Starting a energy company?

Are you thinking about starting a new energy company? or perhaps wondering about the process? Here's a brief on how can possibly go about it, including important terms and concepts in debt financing.

 

The early process of project finance beings with an entrepreneur or parent company realizing an economic opportunity. Through a back of the envelop calculation, rough estimates are made to evaluate if the project is profitable and financeable. The entrepreneur or the company determines the institutional and financial structure for the project. If they determine to proceed through project finance then an LLC is established to protect from the liabilities. The case is then presented to the utility buyer to obtain a financeable PPA through the help of a competent lawyer. The PPA is brought to the investment banker to assist secure the capital required to finance the project. The investment banker helps to obtain debt financing by matching investors to the project. The investment banker will also assist in creating a Pro Forma and other wide range of financial services required for the project finance. Through the debt financing process, because of the non-recourse nature of the project finance, the parties are interested in reducing uncertainty by appropriate risk allocation and mitigation. Some of the important stages in the project finance are provide below:

Offering memorandum: Offering memorandum is the first step in securing an investment. It contains a detailed overview of the project and participants. It includes the capital required, EPC contract, and other entities involved in the project along with their creditworthiness. Offering memo helps to solicit bids from the lenders to obtain the capital.

Commitment Letter: After you have a lead bank, you then arrange to put together the letter of intent or the commitment letter. Commitment letter is a negotiating document that includes the

terms and conditions that need to be met to get a loan. This is subject to the due diligence to the parties.

Credit Agreement: Credit Agreement is the second most important document in project finance after the PPA. It includes the terms and conditions of the loan, including how the loan is dispersed, interest rate and other important factors of the loan. Credit Agreement takes place after the borrower fulfills the obligations in the commitment letter.

Construction Contract: Construction contract is the biggest part of the project finance. The construction contract can either be turnkey, or EPC model. The three most important factors during construction are Price, Performance and Schedule. It is crucial for the plant to be build at specified cost, with specified performance levels before the COD. It is important to select a creditworthy construction contract, who have the credit to support obligations of the contract or have parent guarantee. The contract price should offer sufficient risk premium for the contractor to build the project as specified on the contract. The construction ends on substantial completion where the company takes the ownership of the project.

Security Documents: It is the project collateral that secures the loan and provides guarantees to pay back the funds. The lender is concerned with ensuring that they have sufficient authority to oversee or in need step in and take over the project in event of default. The contract could also include performance bonds and collateral warranties to protect from the losses in termination of the project.

Representation: It is the statement made by the contracting party stating that the fact provided is correct on the date made. Every time there is a reissuance of the contract, it is important to re-represent to know that nothing has changed. This process helps the parties to provides incentive not to deviate from the previously agreed contract.

Legal Opinions: Legal opinions are formal statements from the lawyers based on their legal knowledge and review of the facts that the information provided is true. This provides a backing of the representation. There legal opinions can be classified into 3 types - “would, could and should” types. Legal opinions is one of most valued documents in project finance since it provides reassurance to the lenders.

Covenants: Covenants are agreements or promises the company agrees to perform specified tasks in the future. The covenants would be either affirmative (agree to perform) or negative (withhold from certain action). Violating a covenant can lead to default under which the lender has the rights to undertake corrective measures.

Event of a Default: Any breach of rep, or covenants, bankruptcy, breach of credit support can lead to default. The contract includes remedies for default which provides steps to fix the breach through liquidated damages, termination of the contract, payment of direct or other measures. The final step is the foreclosure where the assets of the company is put up for sale to recoup the loan.

Although project finance offers significant challenge in terms of coordination, allocating risks and reducing uncertainty, the success can be rewarding. As the project building is completed and starts to generate predicted cash flows, the company can assign a developmental fee that the lender would be willing to finance as cost of the project. 

FERC's responsibility towards Environment.

