The viability of any green energy project usually depends on the project developer’s ability to obtain and retain project financing. Projects are typically funded through a combination of equity provided by the developer and investors and short- and long-term debt provided by lenders. Despite the political appeal of green energy projects and the popular perception that massive amounts of funding are readily available at the turn of a tap, developers face increased difficulty in the current economic environment in obtaining both equity and debt financing for projects. In the long term, however, the growing number of states with renewable portfolio standards (RPS), the possibility of a federal RPS, and volatile energy prices will all encourage green power development.

Equity participants, lenders and other project participants are applying more stringent evaluations of the operations, finances, and credit of the developer. As with other industries and investments, the cost of obtaining equity and debt has recently increased. Because of the focus on “safer” investments and growing risk aversion, lenders are also reluctant to provide bridge and construction financing for green projects. Additionally, because the cooling of the economy has slowed energy demand, utilities not subject to mandatory programs are less eager to pay a premium for green power. It is now more important than ever for developers to explore every avenue of project funding to ensure a successful, viable project.

Although construction/installation costs of commercial green energy projects vary widely, all green energy projects have certain attributes in common:

• All depend on federal and state tax incentives and subsidies for financial viability
• Projects derive cash revenues from energy sales and sales of renewable energy credits
• Lenders require developers to contribute or obtain substantial equity in order to qualify for debt financing
• Equity and debt financing can be difficult to obtain from traditional sources
• Loan guarantees, grants, and subsidies are available from multiple federal, state and local programs and organizations

These attributes play a key role in obtaining financing and are touched upon in the following discussion of financing alternatives.

Tax Credits and Incentives and Subsidy Payments

Federal and state tax credits and incentives and subsidy payments play a critical role in successful green project financing. Important federal tax credits include the production tax credit and the renewable energy tax credit. The production tax credit is based on the quantity of renewable energy produced and sold during the first ten years of the project. The renewable energy tax credit (a component of the investment tax credit) is generally calculated as a percentage of the project’s cost (e.g., 30%).

Through tax equity financing, developers have been able to obtain equity from investors by selling the projected dollar value of anticipated tax credits at a discount. Although the tax equity market has diminished because of the state of the economy, developers have received a boost through the introduction of a federal grant program in the American Recovery and Reinvestment Act. Under this program, administered by the Department of the Treasury, developers receive a cash grant generally equal to 30% of the basis of the project facilities in lieu of the investment tax credit or the production tax credit.

Investors can also benefit from accelerated depreciation through being able to deduct certain investments in green projects, including solar and wind, over an accelerated five-year period, with a seven-year period for certain biomass equipment. Accelerated depreciation provides the developer a deduction of a certain percentage of the project’s cost over the five- or seven-year tax life.

The developer or investors can also benefit from state incentives, such as sales tax exemptions, property tax exemptions, and corporate income tax deductions and credits. Certain states have implemented programs that provide grants or subsidies to certain types of green projects, typically solar and wind. Investors are often reluctant to monetize such grants and subsidies because the amount of funding available is usually limited and such programs can be ended at any time. Developers should still attempt to have the expected benefit of such programs taken into account, although a substantial discount may be applied.

Development and Construction Financing

The benefits from most credits, incentives, and subsidies are available only when the project is placed into service. (For certain credits, in-service deadlines apply.) If the developer intends to self-finance the project and has sufficient taxable income to fully utilize the available credits and incentives, the in-service requirement is less important. It is very important, however, to developers who need early-stage financing. These developers must convince potential partners and investors to provide capital at the pre-development stage based on the discounted monetary value of credits and incentives, including the grant-in-lieu incentive.

Green projects tend to be capital intensive at every stage, including the pre-construction stage. Developers will need funding for feasibility and interconnection studies required by utilities, equipment deposits, real estate costs, and initial consulting fees. This funding can be difficult to obtain from outside sources, and finding investors and equity partners at this stage is crucial to ensure the project moves forward. Unless developers have a pre-existing relationship with potential investors, developers may have to approach dozens of potential equity partners and investors to piece together sufficient funding to start project development. Financial institutions are typically reluctant to offer early stage and bridge financing, viewing such products as short-term, high risk loans.

