Project Finance Markets Return but Shun Risk

The renewable energy project market is returning, albeit slowly. Activity in the market seized up during the financial crisis, but some deal-flow has returned with expectations for further gains in 2010.

With the resumption of project activity, attention to detail has returned with a vengeance. Much of this is driven by lenders who want to fund low-risk projects even while their ability to lend remains curtailed. However, another driver stems from lessons learned from previous projects where expectations were not met in terms of construction deadlines, operational performance or change in counterparty creditworthiness. With projects continuing to grow in scope, similar problems threaten to have a larger financial impact unless they are mitigated now. To forestall that potential, known risks are being minimized and previously unanticipated risks are being re-evaluated.

The renewed emphasis on quality is easily seen in the current market for wind project deals. Only very clean deals are getting done and many of these share similar qualities. They start with a Tier 1 turbine supplier that combines low cost, proven availability, good customer support and a strong balance sheet. Next, the developer involved is experienced with a good track record. The power purchase agreement (PPA) is strong with little or no merchant exposure. Even with these improvements in the quality of the deals, however, longer-term financing remains difficult, with developers obtaining less advantageous deals.

Club deals are growing in popularity to reduce lender exposure to any one project and mini-perms are being extended toward 10 years in the face of a still-challenging long-term financing environment. Besides mitigating obvious first-degree risks (such as only obtaining a partial amount of project permits before approval) efforts are being made to understand possible second-degree risks from farther up the supply chain or elsewhere in the financial industry. Unfortunately, it’s difficult in the short term to determine how effective these efforts are at evaluating previously overlooked risks. Some have suggested that one possible proxy for gauging the level of emphasis is to count the number of black swan pictures showing up in presentations on project risk.

This emphasis by lenders on reducing potential secondary risks is having a ripple effect on the entire wind industry. Equipment manufacturers are increasingly judged by their balance sheet in addition to the cost and operational availability of the turbine. Developers are re-evaluating their position largely to reduce their exposure. Many are emphasizing a project’s early-stage efforts and eschewing later stages where more capital is required. Other more established developers recognize that with a growing fleet of turbines, their positioning increasingly is focusing on qualities that are more important to project owners and the project’s reliable production. PPAs continue to be essential for successful deals, with efforts to mitigate exposure by purchasers becoming evident in the details of contract terms and conditions.

Even the federal government is supporting this move toward quality as evidenced by its recently announced Financial Institution Partnership Program. This program’s goal is to ensure efficient renewable energy project funding within the larger Loan Guarantee Program by expediting the underwriting process. By increasing the responsibility of participating private lenders to provide preliminary project due diligence screening, the government is attempting to leverage private sector expertise. The government hopes to ensure that the projects it works with are of sufficient quality and maturity to allow it to focus only on those projects it believes are closest to construction.

Funding wind projects is never easy, even with an experienced team that has done its homework; problems have a tendency to creep in. The recent financial crisis did far more than creep, of course, but not all current problems can be blamed on it. In a fast-moving market, corners were not necessarily cut, but standards were relaxed in some instances to accelerate deal-flow.

The market is returning now, but with a healthy dose of skepticism. We’ve all learned it is always dangerous to rely too heavily on your assumptions—even those you thought you controlled. As Mark Twain once said, “It ain’t so much what we know that gets us into trouble. It’s what we know that just ain’t so.”

The views expressed in this article are those of the author and do not necessarily reflect the opinion of Charles River Associates or its Energy & Environment Practice.

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