Apart from largescale hydro, FERC has no statutory authority over environmental matters. FERC’s role is generally understood to create a market based reliable and affordable whole sale energy market, and environmental concerns are left to be dealt by EPA and other federal and State authorities.  Even though the US power sector emits more than 1/3 of the total CO2 emitted,( in addition to other significant water and land use impacts) FERC is correct that it is not its role to deal with these ‘environmental’ issues. 

However, the flaw with this argument is that, the environment is directly is interlinked with FERC’s objective to create “reliable and affordable” electricity market.

Global and local climate effects can have a significant impact on the electricity market. For instance, unusually cold winter last year created soaring natural gas prices, significantly impacting the electricity market. Hurricane Irene flooded large sections of NYC leaving them without electricity for days. One of the worst droughts in California is severely impacting its hydro-electricity production.  And rest assured, these events will continue to exacerbate with climate change. 

Apart from these large scales, high probability but low frequency catastrophic events, simple increase in temperatures put a severe strain on the grid. Higher summer temperatures increase the peak load, creating high electricity prices and need for extra generation capacity. Transmission lines also gets overburdened. Even night time high temperatures impact the cooling cycle of the transformers, decreasing its lifespan and efficiency.  Creating more power capacity, transmission lines will amount to billions of dollars. 

These are just a tiny fraction of the issues how climate severely threatens  FERCs responsibility to ensure “reliable and affordable” energy. If FERC is serious about fulfilling its objectives, then it should seriously consider measures to limit GHG emission from the power sector, including measures proposed by the article.  Carbon surcharge is an excellent market based tool that will take in considerations of the externalities  of the carbon emission. There is no need to look at a carbon surcharge as an environmental charge, but rather this could be seen as a charge to create reliable and affordable power system, and FERC has the authority to do that.

Framework for Investment for Solar PV in Vermont

Any investment decisions are affected by two major factors- certainty in the recovery of their investment and the size of return for their investment. Investment in renewable greatly depends on the government policy, technology and resource availability. The State of Vermont offers some of the most favorable places for renewable energy investment.

Advantages of Investment in Vermont

Strong State commitment towards renewable energy: Vermont is among the progressive States  that is leading clean energy development. Vermont has a set a goal to achieve 90% of its energy by renwables by 2050. In 2005 Vermont instituted its voluntary RPS program (SPEED program) with the goal to generate 20% of its electric consumption through renewables by 2017.[1] In order to achieve this goal the State requires the state utilities to purchase electricity from qualified SPEED resources through long term contracts with fixed standard rates. The rates and contract length differ by technology and size but is intended to offer reasonable return on investment for the renewable energy developers.[2] The State also offers a net-metering for facilities upto 500kW in capacity. Small projects less than 15kW qualify for “fast-track” permitting process where the utility has to approve the project within 10 days. The net-metered customers in the state are offered a Solar-Adder where the utilities are required to by the electricity at 20c/KWh. This generous feed in traiff program has spurred growth in small solar PV installations in the State. Because of the increased popularity of this program the PSB increased the initial cap of 4% of peak demand to 15% of the utility’s peak demand. The law also allows for group net-metering arrangement where the group of customers can sign up for electricity from a large renewable energy facility.

Support from the Utility:  In addition favorable state policies, Vermont also has electric utilities that are favorable to renewable energy. Green Mountain Power- which serves 75% of the customers in Vermont was recently awarded the “Utility of the Year” for 2013 for its incentive to incorporate solar.[3] Several other cooperatives that serve in the region also have programs that have instituted favorable programs for solar PVs.

As an investor these factors provides a reasonable certainty for the investor and decreases the regulatory and policy uncertainty for the investor. The favorable regulation for renewable energy is likely to continue in Vermont which is attractive to making any investment in the State.

Technology and Timing for investment: Solar PV is the most cost effective technology that can be invested in Vermont. The net-metering for solar adder of 20c/KWh, ITC of 30% of the tax rebate and the decreasing cost of solar PV makes it a lucrative investment. The recent increased cap of 15% of the utility peak for renewables provides plenty of market opportunity for a new investor. New investments in Solar PV could be carried out through 3 types- i) by submitting could an RFP to the PSB to quality as a SPEED resource, ii) invest in companies that provide small capacity net-metering to the residential customers, and/or iii) act as an aggregator to sign up group net-metering. In all three of these decision, the investor is guaranteed stream of reasonable return on their investment.

