A decade ago, community wind projects in Minnesota developed financial structures that have driven much of the first wave of financial innovation within the community wind sector.
A recent report from the Lawrence Berkeley National Laboratory, "Community Wind: Once Again Pushing the Envelope of Project Finance," reviews what its author says is a second wave of financial innovation that moves beyond these now-standard structures.
The report says the majority of community wind projects in the United States have been financed using some form of a partnership flip structure. At its most basic, the structure involves the local project sponsor partnering with a tax equity investor to capitalize a special purpose entity, which then builds and operates the project. Cash benefits include revenue from the sale of power and renewable energy certificates (RECs) and, more recently, possible receipt of Section 1603, federal cash grants. Tax benefits include tax losses from accelerated depreciation deductions and tax credits from the production tax credit (PTC) or the investment tax credit (ITC). Once the tax equity investor has achieved an agreed-upon target internal rate of return, both the cash and the tax allocations flip to favor of the local sponsor.
A second approach has been to privately place equity shares in a project. Here, the project sponsor sells equity shares directly to local investors. Cash and tax benefits are distributed in proportion to the owners' stake in the project. Typically, around half of a project's total construction cost is raised through the private equity placement. The remainder is financed with a bank loan.
The report describes the new wave of financial innovation prompted by recent policy changes, most notably the American Recovery and Reinvestment Act of 2009, better known as the stimulus bill. For a limited time, the ARRA allows projects to elect either a 30 percent ITC or a 30 percent cash grant (the so-called Section 1603 "Treasury" grant). This flexibility enables wind power projects to pursue lease financing for the first time because neither the ITC nor the grant is subject to the production tax credit's mandate that the project owner also operate the project.
In addition, "New Markets Tax Credits" have been available since 2000. Only recently have these been used to finance new community wind projects. The credits provide an investment tax credit of 39 percent over seven years for a qualified equity investment in a so-called "Community Development Entity." This entity channels the equity investment into a loan or equity investment for a qualifying low-income business. The credits seem unlikely to trigger anti-double-dipping penalties when taken in conjunction with the PTC, the ITC or the cash grant. As a result, the report says a wind project could see roughly 60 percent of installed project costs returned through a combination of the New Market Tax Credit and the ITC.
The report also says that Section 6108 of the 2008 Farm Bill expands the Agriculture Department's authority to make loans to renewable generation projects, even if those projects don't serve traditional rural markets. Low-cost debt financing from the Agriculture Department's Rural Utility Service (RUS) potentially is available to an array of wind projects.
The report also profiles five recent projects to demonstrate some of the innovation in recent financing.
Fox Islands Wind LLC
A 4.5 MW wind project (consisting of three GE 1.5 MW turbines) has been operating 12 miles off the Maine coast since November 2009. All electricity from the project is sold at cost to the Fox Island Electric Cooperative, a local provider. Installed cost of the project is $14.5 million, or $3,222/kW. A for-profit subsidiary was formed to own the wind project, Fox Islands Wind LLC. This entity raised $350,000 in seed capital by issuing contingent promissory notes. The project also secured a $9 million construction loan from the Cooperative Finance Corp., a non-profit cooperative formed to bolster the RUS's loan programs. Around $5 million in tax equity investment came from a local business in exchange for a 99 percent interest in Fox Islands Wind LLC.
Permanent financing includes the $5 million equity contribution as well as a $9.5 million, 20-year loan from RUS. This term loan repays both the $9 million construction loan and the $350,000 (plus interest) in promissory notes. The vehicle for the term loan is a Federal Finance Bank loan guaranteed by the Agriculture Department.
Once the project began commercial operations in November 2009, the tax equity investor benefited from the 30 percent ITC as well as accelerated tax depreciation. Structural requirements limited the investor to depreciation deductions for the 2009 tax year. It will maintain its ownership interest, however, for at least five years to avoid ITC recapture. At the end of five years, the electric cooperative hopes to buy out the equity investor's interest.
Ridgewind Power Partners LLC
The 25.3 MW Ridgewind project in Minnesota was developed by Project Resources Corp. through a special purpose entity known as Ridgewind Power Partners LLC. The project consists of 11 Siemens 2.3 MW turbines. Power and RECs are sold to Xcel Energy under a 20-year contract. The project entered commercial service in December 2010.
Union Bank provided $51 million in construction financing, repaid through the sale of the project's hard assets to a Union Bank affiliate. Ridgewind Power Partners LLC then will lease the project for 20 years and will also manage and operate it. Once this sale/leaseback has closed, Project Resources Corp. will expand community ownership by implementing its Minnesota Windshare program, which will open a portion of Ridgewind Power Partners LLC to local investment.
The Union Bank unit benefits from the Section 1603 cash grant, 100 percent of accelerated depreciation deductions and regular lease payments. Ridgewind Power Partners LLC benefits from power sales revenue in excess of operating costs and lease payments. At the end of the 20-year lease term, Ridgewind will have an opportunity to buy back the project's hard assets .
