Geothermal, Project Development, Wind Power

Financing Wind Power

Issue 1 and Volume 1.

According to New Energy Finance wind analyst Tyler Tringas, new build asset financing for wind projects was down 52 percent globally in the first quarter of the year. Total activity was slightly down quarter-over-quarter in the second quarter, at $11.6 billion.

“In the U.S., we expect loan activity to increase over the next 12 months,” said Tringas. “The credit crisis effectively broke down the so-called ‘tax equity’ financing structures that financed the majority of new wind projects in the past.”

The American Recovery and Reinvestment Act (ARRA) provided a possible solution for the problem by allowing the Treasury Department to issue grants for 30 percent of the cost of new renewable energy projects. That, along with a loan guarantee program by the Department of Energy, should spur lending activity after what has been a basically frozen 2009.

“Now that the first sets of rules have been issued, the reaction has been generally positive, with several new wind financings closing just days after the announcement,” said Tringas. “Banks, which avoided new lending this year, seem generally eager to deploy new capital into the renewables sector.”

Tringas said low natural gas prices have brought down average wholesale electricity prices and put some projects in doubt. T. Boone Pickens’ massive Texas wind farm may be the biggest and most public casualty.

“Much of the development in the windy interior of the U.S. is in more regulated electricity markets that are insulated to a large extent from the rise and fall of natural gas, while mandated renewable portfolio standards will continue to create an incentive to build new projects,” said Tringas.

Transmission — or rather the lack thereof — ranks as a significant issue for some wind projects.

“The transmission issue will not get sorted out without additional legislation at the federal level,” said Ed Feo, partner, Milbank, Tweed, Hadley & McCloy LLP. “Our current regulatory and legal scheme is not sufficient to be able to overcome the impediments created at the local levels with respect to transmission.”

To carry out the Obama administration’s policy goals of expanding renewable energy, adequate transmission is needed to wheel resources from areas that are a long way from load centers, but transmission bills being considered in Congress have yet to become law.

“It’s really clear that there is a much more organized opposition to wind farms today than there was a few years ago and it’s not going to surprise me that that opposition will grow, not lessen,” said Feo.

To find out what’s ahead this year for the wind industry, Renewable Energy World North America magazine asked leading firms in the wind farm financing sector to describe their companies’ investment and lending strategies. Roundtable participants include:m

Ed Feo, partner in the law firm of Milbank, Tweed, Hadley & McCloy LLP. Feo co-chairs the firm’s project finance and energy practice. He represents sponsors and investors in the energy and infrastructure industries and specializes in renewable energy projects.

John M. Eber, managing director, energy investments, at J.P. Morgan Capital Corp. Eber manages the firm’s activities for tax-motivated equity investments in energy assets. He directs a team that originates, structures and executes investments and advises other equity co-investors.

Jon Fouts, managing director, global power and utilities group, the Investment Banking Division, Morgan Stanley. Fouts has extensive experience in advising a wide variety of clients in landmark mergers and acquisitions, corporate finance and capital markets issues.

REWNA: Please list some notable highlights of the last 12 months of wind power investment activity for your company.

Feo: Until September last year we were closing transactions at the rate of one every 10 days. September brought the Lehman bankruptcy and the financial crisis, and the new money stopped. We then represented parties on workouts for some of the major wind developers that were big into debt. That kept us busy until the first part of 2009. Since March, the finance market has picked up and while we are perhaps not at the same pace as pre-crash, we are closing deals now about every two to three weeks–evidence I think that there is financing available for the right projects.

Eber: J.P. Morgan closed tax equity investments in nine U.S. wind farms for five sponsors with a total capacity of 1,380 MW. These transactions raised $915 million of tax equity, with J.P. Morgan itself funding $475 million.

Fouts: Morgan Stanley provided construction financing, tax equity financing and a commodities off-take and power hedge for NaturEner Glacier 1 and 2. We advised Duke Energy in its acquisition of Catamount Energy Corp., an independent wind energy company.

The deals we are focused on are not straight up-the-middle project finance deals. In today’s environment, the deals that are getting done are those that are structured transactions where someone is structuring the off-take advantage, someone is providing the financing and someone is providing the equity, as we did in Glacier 1 and 2. Deals can get done in this market but they require a little more work and more structuring.

REWNA: Please describe your company’s investment and lending strategy for wind.

Feo: We focus on financing primarily and development secondarily. Many of the major sponsors and banks have designated us as lenders counsel, which is where we are best known in the wind sector. Our strategy for 2009 is to continue the focus on banks and institutions and to boost our Washington, D.C., practice focused on loan guarantees.

Eber: J.P. Morgan invests tax equity in U.S. renewable power projects including wind, solar and geothermal power projects. We are a principal investor and arrange and advise other institutional tax equity investors who co-invest with us. Our clients are the owners and operators of U.S. renewable power projects, in particular those that do not have the ability to currently utilize the tax benefits that flow to project owners. Our passive investment allows our clients to utilize these benefits as repayment for our investment while providing a significant portion of the project’s capitalization.

Fouts: We are focused on permitted, scalable projects with 150 MW or more. We will do highly complex, nonstandard structured projects. The financing that people are interested in doing now has the off-take and the purchase power agreement (PPA) in place. To the extent that they don’t, a bank has to come in and provide that synthetically. That’s what we’ve done. Instead of having a long-term PPA with one of the big utilities, Morgan Stanley will take the electricity on a long-term basis and we’ll structure the financing based on our off-take of that electricity. We actually buy the electricity from the producer and sell it.

REWNA: How do you currently mitigate investment risk?