The timing is perfect for the investment in Solar PV. As discussed in the market section, the cost of solar worldwide has fallen dramatically. The Federal ITC of 30% is set to expire on 2016 similarly the solar adder in Vermont is also set to expire in 2016. This allows for the investor period of 2 years to complete its solar PV project inorder to get the solar subsidy.

Barriers for Investment:  Before investing in Solar PV in Vermont, the investor needs to be concerned about some of the barriers for investment.

Saturated Market: Since Solar PV is a lucrative market in Vermont, there are already plenty of competitors in market. There are currently more than 45 solar companies in Vermont making it the higher per capita in solar jobs in the US. The investor needs to find a niche market or invest in its own generation facility inorder to make a successful investment.

Timing: As mentioned above the time is against the investor. The generous state and federal subsidies are set to expire at the end of 2016 leaving only 2 years for the investor to gain benefit from the subsidies.

Land use and Interconnection requirements: Interconnection for larger solar PV facility needs to be connected to a three-phase line. In Vermont there are limited properties that are close to the three phase line where the solar farm can be put in. There has also been a rising concern in Vermont about the land use concerns by large solar farms. One of the major challenges for the investor would be find appropriate land to site their facility.

The regulatory policies, cost of solar and State’s strong commitment towards renewable electricity makes Vermont an idea place for investment for renewable energy.

---

[1] http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=VT04R

[2] Id.

[3] http://news.greenmountainpower.com/press-releases/green-mountain-power-named-utility-of-the-year-1061519?feed=d51ec270-a483-4f6c-a55e-8e5fbe2238c2

Technology and Market Development for Renewable Energy

Renewable energy in the world has seen rapid growth in recent years. In 2013 renewable energy projects made up around 43% of the new installed capacity for electricity worldwide increasing its share to 8.5% of total electricity generation.[1] This record number of installed capacity came at total investment of $214 billion, which was 14% reduction in total investment made in 2012.[2] One of the main reasons for low investment was due the rapid decrease in the cost of PV. The price of solar PV and wind energy is energy is decreasing rapidly making cost competitive with some of the fossil fuel generation. While the renewable energy market have seem to stagnate in the US and Europe, developing countries especially China and India have picked up the slack. The investment in US decreased by 10% in 2013 to $36 billion, while China investment $56 billion, which is greater than the total investment in Europe. A report by the City Bank noted that the decrease in costs would continue to fuel renewable energy boom leading to new age of renewable energy.[3] These all provide formidable signs that renewable energy market has now successfully established itself and it will continue to grow in the future.

Solar PV: Solar PV essentially works by converting the solar light that hits the panel into electricity. This technology was developed in the 60’s and was widely used to power space satellites. There are two major Solar PV technologies- Crystalline Silicon and Thin Film. Crystalline Silicone are considered more efficient (20%) and expensive of the two. The leading companies that manufacture Silicon PV are SunPower, Sharp and TrinaSolar. Compared to Silicon PV, Thin Film PV are more affordable and less efficient (13%). FirstSolar and HeiloVolt are two of the leading companies manufacturing thin-film solar.

 Solar PV industry is changing the perspective that the renewables are expensive. According to SEIA and GTM research, the cost of solar power in the US has decreased around 60% compared to 2011.[4] The cost of solar has come down to $3.05/ W making it an attractive investment for many residential customers. Thanks to the economics of scale and technological innovations, the price of solar PV is expected keep decrease by 11% every year. Although the growth in the solar industry in the US has been driven by utility solar market, different companies such as Solar City and SunPower have developing the residential solar PV market to make it attractive investment. Different programs such as Solar leasing, Group metering, EV-Solar PV combo sales have accelerated the penetration of solar PV in the residential market. The generous Federal 30% tax credit (ITC) and different state incentives has played a substantial role in the development of Solar PV in the US. For states with different RPS mandates, the market for Solar RECs provide additional revenue stream for solar projects. Solar RECs which are considered high quality Class I REC sell for as high as $540/MWh.

