Project Financing Renewable Energy Sector

Saurabh Bhat CEO, Ambit Finvest Limited

August 2013

What is Project Finance

Financing against cash flows and project assets to a Project SPV typically for a green-field activity or expansion into new markets Financing generally comprises construction and operating period Usually Project Financing is Non-recourse or Limited Recourse

Why Project Finance

Ability to leverage without impacting Developers balance sheet Risk Diversification may lead to credit enhancement Longer Tenors Best model for Public Private Partnership financing Greater transparency in project execution and operation Tax benefits Documents/structure provide high enforceability for revenue receipts. However, Issues to be prepared for by Sponsors Restrictions on payments to sponsors Restrictions on sale/exit Need to grant oversight and monitoring rights to lenders (interference??) Expectation of backstop to sponsors

Project Finance Decision Making- Lenders Perspective

Counter Party Analysis
Ability and Willingness to Pay Reputation, Experience and Financial Strength

Risk Analysis
Pre Completion Post Completion

Financial Modeling and Base Case Projections

Assumptions Ratios and Debt Servicing Capability

Sensitivity and Break even Analysis

Breakeven DSCR Most Likely and Downside scenarios with probabilities assigned

Project Finance Decision Making (contd..)

Structuring to Mitigate Risks
Sponsor commitments towards project completion and cash shortfall Contractual Framework which diversifies risk of operations Security Package Financial Covenants

Underwriting/Syndication/Participation
Sole or Joint Underwriting Hold Level Pricing and Fee Structure Market Flex, Clear Market

KEY CONSIDERATION IS TO DEVELOP STRUCTURES TO IMPROVE PREDICTABILITY OF CASHFLOWS

Counterparties Governments and Related Institutions

Stability of political system Environmental, FDI policy, coal linkages or other approvals from central and state and local govts Regulatory Risk Criticality of project to state/central Government

Sponsors
Execution Capability (track record, depth of management) Ability to bring in equity and support cost over runs

RM Suppliers Off-takers/Buyers e.g. PPA counterparties EPC Contractors

Contractual Foundations
PPAs (Off-taker and Project SPV)
Fixed and Variable Components of Tariff Linkage to cost of fuel Take or Pay Availability Based Tariff

Fuel Supply Agreements

Price linked to quality (ash content, calorific value) Penalties for non supply Allocation of Mines by Ministry from Central Coal Fields

Transportation Contracts
LNG Charters (dedicated vessels, demurrage Gas through Pipelines Imported coal through dry bulk vessels

Contractual Foundations
Construction Contracts e.g. LSTK (Project SPV and EPC Contractor)
Liquidated Damages Work men Insurance Pass through for FX and other escalations

Security Agreements (Project SPV and Lenders)

Loan Agreement Mortgage and Hypothecation Agreements Assignment Agreements for Various Contracts like PPA, Fuel Supply etc Escrow Agreements

Technology License Agreements O&M Agreements Shortfall Guarantee/Completion Guarantees (Sponsors and Lenders)
Guarantees from sponsors to ensure timely completion of construction phase Shortfall undertaking to ensure min DSCR

Structure
Concessionaire/Offtaker

Concession/Offtake Agreement Third Party Legal and engineering financial due diligence Firms

Independent project Reports

O& M Contract Operator

Project SPV

Project Finance Lenders

EPC Contract

Contractor

Completion Guarantee / Contingent Equity Undertaking Equity

Sponsor

Risk Framework
Market and/or Price Risk
Demand reduction (economic down turn),Substitution, Technology obsolescence, Competition

Construction/Completion Risk
Site Acquisition/ Rehabilitation, Cost Escalation / Time Overrun Risk, Contingency / Event Risk

Political Risk Approvals, change in laws, political instability/war strife, exchange control Financial Closure Risk Interest Rate, Exchange Rate Risk Technology Operational

Nature of Project Financing

Senior Debt/Syndicated Club Loans/Project Bonds
Pari-passu security sharing among lending members (1-2 lenders act as Lead) Common documentation with project Company and interse agreement among lenders Lenders need to act by majority and not unilaterally Construction debt/WC debt and term debt

