Inside Solar Project Finance: How Investors Measure Risk


Whether dominated by debt or tax equity, a successful solar project finance transaction in the current market will require a combination of certain non-negotiable credentials to even be considered by investors. Although many large financial institutions have been paying increased attention to renewable energy investments as compelling additions to their portfolios, perceived risk will continue to factor heavily into decisions.

Therefore, any solar power project developer and its partners seeking financing must first take an honest look at the technology being employed in the project in question, according to Terry Friddle, co-founder and partner of Pathfinder Capital.

‘Project finance works best when the technology that is being used is a proven technology,’ Friddle explained during a recent webinar sponsored by the Solar Energy Industries Association. ‘If there is any sort of development risk, project finance is generally not a good tool to use.’

Technology risk considerations will be most acute for sophisticated tax-equity investors, which tend to be more risk-averse than other types of investors, added Matthew Meares, director of project finance at Amonix Inc. Large Fortune 100 companies, for instance, will seek tried-and-true solar technologies, while also factoring in the deal's structural risk.

But perhaps most importantly, the panelists agreed, the perceived strength of the project's power purchase agreement (PPA) and the credit quality of the PPA's offtaker must be rock-solid.

‘With the difficulties of the general economy, there is a very clear need to deal with creditworthy offtakers,’ Friddle said. ‘Most parties have flat-line criteria; the offtaker must be of investment grade.’

In fact, provided that the project developer is reliable and boasts a sufficient track record, the strength of the PPA is the foundation on which a bank will base its entire deal, added Lee J. Peterson, senior manager of research and planning at Reznick Group PC.

Moreover, a multitude of tax-equity and related accounting intricacies will be directly affected by the language in the PPA, Peterson noted.

‘The [Internal Revenue Service] views the sale of electricity as the sale of a tangible good,’ he pointed out. ‘How the PPA reads can determine precisely whether, for example, you have the ability to defer revenue recognition on a prepaid PPA. There's a whole host of very critical tax issues.’

Prospective investors might next consider resource-assessment liabilities. Fortunately for solar project developers, the resource-assessment concerns that may impede financing for other types of renewable energy projects pose a relatively minor threat to solar deals.

‘One of the things that makes solar more appealing than some other deals is that we don't have feedstock risks or wind variability, for instance,’ noted Peterson. ‘The relatively predictable output does make the argument easier to an investor.’

Construction risk, on the other hand, can present a stumbling block, particularly for small commercial projects, due to their shorter timelines.

‘When you look at the amount of money that a construction lender can make over that short period of time, it becomes a question of whether it's worth it to put that money to work for a short time,’ explained Friddle.

Generally, although investors' individual portfolio needs and interests will determine their ideal projects, developers of small and midsize projects will likely find the dealmaking process more treacherous than their counterparts developing larger projects.

Friddle noted that his firm divides the pool of prospective developments into five approximate categories: 5 MW and below, 5 MW to 50 MW, 50 MW to 100 MW and over 100 MW. ‘All of us are beginning to see incredibly large transactions nearing or above the gigawatt range,’ he added.

Larger projects are generally preferable, Peterson agreed, although he foresees a gradual shift toward growing ease for smaller-scale project developers as the debt markets continue to thaw.

A finance application package for a solar project of any size must include a series of vital documents (in addition to the PPA), ranging from an operations and maintenance agreement to an equipment-supply agreement to an independent engineer's report. The relative importance of each document will be a direct function of the size of the project to be financed, according to Friddle.

Once all of the required documents are in place and the investor and developer have begun negotiations, the risk-assessment rules become highly individualized, based on both investor preferences and deal nuances.

During any project finance discussion, the ‘dynamic tension of the transaction is that the investor will want to see that the developer has skin in the game,’ noted Friddle.

‘In the end, you're building the deal to satisfy the investor during the tax period or until the investor reduces its share so that it is not a dominant partner,’ Peterson added. ‘Until then, you must meet their targets.’

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