One of the significant challenges for solar PV is its high cost during permitting, marketing and installation process. These ‘soft costs’ add upto more than 60% of the total cost of the project. Solar companies and policymakers could target this aspect of the cost to make solar more affordable. DOE funded “SunShot” project is an example of a program that is developing means to bring the cost down. Another challenge in the market for solar PV has been the anticompetitive government policies of China. China has been accused of dumping its solar PV in the international market thus artificially depressing the price.[5] This has allegedly resulted in large economic losses to many international solar manufactures.

The subsidies to solar PV has provided tremendous boost for its development. As the efficiencies in supply chain, technology continues to improve, the final turning point for solar can soon be expected when the price drops enough that it can continue without any governmental subsidies.

            Wind: Wind turbines harness the kinetic energy in the wind to convert it into electrical energy. As the wind spins the turbine, it rotates the inner shaft that is connected to the alternator which produces electricity. The technological development in the wind has been mainly focused on making the turbines taller and larger. Modern wind turbines can have capacity as big as 8MW with 80m blades.[6] Vestas, GE Energy, Siemens are some of the leading wind turbine developers in the market.

            Similar to Solar PV, wind has seen dramatic growth in recent years. In 2013, total of $80 billion investment was made in the wind industry in the world.[7] In the US the total investment for wind energy amounted to $25 billion in 2012. In 2013 total of 4.8% of the electricity in US was produced from wind energy. The total installed capacity of wind in the US amount to 61GW. The wind power is the most cost competitive of the renewable electricity. The average levelized price of wind cost is estimated to be $80/MWh. In comparison the levelized cost of Coal is $95/MWh.[8] The price of wind has gone so low that there has been occasions in the wholesale market where the wind has offered operate at negative price (or pay to produce) at certain periods. In the wind resource rich states in the Mid-West such as Iowa and South Dakota, wind now produces more than 25% of the state’s electricity.[9] Since 2005, wind energy saw sustained investment driven by the Production Tax Credit (PTC). Wind investment grew at record amount in 2013 to build facilities before the PTC expired on 2013. Even without the PTC, investment in wind holds strong value proposition for investment. Wind resource rich areas in the US including Wyoming, New Mexico, Montana and Wyoming offer attractive places for wind development. It can be expected that wind will continue to develop and challenge the status quo of coal and nuclear plants.

Geothermal: Geothermal energy is based on using the heat that is inherent in the Earth’s core. As Earth’s temperature increases with depth, this energy can be harnessed through drilling a hole to use it as heat pump. Depending on the resource availability and temperature needs, wells can be drilled ranging form 200-3000 meters to access the inner heat of the Earth.[10] Electric generation from geothermal is based on three types – Dry steam, Flash stem and Binary Cycle.[11] Geothermal plant usually has high capacity factor of 90% making it suitable for baseload generation.

Total installed geothermal capacity in the world account for 11.2 GW. In 2012 the US had 78 Geothermal plants on operation with the total capacity of 3.2 GW.[12] The cost of geothermal plants are highly depended on the location and technology involved which can range from $1150-$3000 per KW. US has identified resources of additional 9.1GW and estimated potential of 30GW.[13] Most of the resources are located in the western part of the US namely California, New Mexico and surrounding regions. Compared to wind and solar PV, geothermal energy has lacked significant market growth. Even though geothermal enjoy the same federal subsidies at Wind and Solar, other factors such as high capital costs, permitting challenges, policy uncertainty are some of the reasons that the development of geothermal has not gained much ground.[14]

The biggest investments in renewable energy came from public market equity which invested $11 billion, drawn primarily due to the investors increasing yields of portfolios of renewable energy projects. Although the investments in renewables have been primarily driven by the government subsidies, technology and market development has continued to lead to reduction in costs. The turning out point in renewable shall occur when renewable generation can out-compete fossil fuel without any need for government subsides. If the current trend is any indication of future then that day should be expected soon.

