iiml_projfinance_aug2013

7/29/2019 iiml_projfinance_aug2013

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Project Financing

Renewable Energy Sector

Saurabh Bhat

CEO, Ambit Finvest Limited

August 2013


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What is Project Finance

Financing against cash flows and project assets

to a Project SPV typically for a green-field

activity or expansion into new markets

Financing generally comprises construction andoperating period

Usually Project Financing is Non-recourse or

Limited Recourse


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Why Project Finance

Ability to leverage without impacting Developers balance sheet

Risk Diversification may lead to credit enhancement Longer Tenors

Best model for Public Private Partnership financing

Greater transparency in project execution and operation

Tax benefits

Documents/structure provide high enforceability for revenue

receipts.

However, Issues to be prepared for by Sponsors

Restrictions on payments to sponsors

Restrictions on sale/exit Need to grant oversight and monitoring rights to lenders

(interference??)

Expectation of backstop to sponsors


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Project Finance Decision Making- Lenders Perspective

Counter Party Analysis

Ability and Willingness to Pay Reputation, Experience and Financial Strength

Risk Analysis

Pre Completion

Post Completion Financial Modeling and Base Case Projections

Assumptions

Ratios and Debt Servicing Capability

Sensitivity and Break even Analysis Breakeven DSCR

Most Likely and Downside scenarios with probabilities assigned


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Project Finance Decision Making (contd..)

Structuring to Mitigate Risks

Sponsor commitments towards project completion and cashshortfall

Contractual Framework which diversifies risk of operations

Security Package

Financial Covenants

Underwriting/Syndication/Participation

Sole or Joint Underwriting

Hold Level

Pricing and Fee Structure

Market Flex, Clear Market

KEY CONSIDERATION IS TO DEVELOP STRUCTURES

TO IMPROVE PREDICTAB IL ITY OF CASHFLOWS


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Counterparties -

Governments and Related Institutions

Stability of political system

Environmental, FDI policy, coal linkages or other approvals from

central and state and local govts

Regulatory Risk

Criticality of project to state/central Government Sponsors

Execution Capability (track record, depth of management)

Ability to bring in equity and support cost over runs

RM Suppliers Off-takers/Buyers e.g. PPA counterparties

EPC Contractors


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Contractual Foundations

PPAs (Off-taker and Project SPV)

Fixed and Variable Components of Tariff

Linkage to cost of fuel

Take or Pay

Availability Based Tariff

Fuel Supply Agreements Price linked to quality (ash content, calorific value)

Penalties for non supply

Allocation of Mines by Ministry from Central Coal Fields

Transportation Contracts LNG Charters (dedicated vessels, demurrage

Gas through Pipelines

Imported coal through dry bulk vessels


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Contractual Foundations

Construction Contracts e.g. LSTK (Project SPV and EPC Contractor)

Liquidated Damages Work men Insurance

Pass through for FX and other escalations

Security Agreements (Project SPV and Lenders)

Loan Agreement

Mortgage and Hypothecation Agreements Assignment Agreements for Various Contracts like PPA, Fuel Supply etc

Escrow Agreements

Technology License Agreements

O&M Agreements

Shortfall Guarantee/Completion Guarantees (Sponsors and Lenders)

Guarantees from sponsors to ensure timely completion of construction

phase

Shortfall undertaking to ensure min DSCR


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Structure

Sponsor

Lenders

Project SPV

Concessionaire/Off-

taker

Third Party Legal and engineering

financial due diligence Firms

Equity

Concession/Off-

take Agreement

Completion Guarantee /

Contingent Equity

UndertakingContractor

O& M

Contract

Independent

project Reports

Project

Finance

Operator

EPC Contract


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Risk Framework

Market and/or Price Risk

Demand reduction (economic down turn),Substitution,

Technology obsolescence, Competition

Construction/Completion Risk

Site Acquisition/ Rehabilitation, Cost Escalation / Time Overrun

Risk, Contingency / Event Risk

Political Risk

Approvals, change in laws, political instability/war

strife, exchange control

Financial Closure Risk

Interest Rate, Exchange Rate Risk

Technology

Operational


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Nature of Project Financing Senior Debt/Syndicated Club Loans/Project Bonds