Mezzanine finance
Riskier than senior debt with lower security Generally bullet or ballooning with back ended repayment Higher pricing than senior debt used to achieve necessary leverage caps and improve RoE on project

Security Structure for Project Finance

Loan Agreement with charge on project assets , and project cash flows, sponsor shareholding pledge
Material adverse change Step in rights Right to assign loan Dividend and other payment to sponsors restricted No exit/sale for sponsors

Assignment Agreements for all material contracts like EPC, Concession Agreement, PPA, FSA etc which gives lenders step in rights Escrow of cashflows and waterfall mechanism Insurance Loss Payee rights DSRA

Public Private Partnership Types of PPP

Service Contracts Management Contracts Lease Contracts BOT Concessions JVs

PPPs contd..
Service Contracts
Shorter Duration (1-3 yrs) Multiple contracts for various activities Useful when its important to keep entity public but infuse efficiencies in certain operations Need monitoring Easier to sell politically Cant be useful to attract capital investment

PPPs contd..
Management Contracts
Ownership is public but most functions transferred incl management and operations Performance targets clearly defined in terms of improvement of the utility (hospital, bus terminal etc) Incentives linked to performance Capital Investment (asset replacement or expansion) remains with the Public Sector Tariff setting is also responsibility of Public Sector Brings focus on profitability all across Good starting point before complete privatisation Possibility of mis-use/abuse to inflate performance should be checked through independent monitoring

PPPs contd..
Lease Contracts
Operator provides service at own expenses and is allowed to charge a fee Duration is upto 10 years All losses to the head of the operator but so also the upside of profits Fixed lease payments irrespective of revenue achievement Drives efficiency but can also lead to neglect on maintenance expenditure to improve profitability during lease period.

PPPs contd..
Concession Agreements/ BOT
Private sector responsible for operation, maintenance, collection, management, financing etc Normally concession is for existing asset and may involve capacity addition to it or just pure operation Private Operator also responsible for capital investments (e.g. distribution concessions link tariff hikes to capital investment for improvement of distribution network) Tenor of concession is 25-30 yrs

PPPs contd..
Concession Agreements/ BOT
May involve viability gap financing from the Government to assist in capital investment BOT is a specialised concession where a new infrastructure asset is created under the Concession and the builder has the right to operate and charge fee for the same to users

Risk Sharing in PPP projects in India

Construction Risk Risk Participant Operation Risk Revenue Risk Market Risk Interest Rate Risk Regulatory Risk

Equity holder Lender Govt* EPC contractor

No No Partial Yes

Yes No No No

Yes No Partial No

Yes No Partial No

Yes Yes No No

Yes No Yes No

* Govt shares risk through compensation clauses in the Concession Agreement

Degree of Risks in PPP Projects in India

Construction Project Road Port Airport High High High

Operation

Market

Interest Rate

Payment

Regulatory

low Medium High

Project Specific Medium High

Project Specific

Medium Low Low

Medium Medium Medium

Project Specific
Project Specific Project Specific

Power

Medium

Low

Low

High

High

State of Power Sector In India

As of CEA 2011 report, 1,81000 MW of installed capacity with 65% thermal, 21% hydro, 11% renewable and 3% nuclear. Bulk of 12th plan capacity addition of 82 GW left to IPPs and state discoms. 11 th plan additions are 50% of targeted. Of 12 th proposed generation addition target, <40% is expected to be achieved. Peak Demand Deficit continues to be 13% and energy deficit is 12% Of 181 GW of installed generation capacity , operational capacity is <145 GW due mainly to inadequate fuel (coal, gas)

State of Power Sector In India

State Discoms generated about 35-40,000 cr of losses in FY11 contributed by
High Debt leading to interest expenses Inability to raise commensurate tariffs in face of rising input costs Widening T&D losses and unchecked subsidies

Some progress made through adoption of Shunglu committee recommendations in July 2011 by states Total Debt of Power Sector i.e. State , Central Utilities and Private Utilities is Rs 6.5 trillion
40% by Banks, 30% by PFC, REC and Infra Finance Cos 25% from Bonds, Govts and ECBs

