Alternative Energy Investments

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Alternative Energy Investments

“Roads? Where we’re going we don’t need roads”

American College of Investment Counsel Spring Forum

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Jerry Hanrahan

Vice President - Team Leader, Power & Infrastructure,

Bond & Corporate Finance Group, John Hancock Financial Services

Anthony Goodman

Counsel, Babson Capital Management LLC

Eli Hinckley

Partner, Sullivan & Worcester LLP

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 Active industry

Many opportunities for infrastructure investments

 Factors driving investments expected to continue, at least in the near term

 Public policies favoring “green energy”

Abundance of cheap domestic natural gas

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 Trends in investments in the energy sector

Renewable energy  Tax credits

 State incentives

 Recently built merchant gas-fired generation

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Three general areas of funding for alternative energy projects:

Debt

Equity (including tax equity)

Government subsidies and other incentives

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Basics of Investing in Alternative Energy

Equity Debt Subsidies

Collateral Agent/ Paying Agent

Project Company Project Sponsor

Project Assets Offtake Purchaser(s)

Operator

EPC Contractor

Project Operating Expenses

Key

Contractual Relationship

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Key Elements of Project Finance Model

 Single-project special purpose entity

 Investment grade offtake purchaser(s)

 Secure cash flow – long-term offtake contract(s)

 Lockbox for payments

 Waterfall payment structure

 Reserve accounts

 Lien on all project assets/all project equity

 Step-in cure rights for key contracts

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Collateral for Loans

 Lender must be able to step in and own/operate or sell project after a

default – lender is inchoate project owner

 Collateral includes all projects assets:

 Equipment and other tangible assets

 Real estate

 Contract and warranty rights

 Intellectual property

 Permits (if allowed)

 Lockbox accounts

 Collateral typically includes pledge of all project equity

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Equity and Tax Equity

 Pass-through Entity for Federal Income Tax Purposes

Limited liability company  Limited partnership

 Different Classes of Equity Interests

Distribution Preferences  IRR triggers

 “Carried Interest” for Developer

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Equity and Tax Equity

 Tax equity driven primarily by opportunity to realize federal income tax credits

 Production Tax Credits

Investment Tax Credits

 Generally passive investors other than manager/gp

 Income tax credits only matter to investors with income to be taxed

Impact of recession on tax equity

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Equity and Tax Equity

 Passthrough nature of Project Company permits equity investors to use tax credits

 10-year term of PTC creates “flip” structures:

Change in ownership percentages after flipIRS requirements for flip

 Recapture of ITC for certain transfers of interest in first five years after placed in service

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Equity and Tax Equity

 Notices of Defaults on Debt

 Standstill Period

 Potential Cure Rights

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Equity and Tax Equity

 Management Issues

Minority voting and veto rights

FIN 46 issues – consolidation on balance sheetVoting deadlocks and buyout provisions

 Transfer Restrictions

Prohibitions if impact on regulatory statusRight of first offer/first refusal

Federal Power Act Section 203 issues

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Production Tax Credits

 26 U.S.C. § 45 - Per kwh tax credit for energy produced by certain technologies:

Wind Geothermal

Biomass Solar

Poultry waste Hydropower

Marine/Hydrokinetic Refined coal

Municipal solid waste

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Production Tax Credits

 Currently 2.3¢/kwh (wind); $.011/kwh (other technologies)

 Adjusted annually for inflation

 10-year period to realize credit from date placed in service

 Construction must have started by 12/31/13

Continuous construction requirement

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Investment Tax Credits

 26 U.S.C. §48

 30% of qualifying project costs for solar/fuel cells/small wind/PTC-eligible technologies

 10% for geothermal/microturbines/CHP

 Must choose between ITC and PTC

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Do we need to renew/replace the ITC and PTC for Alternative Energy to be Viable?

 Securing financing

large scale projectssmall scale projects

 Competition in market

 Advancement in technology

 Declining energy costs of renewables

 Other subsidies

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Real Estate Investment Trusts (“REITs”)

 Sub-category of a corporation

Corporate purpose is to own real estate assetsREITs do not pay corporate taxes

 Must distribute 90% of taxable income to investors

 REITs raise $$$ and use to purchase real estate assets

 REIT cannot sell inventory

 Energy sales are sales of inventory for these purposes

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REITs and Renewables

 Renewable transactions as lease or loan

Fixed yearly payment for right to occupy/operate renewable

energy asset

 Definition of Real Property

Each asset of a renewable project must be testedAnalysis done on asset by asset basis