South Dakota Wind Partners LLC
South Dakota Wind Partners LLC is a 10.5 MW project next to the existing 151.4 MW Prairie Winds SD1 project owned by Basin Electric Power Cooperative. The project piggybacks on Basin Electric's project, which was permitted for 110 GE 1.5 MW machines but will use 101. Basin is constructing and operating both projects, will buy electricity generated by the new project and eventually may buy the project outright. It is expected to enter commercial operation in the first half of 2011.
The South Dakota Wind Partners project was financed through an "intrastate offering," one way securities may be offered to the public without having to formally register them with the Securities and Exchange Commission. In general, a community wind project offering only equity shares might find a private placement more manageable because only certain types of equity investors will be able to efficiently absorb the tax credits and depreciation losses from the passive investment. In this case, South Dakota Wind Partners offered three investment options, each made up of a different blend of debt and equity.
The project is expected to cost around $23.5 million to build. Through an agreement with Basin Electric, the exact amount will equal 6.48 percent of Basin's total cost to build both the Prairie Winds SD1 and the South Dakota Wind Partners projects. The ratio represents the new wind farm's portion of the combined projects, 10.5 MW out of 162 MW total. The electricity and all RECs will be sold to Basin under a 20-year power purchase agreement at a price that starts at $43/MWh and rises 1.5 percent a year. A buyout option at the end of 6.5 years would terminate the contract. As a result, notes sold under the placement are limited to 6.5 years. South Dakota Wind Partners would need to refinance the note at the end of the 6.5-year period.
In total, the offering raised around $16.8 million from 600 investors, resulting in a mix of $5.8 million in equity and $11 million in debt. The rest of expected project costs-around $6.7 million-will come from the Section 1603 cash grant, leaving overall project leverage at roughly 50 percent.
Coastal Energy Project LLC
The Coastal Energy Project is a 6 MW wind project consisting of four GE 1.5 MW turbines in Washington State. The project's sponsor, Coastal Community Action Program, serves low-income, elderly and disabled residents in the area. Income generated by the energy project will help to fund a range of social programs that Coastal Community offers.
The project takes advantage of New Markets Tax Credits and is financed through an inverted or pass-through lease structure. The inverted lease reverses roles from a normal lease. Here, the project sponsor or developer plays the role of lessor while the tax equity investor serves as lessee. As lessee, the tax equity investor sells power generated by the project and pays most of the revenue to the lessor. Expensing these rent payments roughly equals the value of depreciation deductions, which the tax equity investor has forfeited by serving as lessee. The developer/lessor uses the depreciation deductions to shelter much of the rent revenue and also passes through the ITC or cash grant to the lessee.
Developers may like this structure because as lessor, they retain ownership at the end of the lease term and do not need to buy out the tax equity investor.
Coastal Energy Project used two tax equity investors. Initially, Wells Fargo placed an $8.18 million leverage investment in Shorebank Enterprise Cascadia (a community development entity). Leverage comes from a loan for the $5 million grant that Coastal Community Action Program earlier had received from Washington State. Shorebank provided an $8 million low-interest loan to Coastal Energy Project LLC. Wells Fargo benefits from nearly $3.2 million in New Markets Tax Credits and eventually will recoup its $3.18 million principal, plus interest.
The second investment came from US Bancorp, which invested $6.86 million in a second community development entity known as United Find Advisors' National Community Fund I LLC. Fund I set up a pass-through lease structure and injected equity into Coastal Energy Project LLC. US Bancorp receives not only the New Market Tax Credits but also the Section 1603 grant (which Coastal Energy Project passes through to it via the inverted lease structure) and cash revenue in excess of lease payments.
At the end of the New Markets Tax Credits period (seven years) both community development entities and tax equity investors exit the project, which will be solely owned by Coastal Community Action Program.
PaTu Wind Farm LLC
The 9 MW PaTu community wind project in Sherman County, Ore., is surrounded by the 850 MW Klondike and Biglow Canyon wind farms. At the end of 2009 and after several false starts, the PaTu project had a 20-year power purchase agreement with retained RECs, a 20-year term loan for roughly 40 percent of the project's $23 million cost, a pre-certified Oregon state Business Energy Tax Credit application worth one-quarter of project costs and the prospect of a Section 1603 cash grant. None of the capital from these sources could flow, however, until the project was up and running. Construction financing, both equity and debt, was still needed.
The equity piece-$5.685 million in preferred equity finance-came from Vert Investment Group and two wealthy families. The preferred equity partners start with a 99 percent interest in gross income and a 100 percent interest in cash distributions. Both flip to 90 percent once the investors have earned back their principal. A second flip to 50 percent occurs once the preferred equity investors reach their targeted internal rate of return. At the end of the project's fifth year of operations, Oregon Trail Wind Farm LLM has an option to buy out the preferred equity investors.
A construction loan came from CoBank, a cooperative bank that is part of the Farm Credit System. Using newly expanded authority under the 2008 Farm Bill, CoBank agreed to lend the PaTu wind project $16.5 million in construction financing, representing nearly 75 percent leverage.
The report concludes with eight lessons learned from these innovative financing approaches.
The complete report is available here.
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