Feo: The finance market is focused on projects with (1) long-term power contracts; (2) big name turbines; (3) major sponsors; and (4) great resources including great data supporting that resource. We follow our clients’ lead in that regard.

Eber: We are building a highly diversified portfolio of investments, primarily utilizing the traditional partnership flip investment structure. Our energy portfolio currently includes one thermal solar project and 55 wind farms in which we’ve invested $2.3 billion. These projects are located in 17 states with 13 operators, utilizing all the major turbines, selling power to a highly diversified group of utilities and power marketers. Additionally, we seek experienced sponsors with capital to invest alongside us, adhere to individual project investment limits, structure each investment conservatively and perform extensive due diligence on each project to mitigate investment risk.

Fouts: We create our own internal hedges. By buying the electricity and selling it, we’re hedged on the electricity side and we can provide the financing. It’s all done internally at Morgan Stanley, but from the wind company’s perspective, it’s similar to signing an agreement with the utility to take the electricity and then coming to Morgan Stanley for help financing the project.

REWNA: What is your company’s “sweet spot” in terms of project size (in megawatts), investment level (dollars) and lending target (utility vs. independent power producer and so on)?

Feo: We handle a wide range of deals. The smallest is at $1million and the largest is nearly $1billion. In today’s market the financing sweet spot is 50 MW to 200 MW projects or a cost of between $100 million and $400 million.

Eber: We try to limit our net investment in any single high-quality project to $75 million, with a higher limit for portfolio deals. We have been very successful in the past few years bringing in other institutional investors to join us to cover larger projects or portfolios of projects. In fact, we closed two financings in 2007 totaling $700 million or more of tax equity where we were the lead investor. Under the new cash grant program, a $135 million individual investment amount (inclusive of the cash grant) is likely to support a project size around 100 MW. Most of our clients are either IPPs or non-U.S.-based utilities.

Fouts: Anything over 150 MW. $100 million of financing is what we focus on, with either IPPs or utilities.

REWNA: How have changes to federal tax incentives affected your company’s lending portfolio and prospects for additional lending?

Feo: The biggest problem to date is waiting for Treasury to come out with some rules. In the absence of that there has been an unbelievable amount of rumor and innuendo, usually under the guise of being information presented at conferences, conference calls and webinars. Most of this is junk and unnecessarily pollutes the discussion. In my view, the federal government has done an incredible disservice to the renewable energy space in taking so long to come up with guidelines on how some of the “benefits” of the ARRA are to work. That said, we have worked out structures for transactions in the meantime and have closed deals. More will happen, though, when the federal programs are more active than they are now.

Eber: Over the next two years we expect most U.S. wind power projects to claim the 30 percent cash grant from the U.S. Department of Treasury in lieu of the production tax credit (PTC). Many wind project owners still won’t be able to efficiently utilize the accelerated depreciation deductions earned by wind farm owners, so we expect many of them will look to us and other investors for tax equity. We will utilize very similar structures to the ones that were used for projects that qualified for PTCs. We expect to fund a significant portion of the total project cost. Utilizing the grant will limit our use of our tax capacity and reduce our exposure to project performance. These characteristics will help us draw in new tax equity investors and ultimately minimize the cost of capital to sponsors

Fouts: The tax appetite for most traditional tax equity providers has decreased significantly. Morgan Stanley is still in the tax equity business on a selective basis and we have creative financing structures that use the ITC grant and DOE guarantee that provide developers with alternatives to tax equity.

REWNA: Please describe a wind finance project your company has been involved with since the start of 2009.

Feo: We have closed debt deals for senior bank lenders for Acciona, Invenergy and Eurus, among others. The deals are middle of the fairway for this market–under $400 million, major turbine vendors, major sponsors.

Eber: We are finalizing our first cash grant-based investment for a wind project where we will provide all of the required tax equity. This investment is for a client that would like to utilize our traditional partnership flip structure tax equity financing for its other 2009 wind power projects.

Fouts: For NaturEner Glacier 2, we are the power off-taker and provided a power hedge. We gave 100 percent of construction loan and tax equity take-out. The tax equity deal was the first closing for a wind farm financing incorporating a Department of Treasury cash grant-based structure.

REWNA: What is your outlook for wind power loan activity and lending volume over the next 12 months?

Feo: We expect the market to recover significantly this year. We don’t think the issue for wind is capital, because most wind farms can fit within the size range that the finance market can and will handle. We don’t think the federal loan guaranty program is necessarily of any great benefit to wind projects–unless those projects have unproven technology in which event the DOE loan guarantee program is the only place financing will be available. The biggest restrictions on the market will be (1) availability of power contracts–no PPA, no finance in today’s market; (2) PPA pricing, which in many places is driven by natural gas prices, which have declined; and (3) transmission. Despite all of the noise around ARRA’s benefits accorded to transmission projects, the fact is that no transmission bill has passed through Congress, all of the problems of multi-state jurisdiction still exist and the timeframes for completion of transmission projects remain long.

Eber: The breakdown of wind power financing activity is clearly more difficult to predict in the dynamic environment that we’re presently in. We do believe that all forms of financing will be needed, including tax equity, project debt (whether or not guaranteed/funded by the government), corporate debt and possibly lease financing. J.P. Morgan, along with our institutional partners, would like to continue to fund a significant amount of megawatts of U.S. wind projects over the next 12 months in addition to a significant amount of utility-scale solar PV and geothermal projects.

Fouts: We are starting to see interest again in the sector from infrastructure funds, European strategics and private equity. For high quality developers that have permits, PPAs, transmission strategy or spinning assets in attractive geographies, there are financing opportunities.

Nancy Spring is senior editor at Power Engineering.