Renewable energy financing
March 11, 2014
By Lucas Porter, Patrick Hurley and Dan Bradley, Navigant
One of the most prominent and widely discussed topics in renewable energy finance is how to lower funding costs to make more projects viable. In general, renewable energy technologies are not yet at economic parity with conventional power generation technologies. Renewable projects typically rely on government incentives in the form of either direct cash grants or tax credits, both which combine to cover more than half the capital cost of a renewable energy project.
Uncertainty over the future of tax credits undermines their benefit when it comes to financing renewables. Also, projects involving tax credits require specialized structures that only certain lenders and investors are willing or able to fund. This makes capital less competitive and higher cost, which precludes more projects from being developed. As a result, renewable project developers are exploring investment vehicles that expand the potential investor base and drive down the cost of capital. At present, the three investment vehicles that can expand the investor base are the Real Estate Investment Trust (REIT), the Master Limited Partnership (MLP), and the YieldCo. All three vehicles can be traded on public markets and pass earnings through to investors without corporate earnings taxation.
Financing limitations Each vehicle, however, faces certain limitations and applicability to the renewable energy space. While a number renewable energy REITs and MLPs are active today, they are small and limited in scope and impact. REITs face restrictions on what assets may be owned such that 75 percent of their holdings must be real property. Because renewable energy generation assets are not considered real property, there is limited room for their inclusion within the structure. Meanwhile, MLPs are limited to ownership of depleting assets and are thus more widely used in the oil and gas industry. Federal legislation proposed in May of 2013 called the MLP Parity Act sought to expand the list of acceptable assets for MLPs, but has not yet gained enough traction to become law.
The YieldCo, which generally refers to a limited liability corporation specifically structured to behave like an MLP, has been the only structure to achieve major success and is widely believed to have the greatest potential impact. The success of the YieldCo stems largely from its ability to trade on public markets and pass through earnings untaxed. Also, unlike REITs and MLPs, YieldCos are able to acquire and own large portfolios of contracted and merchant generating assets in both conventional and renewable energy. Recent offerings have demonstrated the breadth of assets that can be organized in a YieldCo portfolio. These include two large pure-play renewable energy companies (Pattern Energy Group and Transalta Renewables), and one diversified energy company holding distributed, conventional and renewable generation assets (NRG Yield).
Benefits outweigh YieldCo drawbacks Despite the advantages, there are potential drawbacks to consider when analyzing the YieldCo structure. The YieldCo's tax advantaged status is based on having sufficient depreciation costs to cover operating asset revenues, such that the company reports no accounting profit.
Because depreciation is a non-cash charge, cash flows from operations are still available for distribution to shareholders. Unless the company is able to acquire sufficient new assets to replace the depreciation costs of fully depreciated assets, the company will become a tax-paying entity and lose one of its major structural benefits. Additionally, YieldCo valuations are generally based on the assumption that there will be dividend growth through the acquisition of new assets. If new assets are unavailable or are of low quality, the YieldCo may not reach its target growth expectations, which is one of the major management and operating risks implicit in is this kind of investment. Other drawbacks to YieldCos exist, but the inherent opportunity is great. By offering institutions and individuals a conduit to invest in diverse portfolios of assets that are otherwise inaccessible, YieldCos broaden the investor base. This makes capital providers more competitive and thus lowers the cost of capital for new and existing projects. Utilities can use a YieldCo take advantage of lower financing costs while maintaining control of their assets through partial sales. Monetizing contracted assets allows utilities to optimize their capital structure and pursue other business and development opportunities. Geographic, regulatory and technological diversity within these asset portfolios can also serve to significantly reduce overall risk to a single investor. Because one investor owns a small piece of a potentially large number of projects, any negative event such as a natural disaster or regulatory regime change may affect only a portion of the owned assets.
Typically, power generation assets are owned by one or a handful of investors, including utilities, banks and private equity funds. Through the YieldCo structure, there can now be hundreds or thousands of investors in a wide array of projects. Spreading risk over a broad investor base can, if properly diversified, reduce the risk to each individual investor, which in turn can reduce the required return and lower the cost of capital. The renewable energy industry still has a significant amount of ground to cover with regard to lowering technology costs. However, through sustained demand growth and funding for renewable power, there will be increased opportunity for achieving economic parity with conventional energy generation technologies. The YieldCo structure has provided a means by which to finance projects cheaply and incent future growth -- offering large environmentally conscious and sustainability oriented investors an effective means by which to provide capital to the renewable energy industry. Thus far, the YieldCos in the today's marketplace have achieved relatively low funding costs and have been able to acquire assets through greater capital efficiency. Since the YieldCo structure is driving value in power asset acquisition, the energy industry should expect to see a great deal more activity in the future. About the Authors Patrick Hurley is a Managing Director in Navigant's Energy Practice and assists clients in operations improvement, procurement of operations services, business transaction due diligence and utility ratemaking, among other things. Hurley has been an advisor to the utility industry since 1980 working with utilities, power developers, investment banks, industrial and commercial energy users, as well as government agencies and ministries in North America and overseas. Dan Bradley is a Director in Navigant's Energy Practice specializing in procurement and resource planning with a recent focus on Renewable Energy Credits for Renewable Portfolio Standards targets, renewable generation, energy efficiency and demand response. Over the past 10 years, Bradley has assisted clients in procuring more than 2,000 MW of generation, including solar and renewable resources, more than 2 million RECs, and 1,000 MW of HVDC transmission, as well as energy-efficiency programs/initiatives, peak/demand response programs, and generation biddings service. Bradley is also experienced in PJM/NYISO stakeholder processes, resource planning, electric/energy plans and resource decision making. © 2014 FierceMarkets, a division of Questex Media Group LLC. All rights reserved. http://www.fierceenergy.com/story/renewable-energy-financing/2014-03-11?page=full |