Investments in the clean technology sector often combine capital intensity with new technologies. Securing project finance can prove to be a critical step in the path to commercialization. Project finance succeeds best when you have long-term off-take agreements with quality-credit counterparties (such as power purchase agreements with utilities) but commodity-based projects that sell into open markets (such as biofuels) can also benefit from the project finance model.
This primer provides an overview of project finance for renewable energy investors, with a focus on the pros and cons, as well as a survey of key concepts and requirements, including tax incentives and monetization strategies and other key structuring considerations in determining whether to project finance.
• Project finance has emerged as a leading way to finance large infrastructure projects that might otherwise be too expensive or speculative to be carried on a corporate balance sheet.
• The basic premise of project finance is that lenders loan money for the development of a project solely based on the specific project’s risks and future cash flows. As such, project finance is a method of financing in which the lenders to a project have either no recourse or only limited recourse to the parent company that develops or “sponsors” the project.
• For equity investors, the appeal of project finance is that it can maximize equity returns, move significant liabilities off balance sheet, protect key assets and monetize tax financing opportunities. A wide range of commercial and legal issues must be addressed to secure adequate returns. Tight credit markets exacerbate competition for long-term financing, so even small differences in deals can impact the availability of financing, increase costs or reduce leverage.
• Project financing became particularly important to project development in emerging markets, with participants often relying on guarantees, long-term off-take or purchase agreements, or other contractual relationships with the host sovereign or its commercial appendages to ensure the long-term viability of individual projects. These were typically backstopped by multilateral lending agencies that mitigated some of the “political” risks to which the project lenders were exposed. Analogies to and alternative energy projects help investors de-risk higher-risk new technologies.
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