Wind Project Financing Structures: A Review & Comparative ...

ERNEST ORLANDO LAWRENCE BERKELEY NATIONAL LABORATORY

LBNL-63434

Wind Project Financing Structures:

A Review & Comparative Analysis

John P. Harper, Birch Tree Capital, LLC Matthew D. Karcher, Deacon Harbor Financial, L.P. Mark Bolinger, Lawrence Berkeley National Laboratory

Environmental Energy Technologies Division

September 2007

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The work described in this report was funded by the Office of Energy Efficiency and Renewable Energy, Wind & Hydropower Technologies Program of the U.S. Department of Energy under Contract No. DE-AC02-05CH11231.

Disclaimer

This document was prepared as an account of work sponsored by the United States Government. While this document is believed to contain correct information, neither the United States Government nor any agency thereof, nor The Regents of the University of California, nor any of their employees, makes any warranty, express or implied, or assumes any legal responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product, or process disclosed, or represents that its use would not infringe privately owned rights. Reference herein to any specific commercial product, process, or service by its trade name, trademark, manufacturer, or otherwise, does not necessarily constitute or imply its endorsement, recommendation, or favoring by the United States Government or any agency thereof, or The Regents of the University of California. The views and opinions of authors expressed herein do not necessarily state or reflect those of the United States Government or any agency thereof, or The Regents of the University of California.

Ernest Orlando Lawrence Berkeley National Laboratory is an equal opportunity employer.

Acknowledgements

The work described in this report was funded by the Office of Energy Efficiency and Renewable Energy, Wind & Hydropower Technologies Program of the U.S. Department of Energy under Contract No. DE-AC02-05CH11231. The authors would particularly like to thank Steve Lindenberg, Alejandro Moreno, and Jack Cadogan (retired) of the U.S. Department of Energy for their support of this work. For contributing information and reviewing earlier versions of this manuscript, the authors thank (in alphabetical order, by last name): Jeff Chester (Kaye Scholer LLP), Karlynn Cory (NREL), Mike Davies (FreeStream Capital LLP), Ed Ing (Law Offices of Edwin T.C. Ing), Tim MacDonald (Meridian Investments), Alejandro Moreno (U.S. DOE), Ric O'Connell (Black & Veatch), Kevin Pearson (Stoel Rives LLP), Liz Salerno (AWEA), Ryan Wiser (LBNL), and one anonymous reviewer. Of course, any remaining errors or omissions are the sole responsibility of the authors.

Table of Contents

Executive Summary ....................................................................................................................... i 1. Introduction.............................................................................................................................. 1 2. A Recent History of Modern Wind Project Finance ............................................................ 5

2.1 1998-2002: Strategic Investors Dominate the Market ........................................................ 6 2.2 2003-2006: Rise of the Institutional Investor ..................................................................... 7 2.3 Recent Equity Financing Developments.............................................................................. 9 2.4 Recent Debt Financing Developments............................................................................... 11 2.5 Summary ............................................................................................................................ 13 3. Description of Current Financing Structures ..................................................................... 14 3.1 Corporate Structure............................................................................................................ 15 3.2 Strategic Investor Flip........................................................................................................ 18 3.3 Institutional Investor Flip................................................................................................... 22 3.4 Pay-As-You-Go ................................................................................................................. 25 3.5 Cash Leveraged.................................................................................................................. 28 3.6 Cash & PTC Leveraged ..................................................................................................... 31 3.7 Back Leveraged ................................................................................................................. 34 3.8 Summary: Choosing a Structure ....................................................................................... 36 4. The Impact of Financing Structure on the Levelized Cost of Wind Energy.................... 39 4.1 Overview of Pro Forma Financial Model .......................................................................... 39 4.2 Levelized Cost of Energy Comparisons ............................................................................ 40 5. Conclusions ? Observations & Future Trends.................................................................... 48 References.................................................................................................................................... 52 Appendix A: Glossary ............................................................................................................... 54 Appendix B: Description of Pro Forma Financial Model and Assumptions........................ 57 Appendix C: Overview of Partnership Tax Accounting Issues ............................................. 69

Executive Summary

Wind power capacity in the United States has grown substantially in recent years. From 1998 through 2006, almost 9,900 megawatts ("MW") of new wind capacity was added, accounting for 85% of the 11,575 MW cumulative total capacity as of the end of 2006. In 2006 alone, 2,454 MW of new wind capacity was installed, representing a 27% increase in cumulative capacity.

This rapid expansion has required the mobilization of a tremendous amount of capital to finance wind project costs. Roughly $18 billion (in real 2006 dollars) has been invested in wind project installation in the U.S. since the 1980s, with more than $3.7 billion invested in 2006 alone. Looking ahead, wind project developers will need to raise close to $6 billion in 2007 in order to finance the expansion projected by the American Wind Energy Association ("AWEA"), and the required amount of capital will likely continue to increase in future years if market growth continues.

The financing of new wind projects varies from that of fossil-fueled power projects due to the different cost characteristics of each. Specifically, wind projects are capital-intensive to build but have no ongoing fuel costs, while fossil-fueled power projects are less capital-intensive (per unit of production) but have higher operating (e.g., fuel) costs. Furthermore, whereas Federal tax incentives for fossil-fueled power plants can be (and generally are) distributed throughout the entire fuel cycle (e.g., from exploration and extraction to transportation, power production, and emissions controls), tax incentives for wind projects are instead targeted almost exclusively at the power production stage. The two principal Federal tax incentives available to wind projects are the production tax credit ("PTC") and accelerated depreciation deductions (together with the PTC, the "Tax Benefits"). These Tax Benefits provide a significant value to wind projects, but also complicate wind project finance, since most wind project developers lack sufficient Federal income tax liability to use the Tax Benefits efficiently.

In response, the wind sector has developed multiple financing structures to attract various investors to projects, manage project risk, and allocate Tax Benefits to entities that can use the Tax Benefits most efficiently. Some of these structures are intended to attract actively involved large equity investors with a strategic interest in the wind sector, labeled here as "Strategic Investors." Others are designed to tap into more-passive equity capital from "Institutional Investors," which are primarily interested in the Tax Benefits. Still others enable developers and equity investors to layer on debt financing to leverage their equity exposure and returns.

This report surveys the seven principal financing structures through which most new utility-scale wind projects in the United States have been financed from 1999 to the present, excluding projects owned by investor-owned and publicly-owned utilities where the project becomes part of the utilities' internal generating portfolio and rate base. The report defines utility-scale wind projects as those designed to sell electricity directly to utilities or into power markets on a wholesale basis. The report does not cover financing structures used for smaller communitybased wind power projects, though it may have some indirect utility for parties considering such projects, as several financing options used for smaller projects are derived from structures first conceived for larger projects. Finally, this report is relevant only to the U.S. market, since the

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