Alternative Energy Investments
“Roads? Where we’re going we don’t need roads”
American College of Investment Counsel Spring Forum
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
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
Trends in investments in the energy sector
Renewable energy Tax credits
State incentives
Recently built merchant gas-fired generation
Three general areas of funding for alternative energy projects:
Debt
Equity (including tax equity)
Government subsidies and other incentives
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
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
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
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
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
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 flip IRS requirements for flip
Recapture of ITC for certain transfers of interest in first five years after placed in service
Equity and Tax Equity
Notices of Defaults on Debt
Standstill Period
Potential Cure Rights
Equity and Tax Equity
Management Issues
Minority voting and veto rights
FIN 46 issues – consolidation on balance sheet Voting deadlocks and buyout provisions
Transfer Restrictions
Prohibitions if impact on regulatory status Right of first offer/first refusal
Federal Power Act Section 203 issues
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
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
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
Do we need to renew/replace the ITC and PTC for Alternative Energy to be Viable?
Securing financing
large scale projects small scale projects
Competition in market
Advancement in technology
Declining energy costs of renewables
Other subsidies
Real Estate Investment Trusts (“REITs”)
Sub-category of a corporation
Corporate purpose is to own real estate assets REITs 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
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 tested Analysis done on asset by asset basis
Structuring
Using a REIT as a Developer
YieldCos
Entity that owns cash-generating (operating) infrastructure assets
Offered in public markets Typically lower risk
Tax benefits
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 portfolio Loans through holding company structure Multiple borrowers or guaranty structure
Permits spreading of risks
Solar RECs and Solar Leases
Solar/REC Leases
Lease to own structure for solar system Capital Lease vs. Operating Lease
Low up front costs
Tax treatment of lease payments Shorter term than PPAs
Environmental attributes typically owned by customer
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
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
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.
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
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 agreement Cap cost of compliance
“Commercially reasonable efforts” to comply
Emerging Due Diligence Issues
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
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
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?
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
Paul Belval: pnbelval@daypitney.com
Anthony Goodman: AGoodman@Babsoncapital.com
Jerry Hanrahan: jhanrahan@jhancock.com