---

[1] Global Trends in Renewable Energy Investment 2014 (Frankfurt School- UNEP Center/BNEF 2014)

[2] Id.

[3] http://www.businessinsider.com/citi-the-age-of-renewables-is-beginning--2014-3

[4] http://www.pv-magazine.com/news/details/beitrag/us-solar-power-costs-fall-60-in-just-18-months_100012797/#axzz363JeEPeD

[5] http://www.bloomberg.com/news/2012-10-10/u-s-sets-anti-dumping-duties-on-china-solar-imports.html

[6] http://www.windpowermonthly.com/article/1211056/close---vestas-v164-80-nacelle-hub

[7] Global Trends in Renewable Energy Investment 2014 (Frankturt School and UNEP)

[8] http://www.eia.gov/forecasts/aeo/electricity_generation.cfm

[9] http://www.awea.org/Advocacy/Content.aspx?ItemNumber=797

[10] Geothermal  for Electric Power REPP Issue Brief

[11]  Id.

[12] B. Speer, Geothermal Brief: Market and Policy Impact Update, NREL 2012

[13] Id.

[14] Id. 

Federal, State and Local Policy in Renewable Energy Development

Federal, State and local energy policy has a significant role to play in development renewable energy resources. The unique legal framework in the US provides sufficient separation of power between these three levels to achieve range of energy policy scenarios.

Federal: Federal level energy policy is overseen by the Department of Energy that deals with national energy policy design, manages the nuclear infrastructure and various national laboratories. Federal Energy Regulatory Commission (FERC) is also major player in federal energy policy through its role to regulate the interstate transmission of electricity, natural gas and oil. Energy Policy Act of 2005, PURPA (1978), Energy Independence and Security Act (2007) and American Recovery and Reinvestment Act (2009) are some of the major legislation that deal with renewable energy development in the federal level. There are also numbers of environmental regulations that have been indirectly helping the growth of renewables. The Clean Air Act has been phenomenal limiting the growth of coal fired plants and pushing the utilities towards renewable energy sources.

Incentives for renewable energy development come in 3 types – as direct grants, tax breaks and technical assistance. Two major federal programs that have been very successful for renewable energy development are Renewable Electricity Production Tax Credit (PTC) and Business Energy Investment Tax Credit (ITC). PTC provides a tax credit for each KWh of electricity generated by a qualifying energy resource. This program has been very popular with wind resource which obtained 2.3c/kWh for each KWh produced. This program however expired in 2013.[1] ITC provides tax credit upto 30% of the expenditures for eligible projects.[2] This program has been popular with solar projects for which the total maximum credit is not capped. ITC is set to expire at 2016, at which it is the tax break is set to decrease at 10%. As both of the programs have been designed as tax credit rather than direct rebate, they are more attractive to investors with large tax appetite. Some of the solar developers have come up with innovative market schemes to transfer the tax subsidy to third party by directly subsidizing the project cost for customers. ARRA act played a major role in renewable energy development by providing more than $2 billion dollars in funding to modernize the grid which has increased the feasibility of integration of renewables into the grid.

The current federal energy goal of “all of the above” is a serious impediment for renewable energy development. The federal energy policy goal is targeted toward energy security, job creation and environmental benefits.  Conflict between these diverse objectives which often contradict each other, the federal energy policy can be best described as betting on all the horses. It provides generous subsidies to nuclear and provides substantial amount of subsidies for fossil fuel companies, which in turn decreases the cost competitiveness of renewable energy. The federal level policy needs to strongly affirm the direction for policy that focus on promoting renewable energy.