Pari-passu security sharing among lending members (1-2

lenders act as Lead)

Common documentation with project Company and interse

agreement among lenders

Lenders need to act by majority and not unilaterally Construction debt/WC debt and term debt

Mezzanine finance

Riskier than senior debt with lower security

Generally bullet or ballooning with back ended repayment

Higher pricing than senior debt

used to achieve necessary leverage caps and improve RoE on

project


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Security Structure for Project Finance

Loan Agreement with charge on project assets , and project cash

flows, sponsor shareholding pledge

Material adverse change

Step in rights

Right to assign loan

Dividend and other payment to sponsors restricted

No exit/sale for sponsors

Assignment Agreements for all material contracts like EPC,

Concession Agreement, PPA, FSA etc which gives lenders step in

rights

Escrow of cashflows and waterfall mechanism Insurance Loss Payee rights

DSRA


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Public Private Partnership -

Types of PPP Service Contracts

Management Contracts

Lease Contracts BOT

Concessions

JVs


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PPPs contd..

Service Contracts Shorter Duration (1-3 yrs)

Multiple contracts for various activities

Useful when its important to keep entity public butinfuse efficiencies in certain operations

Need monitoring

Easier to sell politically

Cant be useful to attract capital investment


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PPPs contd..

Management Contracts

Ownership is public but most functions transferredincl management and operations

Performance targets clearly defined in terms ofimprovement of the utility (hospital, bus terminal etc)

Incentives linked to performance Capital Investment (asset replacement or expansion)

remains with the Public Sector

Tariff setting is also responsibility of Public Sector

Brings focus on profitability all across

Good starting point before complete privatisation

Possibility of mis-use/abuse to inflate performanceshould be checked through independent monitoring


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PPPs contd..

Lease Contracts

Operator provides service at own expenses and isallowed to charge a fee

Duration is upto 10 years

All losses to the head of the operator but so also the

upside of profits

Fixed lease payments irrespective of revenue

achievement

Drives efficiency but can also lead to neglect on

maintenance expenditure to improve profitabilityduring lease period.


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PPPs contd..

Concession Agreements/ BOT

Private sector responsible for operation,maintenance, collection, management, financing etc

Normally concession is for existing asset and may

involve capacity addition to it or just pure operation

Private Operator also responsible for capitalinvestments (e.g. distribution concessions link tariff

hikes to capital investment for improvement of

distribution network)

Tenor of concession is 25-30 yrs


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PPPs contd..

Concession Agreements/ BOT

May involve viability gap financing from the

Government to assist in capital investment

BOT is a specialised concession where a new

infrastructure asset is created under the Concession

and the builder has the right to operate and charge

fee for the same to users


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Risk Sharing in PPP projects in India

ConstructionRisk

OperationRisk

RevenueRisk

MarketRisk

Interest RateRisk

RegulatoryRisk

Risk Participant

Equity holder No Yes Yes Yes Yes Yes

Lender No No No No Yes No

Govt* Partial No Partial Partial No Yes

EPC contractor Yes No No No No No

* Govt shares r isk through compensat ion clauses in the Concession Agreement


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Degree of Risks in PPP Projects in India

Construction Operation Market Interest Rate Payment Regulatory

Project

Road High lowProject

SpecificProject

Specific Medium Medium

Port High Medium MediumProject

Specific Low Medium

Airport High High High

Project

Specific Low Medium

Power Medium Low LowProject

Specific High High


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State of Power Sector In India

As of CEA 2011 report, 1,81000 MW of installed capacity with

65% thermal, 21% hydro, 11% renewable and 3% nuclear.

Bulk of 12th plan capacity addition of 82 GW left to IPPs and

state discoms.