State of Power Sector In India

Significant reliance on thermal
Share of thermal expected to increase from 65% as of now to 70% Sector needs 472 mn tonnes of coal and 72 mmscmd of gas p.a. however coal supply stagnated with 77 mn tonne deficit which will rise to over 200 mn tonnes p.a. hence huge dependence on imported coal

Renewable Sources of Power A Distant Dream

While state have renewable power obligations, they dont have fiscal bandwidth to give higher tariff or tax breaks/subsidies Hydro Power mired in environmental and R&R issues. Several large projects in NE and Himachal facing delays Wind Power PLF is key issue. Except for Rajasthan and TN, not many lucrative sites Solar : capital cost is high and hence breakeven tariffs are > Rs 10/kwhr

Delays Plaguing Capacity Addition

Land Acquisition Complexity in Technology Delays in Financial Closure Delays in Coal or other fuel supply linkages Delays in government approvals
Environment R&R issues

Delays lead to cost over run and financial closure of the same leads to further delays

Renewable Energy World Status

In 2012, renewable energy (excl traditional biomass) supplied 10% of world energy demand. Of new capacity addition in last 2 years, share of renewable energy was about 50%. Of this 20% was wind and 13% each was solar PV and hydropower with balance 4% from biofuels. Renewables esp solar and on shore wind have become more price competitive due to economies of scale reducing capital costs Top countries using renewable energy sources were USA, China, Germany, Brazil and Canada with Spain , Italy and India being in the next bracket. Total world renewable capacity (excl hydro) at end of 2012 was 480 GW and hydro was 990 GW. Of the 480, solar PV was 100 GW with balance coming from wind and non traditional biomass.

Renewable Energy India Status

As per 2009 IREDA estimate, Indias renewable energy capacity (excl large hydro) is 85000 MW comprising
Wind (45000), Small Hydro (15000), Biomass (17000), Cogen (5000), solid Waste to energy (3000)

Actual 16GW installed wind capacity (18-19% CAGR over last 5 years) Actual 400+ MW of solar capacity after a great start in 2011, capacity additions have sputtered in last 2 years. 40 GW of installed hydro power Actual Generation of renewable energy was 20 bn kwhr as compared to 40 bn by Brazil and 60 bn by China (2010)

Renewable Energy- India Status report contd..

JNNSM unveiled 20 GW targeted by 2020 under USD 19 bn program. Achieve 20 mn sq mtr of solar collection area by 2020. Renewable Purchase Obligations to include solar power purchase to form 0.25% for discoms by 2012 and 3% by 2020. Renewable Energy Certificates (REC) launched in 2011. Incentives in form of Preferential Tariffs, REC, CDM, Accelerated Depreciation, Tax Exemption, Excise Concessions, Waiver on wheeling charges by state or central govts.

Key Challenges for Renewable Energy

Long gestation period of projects Access to capital difficult and costly especially debt
High cost compounded by shorter tenors and absence of fixed rate lending

Not very favourable state govt policies on renewable energy Poor financial health of discoms means pressure on tariffs (solar and wind projects with high capital costs need higher tariffs) Perceived technology risk and absence of successful renewable energy debt financing case studies means banks are wary

Key Challenges for Renewable Energy

300 bn gap in infrastructure financing over next 5 years and renewable energy is lower in pecking order of priority Cost of solar power generation/kwhr is higher in India due to high financing costs and lower operating efficiencies PLF uncertainty (wind flow predictions or sunny day predictions) Projects dont meet base load requirements hence not attractive from a utility off-taker perspective

Project Finance in Renewable Energy

Project finance has emerged as a key financing tool
Renewable projects need large investments as they are capital intensive balance sheet financing would distort risks and returns