            State: The state energy policies are varied as the number of states itself. The 10^th amendment to the US constitution delegates police power to the State allowing them to creates laws for safety, health, welfare of their communities. The states also have the power to regulate the retail sale of electric rates and siting of facilities in their states. These allow the States for sufficient rights to create their energy policy. Each of the states has their own unique energy policy that has been influenced by different factors. There is a wide spectrum of state energy policy from California which has been a leader in renewable energy development to states like Oklahoma[3] whose energy policy seems to be designed to suppress renewable energy growth. Renewable Portfolio Standards (RPS), Net Metering and Feed in Tarriff are the three major policy programs popular in state level that has been targeted for renewable energy development. RPS is a requirement that usually requires the electric retail suppliers to meet certain amount of electricity load through renewable energy. RPS does not provide direct subsidy to the renewable energy but they benefit from selling Renewable Energy Credit (REC) in the market. Around 30 states in the US have some form of RPS with different variation on structure, enforcement, size and application.[4] For instance CA has an RPS to derive 33% of their retail load by renewables by 2020 while Virginia has voluntary RPS goal to meet 15% of load by renewables by 2025.[5] Unlike RPS, net meting and FIT provide direct credit to the renewable energy generation. Various states have enacted policies that either allow customers to offset their electric bill by producing their energy through net meting or provide guaranteed pricing per kWh for a period of time form a qualifying resource through FIT. An example of variation of FIT is used in Minnesota as “Value of Solar Tariff” where customers get a specified amount of credit per KWh. Similarly in Vermont has policy of feed in tariff of 20c/kWh for solar projects. Some of the states however have instituted programs that counter renewable energy development. For instance Oklahoma includes  a law that charges resident extra amount to produce their own energy through solar panels.[6] Similarly Ohio has froze its RPS requirement creating a severe blow to renewable energy development in the State. 

            It is unfortunate that the issue of renewable energy in the US has been a partisan issue. While the Democrats seem to be in favor or renewable energy, the majority of the Republicans have undermined them. This uncertainty in the policy in State and Federal level has been a severe impediment for renewable energy development.

            Local: Despite overarching Federal and State energy policy, local communities have sufficient discretion to develop their energy policy. Local governments and form electric cooperatives, set local ordinances and make land use decision that can directly affect energy policy in the grassroot level. There are more than 800 electric cooperatives in the US that provide electricity to around 12% of the population. The cooperatives are managed and owned by the local people and have direct voice and reflect the values of the community. For instance,  the Washington Electric Coop in Vermont is committed to provide electricity to its residents through clean and renewable sources where the residents have agreed to pay higher rates for renewable energy.[7] Community aggregation model are another example of how communities have been able to affect energy policy in local level. Community aggregation allows the communities to directly buy power at wholesale rates from their selected renewable suppliers and pay the utilities for distribution service. Marin Clean Energy in CA is an example of such community aggregation model which provides its customers choice of consuming 50%-100% electricity from renewable sources.[8] Local ordinances can also have significant impact for renewable energy development. The ordinance enacted in Sebastopol, CA requires the new and improved buildings to include solar PV. Inaddition to fostering renewable energy development, locals can also play big role in inhibiting the growth of fossil fuels. The residents of Oakland blocked the construction of new coal exporting terminal in Oakland, CA.[9] There have also been several local ordinances banning hydro-fracking in several States.

            The legal framework structure in the US has especially designed in a way to encourage wide variety of policies across the nation. The policies for growth of renewable energy vary from each towns, cities and state. The policies range strong programs in place for the growth of renewables others to policies placed to act as barriers for the growth of renewables.  

---

[1] http://dsireusa.org/incentives/incentive.cfm?Incentive_Code=US13F

[2] http://www.dsireusa.org/incentives/incentive.cfm?Incentive_Code=US02F

[3] http://thinkprogress.org/climate/2014/04/16/3427392/oklahoma-fee-solar-wind/

[5] www.dsireusa.org

[6] http://thinkprogress.org/climate/2014/04/16/3427392/oklahoma-fee-solar-wind/

[7] http://www.washingtonelectric.coop/about-wec/bylaws/

[8] http://marincleanenergy.org/

[9] http://www.the-american-interest.com/blog/2014/05/14/new-green-motto-not-in-your-backyard/