11 th plan additions are 50% of targeted. Of 12 th proposed

generation addition target,


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State Discoms generated about 35-40,000 cr of losses in FY11 contributed

by High Debt leading to interest expenses

Inability to raise commensurate tariffs in face of rising input costs

Widening T&D losses and unchecked subsidies

Some progress made through adoption of Shunglu committeerecommendations in July 2011 by states

Total Debt of Power Sector i.e. State , Central Utilities and Private Utilities is

Rs 6.5 trillion

40% by Banks,

30% by PFC, REC and Infra Finance Cos

25% from Bonds, Govts and ECBs


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Significant reliance on thermal Share of thermal expected to increase from 65% as of now to 70%

Sector needs 472 mn tonnes of coal and 72 mmscmd of gas p.a.

however coal supply stagnated with 77 mn tonne deficit which will rise to

over 200 mn tonnes p.a.

hence huge dependence on imported coal

Renewable Sources of Power A Distant Dream While state have renewable power obligations, they dont have fiscal

bandwidth to give higher tariff or tax breaks/subsidies

Hydro Power mired in environmental and R&R issues. Several large

projects in NE and Himachal facing delays

Wind Power PLF is key issue. Except for Rajasthan and TN, not many

lucrative sites

Solar : capital cost is high and hence breakeven tariffs are > Rs 10/kwhr


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Delays Plaguing Capacity Addition

Land Acquisition

Complexity in Technology

Delays in Financial Closure

Delays in Coal or other fuel supply linkages

Delays in government approvals Environment

R&R issues

Delays lead to cost over run and financial closure of the

same leads to further delays


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Renewable Energy World Status

In 2012, renewable energy (excl traditional biomass) supplied 10%of world energy demand.

Of new capacity addition in last 2 years, share of renewable energy

was about 50%. Of this 20% was wind and 13% each was solar PV

and hydropower with balance 4% from biofuels.

Renewables esp solar and on shore wind have become more pricecompetitive due to economies of scale reducing capital costs

Top countries using renewable energy sources were USA, China,

Germany, Brazil and Canada with Spain , Italy and India being in the

next bracket.

Total world renewable capacity (excl hydro) at end of 2012 was 480GW and hydro was 990 GW. Of the 480, solar PV was 100 GW with

balance coming from wind and non traditional biomass.


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Renewable Energy India Status

As per 2009 IREDA estimate, Indias renewable energy capacity(excl large hydro) is 85000 MW comprising

Wind (45000), Small Hydro (15000), Biomass (17000), Cogen (5000),

solid Waste to energy (3000)

Actual 16GW installed wind capacity (18-19% CAGR over last 5

years) Actual 400+ MW of solar capacity after a great start in 2011,

capacity additions have sputtered in last 2 years.

40 GW of installed hydro power

Actual Generation of renewable energy was 20 bn kwhr as

compared to 40 bn by Brazil and 60 bn by China (2010)


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Renewable Energy- India Status report

contd..

JNNSM unveiled 20 GW targeted by 2020 under USD

19 bn program. Achieve 20 mn sq mtr of solar collection

area by 2020.

Renewable Purchase Obligations to include solar power

purchase to form 0.25% for discoms by 2012 and 3% by

2020.

Renewable Energy Certificates (REC) launched in 2011.

Incentives in form of Preferential Tariffs, REC, CDM,

Accelerated Depreciation, Tax Exemption, Excise

Concessions, Waiver on wheeling charges by state or

central govts.


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Key Challenges for Renewable Energy

Long gestation period of projects Access to capital difficult and costly especially debt

High cost compounded by shorter tenors and absence of fixed rate

lending

Not very favourable state govt policies on renewableenergy

Poor financial health of discoms means pressure on

tariffs (solar and wind projects with high capital costs

need higher tariffs) Perceived technology risk and absence of successful

renewable energy debt financing case studies

means banks are wary


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300 bn gap in infrastructure financing over next 5

years and renewable energy is lower in pecking order

of priority

Cost of solar power generation/kwhr is higher in India

due to high financing costs and lower operatingefficiencies

PLF uncertainty (wind flow predictions or sunny day

predictions)

Projects dont meet base load requirements hence

not attractive from a utility off-taker perspective

Key Challenges for Renewable Energy


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Project Finance in Renewable Energy

Project finance has emerged as a key financing tool

Renewable projects need large investments as they are capital intensive

balance sheet financing would distort risks and returns

Multi-lateral agencies have emerged as backstops for

political/country risks but project viability is being evaluated on stand

alone limited recourse basis (non recourse financing is RARE)

Renewable energy projects will have limited predictability of cashflows given insufficient track record

Solar projects have limited merchant attraction due to peak non peak production,

high marginal costs/tariffs need PPAs to attract lenders

Wind power faces similar issues with climate change risks making merchant or

limited period PPAs unacceptable.

