NEVEEN AYAD* outlines the financing options for renewable energy projects, the concerns of private investors, and incentives currently available to developers in this regard.
In 2008, Abu Dhabi hosted the first World Future Energy Summit, the foremost global event dedicated to renewable energies, energy efficiency and clean technologies.
Since then, the GCC has made significant strides in the renewable energy sector by developing a number of ambitious projects across the region. These are being supported by:
• Renewable energy targets: Abu Dhabi, for example, has set a renewable energy generation capacity target of seven per cent by 2020 and Dubai a target of five per cent by 2030. Saudi Arabia’s target for generating power from renewable and nuclear energy sources is 54 GW by 2032.
• Innovative research and development: In Abu Dhabi, the Masdar Institute is focusing on the science and engineering of advanced alternative energy, environmental technologies and sustainability. And in Saudi Arabia, the research, development and innovation arm of King Abdullah City for Atomic and Renewable Energy (KA Care) is responsible for the development of renewable and nuclear energy technologies optimised for the kingdom’s environment.
• Clean development funds: The DB Masdar Clean Tech Fund invests primarily in companies in the clean energy, environmental resources and energy and material efficiency sectors. The fund is reported to have secured financial commitments of $290 million.
• Government-backed renewable energy companies: In Abu Dhabi, Masdar was established to invest and establish a commercially viable renewable energy industry in the GCC by developing and investing in projects within the GCC. In Saudi Arabia, KA Care was set up with the fundamental aim of building a sustainable future for Saudi Arabia.
• Investments in international projects: Masdar, for example, has a 20 per cent stake in the world’s largest offshore wind farm, London Array in the UK.
Let us look at the financing options for renewable energy projects such as solar and wind; the key concerns that private developers must address in order to attract funding from private investors, particularly debt funding from lenders; and the incentives currently available to developers of renewables projects.
There are four possible routes for financing a renewable energy project:
• Use of company or personal reserves;
• On balance sheet financing with bank loans secured against other parts of the developer’s business or major assets or personal guarantees;
• Co-development of the project with a joint venture partner who is in a stronger position to raise the finance; and
• Limited recourse project financing.
This article focuses on the requirements to attract limited recourse project financing.
The key project contracts are:
• EPC (engineering, procurement and construction) contract: The contractor will assume single-point responsibility for the design, engineering, procurement and construction on a lump-sum basis. Typical terms of interest to lenders include completion testing and a robust liquidated damages regime for delay or performance failures.
• Fuel supply contract: Lenders will require the term of a fuel supply contract to exceed the term of the debt by a reasonable margin (typically between two and three years). This contract will specify the price, amount and specification of fuel to be delivered on a daily, monthly and annual basis.
• Operation and maintenance agreement (O&M): Lenders will expect to see the operation of the plant being carried out by a company with a good track record. Typically, operating agreements will provide for an incentive-related performance fee.
• Power purchase agreement (PPA): The PPA is the cornerstone of most renewables projects. Usually, lenders will expect the PPA to be on a take-or-pay basis to provide certainty as to servicing of the debt the lenders have provided. Lenders will also expect the term of the PPA to extend beyond the term of the loan.
Key lender concerns
The bankability of the project will depend on the following factors:
• A careful analysis of project risks;
• An appropriate allocation of risks;
• Recognition that financiers are fundamentally averse to risks;
• Realistic capitalisation and distribution arrangements;
• Having reserves for unexpected liabilities; and
• Appreciation of syndication requirements.
Since certainty is key, typically lenders will not accept risks that cannot be properly assessed or are potentially open-ended. Whilst not exhaustive, the following principles illustrate some of the key considerations:
• Single-point responsibility: The contractor provides a “full wrap”, that is, taking responsibility for both the detailed design, the technology and the construction of the plant.
• An appropriate delay liquidated damages regime: Lenders will expect to see provisions which require the contractor to pay liquidated damages for delay. Typically, these will be capped. Certain delay risks may also be mitigated by insurance policies such as business interruption insurance.
• An appropriate performance testing regime including performance liquidated damages: Solar projects are very climate dependent, which may necessitate an extended testing of the performance guarantees in all possible climates. The adequacy of the performance liquidated damages is important to lenders in the context of assessing the developer’s ability to continue to make the debt service repayments despite any performance shortfalls.
• The perfect security package: Lenders will expect an unconditional and on-demand performance bond issued by reputable banks or financial institutions to secure the performance of EPC and O&M contractors. Often, contractors will push for these to be provided by insurance companies as this is a cheaper option. Lenders have previously accepted a bonding package which was partly issued by banks and partly by insurance companies, on the condition that the insurer maintained a minimum credit rating. Lenders will typically expect a parent company guarantee from the contractors as completion support. With respect to the PPA and the fuel supply agreement, the objectives of bonding may also be achieved by standby letters of credit provided by the banks.
• The ability to take assignment by way of security: Lenders will take an assignment by way of security over the project contracts and the bonds.
• The ability to step in: This is usually done to pre-empt termination of project contracts, where the banks are enforcing their security over the developer’s shares or assets, and is achieved through direct agreements with the developer’s counterparties.
Subsidised fuel and electricity prices in the GCC make renewable electricity ventures a comparatively costly investment. Therefore, government support in the form of financial incentives will be instrumental in encouraging investment in renewables.
The Shams One solar power station (Shams One), valued at $700 million, is one of the largest concentrated solar power plant in the Middle East with a generation capacity of 100 MW and a solar field consisting of 768 parabolic trough collectors. It was intended that the electricity produced by Shams One would be purchased by Abu Dhabi Water and Electricity Authority (Adwea) under a 25-year power purchase agreement. As a measure of its commitment to renewables, the Abu Dhabi Ministry of Finance reportedly compensated Adwea for the difference between the average domestic power generation cost and the generation cost for Shams One. This incentive, known as a green payment, is believed to be a better option than setting a national a feed-in tariff (FIT) which would need adjustment over time because of the changing cost of renewable and conventional energy in the UAE.
In Dubai, the government is reportedly finalising legislation that will enable property owners to feed solar power into the grid.
In Abu Dhabi, Masdar and the Abu Dhabi Distribution Company have proposed the development a solar rooftop scheme (SRP) which aims to encourage residents and owners of commercial and government buildings (collectively ‘investors’) to install rooftop photovoltaic (PV) panels. The SRP is based on a financial incentive scheme consisting of:
• A rebate payment of approximately 35 per cent to 40 per cent payable to the ‘investors’ at the time of installation; and
• A premium FIT paid per KWh produced and fed into the grid over 20 years (approximately $0.25-0.28 per KWh).
Pilot programmes are already commencing in schools, the Abu Dhabi Judiciary and at Al Ain Zoo. In Saudi Arabia, the government has installed solar panels on some of its buildings. KA Care has announced plans to investigate the development and implementation of a FIT scheme.
There is clearly enormous potential for renewables projects in the GCC and a desire to see renewables projects prove to be a commercially viable alternative to conventionally generated electricity. As lenders struggle to become comfortable with financing renewables projects, having a financially strong equity partner will certainly assist in bridging the gap.
* Neveen Ayad is senior associate based at the Sydney (Australia) office of the international law firm King & Wood Mallesons (KWM). Having been based in Abu Dhabi for six years, she continues to be active in Middle East work.