty system performance for a sufficient period of time, or for the developer to provide its own warranty support as has been announced by SunEdison Canada, which is planning to use panels for its FIT projects in Ontario that are branded and warranted by its parent.

Connection Capacity - A project will not be issued a FIT contract unless the OPA expects it can be connected to either the Ontario transmission grid or the local distribution system. Certain small projects that are connection-capacity exempt (<500 kW) are still finding that their connection costs are prohibitive. Concerns have been raised by developers and acknowledged by the OPA that without additional investment in Ontario's transmission and distribution systems there will be a limited number of new FIT projects that can be added to the Ontario grid.

(Left, Andrew Kinross)

From a lender's perspective, this issue is low risk as lenders will not provide funding until a FIT contract has been issued and a FIT notice to proceed (NTP) milestone has been achieved. Prior to NTP, the OPA has the ability to retract a project's FIT contract at its discretion. As such, lenders are not expected to fund before NTP.

Political Risk - Rising utility rates coupled with a provincial election less than a year away has led to concern that renewable energy development will be seen as an imprudent use of ratepayers' money in a challenging economic environment. It is true that without the support of programs like the FIT, renewable energy projects would not currently be economic in Ontario. However, the added cost is not responsible for the majority of expected rate increases. Those increases are a result of costs of electricity infrastructure upgrades in the province including the phase out of old coal plants, the refurbishment and expansion of conventional power plants and other outdated infrastructure that is overdue for replacement or upgrading. It will be important for the renewable energy industry to communicate with the public and all political parties that the industry is creating quality jobs and contributing to the province's wellbeing without materially increasing electricity costs.

Regardless, from a lender's perspective, political risk is low because once a project reaches NTP under its FIT contract it is unlikely that political pressure alone can result in a material adverse impact on a project without impacting the province's international reputation. Political risk is not expected to affect projects already in operation or under construction.

Overall, Ontario's FIT program has, as intended, sparked significant interest in renewable energy development in the province. Like any policy initiative, there are challenges that have come along with the opportunities, but the lending community should be able to address them in much the same way they have for conventional power project financing. Prior OPA programs have demonstrated that wind and solar projects can be successfully financed and constructed in the province. We don't expect that will be much different under FIT.

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