Certain smaller projects might be eligible for development dollars from government grants, such as USDA Value-Added Producer Grants for farm-based renewable energy projects and feasibility study funds from the Rural Energy for America Program for rural wind, solar and biomass projects. Several states also have programs available under which funds are provided to projects for feasibility studies and pre-development costs. These sources should not be overlooked, even if they will cover only part of the pre-development costs. Potential investors and partners may view the developer’s receipt of such grants as a positive indication of the developer’s dedication to the project and ability to successfully convince lenders to offer future, permanent financing.

Construction financing can be harder to obtain than permanent financing in the current economic climate. Because government programs typically provide funding upon commercial operation, developers will have to look to private market capital sources for funding. For larger projects, lenders may include European banks (which have deeper experience with green power projects), life insurance companies, and finance companies. Developers can also obtain private equity funding from hedge funds, investment banks, and energy-focused investment firms. Developers with projects in rural areas might also obtain construction financing from agricultural banks, such as CoBank. Some sources might also be willing to include a permanent financing option, although possibly at higher rates that “traditional” permanent financing sources.

Long-Term Financing

Unless the developer has access to equity partners that can provide all financing required for the project, the developer will need permanent financing from a financial institution. Depending on the size of the project, the developer might approach large national banks or smaller regional banks for financing. All steps in the project will have to be taken with an eye toward meeting the requirements for permanent financing, and developers will often have to demonstrate the availability and commitment of permanent financing in order to obtain early stage and construction financing from lenders, equity partners, and investors. Project financing thus tends to have a “chicken or the egg” feel, since partners and investors also want assurance that permanent financing is available for the project.

Although green energy financing is relatively new, lenders have financed enough projects to build a set of requirements and expectations, including:

• A team assembled by or accessible to the developer that includes construction, financial, regulatory and legal expertise
• Proven technology that has been demonstrated to work and comes with suitable warranties and performance guarantees
• Detailed financial projections and pro forma statements and a good understanding of grants, loans, loan guarantees, and available federal, state and local programs
• Strong guarantors or a sufficient combination of credits, incentives and investors to conform to underwriting standards
• Solid contracts with utilities, equipment suppliers/manufacturers and partners
• Projected stable cash flow, whether from energy sales, renewable energy credits, lease payments or other revenue sources

Because of the problems faced by lenders as a result of the real estate downturn and the economy in general, lenders have grown more reluctant to fund green energy projects, especially those using new technologies, and they must be “sold” on the financial viability of the project. As a result, lenders are discounting the value of collateral and projected cash flow and requiring increased equity contributions and guarantees from equity partners and investors.

Lenders expect that most projects will involve some form of assistance from federal and state programs. Loan guaranty programs offered by the federal government offer substantial assistance in obtaining long-term financing from commercial lenders. These programs include:

• USDA - Business and Industry Guaranteed Loan Program. Available for equipment, real estate, and permanent working capital for certain projects in rural areas. Guarantees available for up to 80% of loan value.
• USDA - Rural Energy for America Program. Grants and loan guarantees for renewable energy projects, but limited to rural small businesses and farmers. Grants/loans can be combined to cover up to 75% of project costs.
• DOE – loan guarantee programs. Available for green projects including biomass, solar, wind, and hydropower. Guarantees available for up to 80% of loan amount, and have to date typically been for large-scale projects.


Developers can also obtain permanent financing from private market capital sources such as banks, life insurance companies, finance companies, energy funds, investment banks, and certain utilities.

Conclusion

In the current economic climate, developers need to consider all potential sources of project financing. Project participants must consider various ownership and financing structures, depending on the identity and nature of the developer’s equity partners and investors and their ability to use and thus place value on proposed subsidies, credits, other tax incentives, and accelerated depreciation. For some projects, partnerships with local governments or electric cooperatives might prove beneficial as well, and may provide access to additional sources of financing. Regardless of the project, its participants, and the proposed funding, developers must thoroughly consider all sources and costs of project financing long before beginning negotiations with prospective investors, lenders, partners, and other project participants.

LEARN MORE ABOUT ENERGY TAX CREDITS:

Tax Credits Available to Energy Investors

Energy Tax Credits