Relatively new technology

Sponsor exits are restricted under project financing esp renewable

energy project financing


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Some Notable Successes in Renewable

Energy from Financial Closure Perspective

Reliance 40 MW 560 cr Dahanu Solar Project

(USEXIM, ADB financed), 25 yr PPA with Reliance

Power at Rs14.9/kwhr

Accionas Tuppadahalli 56 MW, 340 cr wind power

project. PPA with Rs 3.4 /kwhr for 20 yrs with SEB

Lancos Chinnu Solar Project. 100 MW 1800 cr project,

Winner under JNNSM. 25 yrs PPA with state agency at

Rs10.5/kwhr

Nuziveedu Groups 20 MW solar project for 235 cr.


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Key Challenges for Large Hydro

R&R / Environmental issues

Capital Cost/Mw is high 7-9 cr/MW as compared to 5-6 cr for

thermal

Long construction period and higher chance of delays and overruns

due to geological and political uncertainties High share of civil work as component of project cost (scope of ECA

financing lower as compared to thermal or solar)

Seasonality of generation and position on load duration curve

Flood and natural disaster risk due to presence in high risk zone


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Key Success Factors for Renewable Energy

Projects

Strong policy support including semi-conductor policy for generation of PVin India to reduce capital costs for solar

Incentives which are long term and predictable

Monitoring of RPOs and incentivise states/discoms for the same (pass

through in tariff needed)

Greater involvement of ECAs, Multilateral financiers RECs are internationally key component of renewable energy project

financing

Renewable Power Obligations on state utilities/discoms encourage capacity

additions worldwide

Wind power technology has improved and become standardised. Alsoreliability of performance has increased. Wind studies have got better.

Utilities owning wind power projects is becoming the norm. This mitigates

the input price volatility of fossil fuel based power plants

Ri k A l i P P j t


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Risk Analysis Power Projects

Risks Mitigants

Weak financial state of

SEBs/discoms which arethe main off-takers in most

projects

Power sector reforms have picked up pace and financials of many state

discoms have improved Limit exposure to top 10 SEBs

Criticality of project to the state and merit order ranking on tariff

For mega projects risk spread across several SEBs as off-takers

Significant demand supply gap

Land Acquisition / Rehabilitation Already identified land with survey reports on extent of rehabilitation and

opposition expected

State governments active participation

Conservative assumptions on project completion timelines and costs to arrive

at debt sizing

Constraints on fuel supply and

quality

Acquisition of land and Environmental clearances for the coal land (in case of

captive mining) would be a pre-requisite for loan sanctions

In case of coal being purchased or imported, long term supply contracts or

linkages need to be established.. Also critical infrastructure incl coal handling ,

rail connectivity and coal washeries etc is critical

For gas based projects firm supply contracts with penalties for non supply

would be a precondition.

Inability to achieve pass through

of costs overruns Contingent equity undertakings from sponsor for cost runs based onsensitivities on DSCR as a result of project cost escalations. EPC contracts would have covenants covering Liquidated damages

Performance bonds/guarantees In cases where the sponsor is executing the project through various small

contracts for supply and construction, a construction completion guarantee

from Sponsor isbe taken

Ri k A l i P P j t


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Risk Analysis Power Projects

Risks Mitigants

Environmental risks due to fly

ash disposal,

change in emissions norms

The project would need to conform to Equator Principles and the same will be

certified and monitored by a reputed agencyRisk of the project being non-

competitive in

merit order

Credit analysis and due-diligence would involve detailed benchmarking

exercise with respect to merit order of the proposed project to establish the

tariff competitiveness of the project vis--vis other projects in the region

Operating Risk arising out of

poorequipment performance or

breakdown

Coal based thermal power plants and even hydro and wind power plants have

proven technology and are not complex operations Insist on a maintenance reserve account which would be funded annually

through the cash flows waterfall to ensure that major maintenance can be

carried out every 3-5 years if necessary.

FX and Interest rate Risk FX and interest rate sensitivities would be part of credit analysis Appropriate hedging for these risks

Other Risks including Force

Majeure

Insurance cover with banks as loss payee