Multi-lateral agencies have emerged as backstops for political/country risks but project viability is being evaluated on stand alone limited recourse basis (non recourse financing is RARE) Renewable energy projects will have limited predictability of cash flows given insufficient track record
Solar projects have limited merchant attraction due to peak non peak production, high marginal costs/tariffs need PPAs to attract lenders Wind power faces similar issues with climate change risks making merchant or limited period PPAs unacceptable. Relatively new technology

Sponsor exits are restricted under project financing esp renewable energy project financing

Some Notable Successes in Renewable Energy from Financial Closure Perspective

Reliance 40 MW 560 cr Dahanu Solar Project (USEXIM, ADB financed), 25 yr PPA with Reliance Power at Rs14.9/kwhr Accionas Tuppadahalli 56 MW, 340 cr wind power project. PPA with Rs 3.4 /kwhr for 20 yrs with SEB Lancos Chinnu Solar Project. 100 MW 1800 cr project, Winner under JNNSM. 25 yrs PPA with state agency at Rs10.5/kwhr Nuziveedu Groups 20 MW solar project for 235 cr.

Key Challenges for Large Hydro

R&R / Environmental issues Capital Cost/Mw is high 7-9 cr/MW as compared to 5-6 cr for thermal Long construction period and higher chance of delays and overruns due to geological and political uncertainties High share of civil work as component of project cost (scope of ECA financing lower as compared to thermal or solar) Seasonality of generation and position on load duration curve Flood and natural disaster risk due to presence in high risk zone

Key Success Factors for Renewable Energy Projects

Strong policy support including semi-conductor policy for generation of PV in India to reduce capital costs for solar Incentives which are long term and predictable Monitoring of RPOs and incentivise states/discoms for the same (pass through in tariff needed) Greater involvement of ECAs, Multilateral financiers RECs are internationally key component of renewable energy project financing Renewable Power Obligations on state utilities/discoms encourage capacity additions worldwide Wind power technology has improved and become standardised. Also reliability of performance has increased. Wind studies have got better. Utilities owning wind power projects is becoming the norm. This mitigates the input price volatility of fossil fuel based power plants

Risk Analysis Power Projects

Risks Mitigants

Weak financial state of SEBs/discoms which are the main off-takers in most projects

Power sector reforms have picked up pace and financials of many state discoms have improved Limit exposure to top 10 SEBs Criticality of project to the state and merit order ranking on tariff For mega projects risk spread across several SEBs as off-takers Significant demand supply gap
Already identified land with survey reports on extent of rehabilitation and opposition expected State governments active participation Conservative assumptions on project completion timelines and costs to arrive at debt sizing Acquisition of land and Environmental clearances for the coal land (in case of captive mining) would be a pre-requisite for loan sanctions In case of coal being purchased or imported, long term supply contracts or linkages need to be established.. Also critical infrastructure incl coal handling , rail connectivity and coal washeries etc is critical For gas based projects firm supply contracts with penalties for non supply would be a precondition. Contingent equity undertakings from sponsor for cost runs based on sensitivities on DSCR as a result of project cost escalations. EPC contracts would have covenants covering Liquidated damages Performance bonds/guarantees In cases where the sponsor is executing the project through various small contracts for supply and construction, a construction completion guarantee from Sponsor isbe taken

Land Acquisition / Rehabilitation

Constraints on fuel supply and quality Inability to achieve pass through of costs overruns

Risk Analysis Power Projects

Risks Environmental risks due to fly ash disposal, change in emissions norms Risk of the project being noncompetitive in merit order Operating Risk arising out of poor equipment performance or breakdown FX and Interest rate Risk Other Risks including Force Majeure Mitigants The project would need to conform to Equator Principles and the same will be certified and monitored by a reputed agency Credit analysis and due-diligence would involve detailed benchmarking exercise with respect to merit order of the proposed project to establish the tariff competitiveness of the project vis--vis other projects in the region Coal based thermal power plants and even hydro and wind power plants have proven technology and are not complex operations Insist on a maintenance reserve account which would be funded annually through the cash flows waterfall to ensure that major maintenance can be carried out every 3-5 years if necessary. FX and interest rate sensitivities would be part of credit analysis Appropriate hedging for these risks Insurance cover with banks as loss payee