 Structuring

 Using a REIT as a Developer

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YieldCos

 Entity that owns cash-generating (operating) infrastructure assets

 Offered in public markets  Typically lower risk

 Tax benefits

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Project Portfolios

 Small size of renewable projects can make financing uneconomic due to transaction costs

 Warehouse

Standard terms with same lender(s) for multiple projects

 Portfolio

Bundling of multiple projects in portfolioLoans through holding company structureMultiple borrowers or guaranty structure

 Permits spreading of risks

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Solar RECs and Solar Leases

 Solar/REC Leases

Lease to own structure for solar systemCapital Lease vs. Operating Lease

Low up front costs

Tax treatment of lease payments  Shorter term than PPAs

 Environmental attributes typically owned by customer

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Project Risk Factors

Completion Risk: technology risk, contractor

qualifications, construction contract terms

Operation Risk: qualified operator, maintenance plan,

technology

Resource Risk: resource reliability, energy production

forecast

Offtake Risk: offtake sales arrangement, purchaser

strength

Regulatory risk: stability of any regulations forming

Investment Structures

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Utility Concerns with Long-Term PPAs

 Declining customer usage

 Distributed generation causing further erosion

 Long-term liabilities spread over declining base

 Out-of-region resource challenges

 Necessity of outside hedges

 Change in law risks

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Constitutional Framework

Supremacy Clause

U.S. Constitution, Article VI, Clause 2: This Constitution, and the laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding.

Preemption

 Legal doctrine developed by courts based on Supremacy Clause. Any state law that conflicts with a federal law is preempted and is void.

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Recent Constitutional Cases

PPL EnergyPlus, LLC v. Nazarian, 753 F.3d 467 (4th Cir. 2014) (“Nazarian”)

 Program at issue solicited proposals for construction of new power plant, winner got a fixed 20 year Contract for Differences that state would compel Utilities to sign

 Generator was paid difference between wholesale price and the Contract for Differences Price

Court found preemption existed because the compensation under the Contract for Differences superseded the price in the federally regulated wholesale market

PPL EnergyPlus, LLC v. Solomon, 766 F.3d 241 (3rd Cir. 2014) (“Solomon”)

 New Jersey’s Long Term Capacity Pilot Program Act (“LCAPP”) instructed the New Jersey BPU to offer Standard Offer Capacity Agreements for 15 year terms (similar structure as Contracts for Differences)

Court found preemption existed because the LCAPP program superseded wholesale prices in PJM

Allco Finance Limited v. Klee, No. 3:13cv1874, 2014 U.S. Dist. LEXIS 170674 (D. Conn. Dec.

10, 2014) (“Allco”)

 At issue is Section 6 of Connecticut Public Act 13-303 that gives the Commissioner of the Connecticut Department of Energy and Environmental Protection (“CT DEEP”), authority to

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Allocating Change of Law Risks

 Incentive Structure Changes

New incentives

Repealing/changing existing incentives

 Who should bear the risk of a change in the law?

Seller vs. Buyer

Compliance representation as of date of agreementCap cost of compliance

“Commercially reasonable efforts” to comply

Emerging Due Diligence Issues

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Emerging Technology: Offshore Wind

 Recent Offshore projects

Deepwater Wind, Rhode Island

 Transmission assets purchased by utility in 2015  Wind farm to begin construction in 2015

Cape Wind, Massachusetts  PPAs terminated in 2015

 Construction stalled

Fisherman’s Energy, New Jersey

 NJPUC denial of approval in 2014 (appeals pending)

Emerging Investment Opportunities

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Emerging Technology: Energy Storage and Smart Grid

 Smart Grid or Grid Modernization

Improve grid efficiency and reliability

Better integration of renewable energy/storage tech.State approaches to implementation

Privacy concerns

 Energy Storage

Thermal storage

Compressed air storage

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Evolving Capacity Markets

 Capacity payments compensate generators for being available

 Capacity Payments as revenue stream for generators

 Without capacity payments, units that operate only during peak demand times would require huge payments to recover their full costs during few hours of operation

 Capacity Markets

 Commitment to pay generators for capacity several years in advance

 Some generators can get a multi-year commitments – enough to support financing?

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Merchant Transmission

 Financing

 Prior FERC limitations on allocation of transmission capacity other than through open season competitive process and impact on financing options

 Evolving FERC policy to permit early allocation of 100% of

transmission line capacity through negotiation

 Increase in available funding for merchants from:

 Private equity, transmission

developers, construction companies

 Merchant transmission rates

 Merchant provider must obtain

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 Paul Belval: pnbelval@daypitney.com

 Anthony Goodman: AGoodman@Babsoncapital.com

 Jerry Hanrahan: jhanrahan@jhancock.com

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