Wind power financing
The US wind industry, like other energy sectors, relies heavily on project finance markets to fund new projects. This approach to energy infrastructure treats each energy project like a stand-alone company, using only the project cash flows to support debt or equity investments. Project Finance investors perform a critical role in the industry as their risk preferences drive industry trends and reinforce safeguards in favor of economically sound projects.
In project finance, U.S. wind projects primarily recruit two types of investment; tax equity and project debt.
Tax equity investing is common in sectors including renewable energy, affordable housing, and film-making, and was a major force in launching the growth of the U.S. shale gas boom just a few years ago. In each of these cases, some form of federal tax credits helped industry recruit private capital from investors whose large federal tax obligation makes such investments attractive. This is similar to the way many companies across the U.S. economy prefer to lease equipment from a financial entity instead of purchasing. Tax equity investors make an equity investment into a wind project on or around the date that construction is completed. Tax equity investors “prescreen” and assess projects during the late stages of development, commit to deals when sufficient detail is available for the project, and close the deal when operations commence. Tax equity investors evaluate projects on the basis of projected cash flows and expected output to generate production tax credits (PTCs), and the investment basis by which depreciation is calculated.
Project debt transactions also tend to close near the finish of construction, but can often be coordinated with construction lending that is used to pay for the construction contractor. Project loans go through a similar prescreen process as tax equity, so the activity associated with raising this capital occurs largely before the project is completed. Project lenders focus on a metric known as debt service coverage, which measures how free cash flows from project operations compare to required principal and interest payments with project debt obligations.
Project finance markets illustrate the forward-looking nature of this process: overall capital raised in 2012 declined during the industry’s record-breaking development year because many deal packages were raised in the prior year. In addition to this, tax equity has quickly reflected the industry’s trend towards the PTC, as 80% of tax equity dollars went to projects using the PTC compared to 52% of projects overall. Both tax equity markets and wind projects overall trended towards the PTC in 2011 and 2012 as projects continue to get more efficient due to new technology improvements increasing production.
Debt and tax equity markets have each displayed resiliency in recent years. Tax equity volumes dipped sharply to less than $1 billion in 2009 as the financial sector was afflicted by the 2008 crisis, but have rebounded significantly in recent years as financial institutions recovered. Since the 1603 program has expired, the wind industry will increasingly rely on these funding sources to develop projects. Project debt markets reflect a very global marketplace and a strong presence from European and Asian banks, and have successfully weathered the storm of the European currency crisis recently.
Many types of investors perform different roles for the U.S. wind industry:
- Financial Institutions, domestic: Large US banks and insurance companies are the major players in the tax equity field. Some insurance companies are also active in the project debt space as they are drawn to the long-term debt that is common in project finance.
- Financial Institutions, foreign: European and Asian banks are leaders in project debt markets. Active project finance groups in all energy markets are common for these investors, and not all institutions have the necessary tax position to make tax equity attractive.
- Energy Companies: Strategic corporate investors, like power utilities or turbine manufacturers, often participate in tax equity or debt markets. These investors see an attractive opportunity related to their primary industry, or may want to support key product lines.
- Other Corporates: Some companies like Google or Native Alaska Corporation Cook Inlet Region participate in project finance for wind
- Private Equity: Hedge funds and private equity focus mainly on company investments, but occasionally make investments into projects with equity, debt, or mezzanine (hybrid) structures.