Financing Incentives in the Stimulus Package Project Finance

Financing Incentives in the Stimulus Package Project Finance Basics Power Purchase Agreements September 2009 Florida Renewable Energy Producers Association PL 30726 Fred Greguras Palo Alto Office fred. gregras@klgates. com 650. 798. 6708

Overview of the Firm § Over 1800 lawyers in 33 offices throughout the U. S. , Asia and Europe. Office in Miami. § Project financings for cleantech clients in the U. S. , Europe and Asia. § Washington, D. C. office helps clients get access to grants, loan guarantees and other financing incentives § One of the largest international practices in Asia with offices in Hong Kong, Beijing, Shanghai, Taipei and Singapore.

Overview of the Presentation § Stimulus Package Financing Incentives § Project Finance Basics § Power Purchase Agreements

Overview of Stimulus Package Financing Incentives § Types of Financing Incentives § Spending § Tax Incentives § Loan Guarantees § Applying the Incentives § Technology § Product § Project

Types of Financing Incentives (I) Spending § § § FOAs for grants, cooperative agreements, TIAs See spreadsheet handout for list Research, development, pilot, demonstration, deployment, education, evaluation, etc. § ARPA-Energy concept paper (closed June 2) § ARPA-E next round request for information (closes Sept 25) Unsolicited proposals Large and small companies are eligible Single solicitations rather than rolling solicitations

Types of Financing Incentives (II) Tax Incentives § § 30% cash grant in lieu of investment tax credit (spending). Funds need to continue to be paid to provide predictability for investors 30% ITC tax credit in lieu of PTC Manufacturing investment tax credit (closed September 16) Bonus accelerated depreciation-2009 only, extend for 2010? (Basis is 85% of cost) New Federal Loan Guarantee Program § § Costs of program make it feasible only for companies with strong balance sheets Investment committee of most banks will evaluate whether the underlying loan should be approved on the assumption there is no guarantee.

New Loan Guarantee Program (I) § First solicitation under Recovery Act was for electric transmission infrastructure projects deploying commercial technology (closed September 14) § Additional solicitations to be for “renewable energy systems, including incremental hydropower, that generate electricity or thermal energy and facilities that manufacture related components” and certain leading edge biofuel projects § Amount available for renewable energy systems may be limited to $750 M because of shift of funds to cash for clunkers program § Guarantees are generally limited to 80% of project costs. DOE may guarantee 100% of a loan funded by the Federal Financing Bank which may be for no more than 80% of eligible project costs.

New Loan Guarantee Program (II) § Borrower and other principals must make a significant cash investment in the project. § DOE may determine an appropriate collateral package among creditors § Under existing guarantee program, only “New or Significantly Improved Technology” may be deployed and borrower must pay credit subsidy costs if the project is not in a Recovery Act category.

New Loan Guarantee Program (III) § Application fees: $200 K with Part I; $600 K with Part II § Facility fee: ½ of 1% of the guaranteed amount due at time of signing final term sheet § Maintenance fees: $200 K – 400 K per year § DOE outside counsel and consultant fees paid by applicant with no cap

New Loan Guarantee Program (IV) § None of the fees are refundable or may be reimbursed out of guaranteed loan proceeds § Credit subsidy cost (approximately 10%) paid out of Recovery Act funds § Fees for other types of projects must be lower and decision-making faster so commercial as well as utility scale projects can benefit. § Solyndra: $535 M loan guarantee for 500 MW capacity manufacturing plant. Credit subsidy cost likely paid from Recovery Act.

Applying the Incentives: Thin Film Concentrating Solar Technology Description and Status: Strong technical team with credibility in solar. Still in development mode. Technology, scaling and manufacturing cost risks still being determined. Financing Opportunities: § ARPA-E-closed June 2 (single solicitation) § Other grants directly from DOE (development, pilot, demonstration, etc. ) § Solar America Initiative from NREL Pre-incubator-closed March 10 (single solicitation) Full incubator-letter of interest closed July 13 (single solicitation) § Angel, venture capital? § Company likely to be funded in China under new structure

Applying the Incentives: Mobile Biodiesel Generation Product Description and Status: 500 gallons of biodiesel produced in a 24 hour period; oil based feed stock. Enables mobile and distributed biodiesel generation. Product has been released for commercial sales. Company has reference customers and revenue. Needs expansion capital. Financing Opportunities: § Venture capital § Can use cash grant in lieu of ITC (30% up front) to help customers decide to purchase § Possible grant for research, development, pilot, demonstration of next generation of technology

Applying the Incentives: Wind Electric Generation Project Description and Status: Site selected near high voltage lines; land use approvals obtained for 100 MW project; many jobs will be created; proven technology selected but unable to secure equipment financing or construction loan based solely on revenue streams. Financing Opportunities: § ITC rather than PTC: 30% upfront rather than over 10 years as energy is produced § Cash grant in lieu of ITC § New loan guarantee program § State incentives-feed-in tariffs § Venture capital?

Approach for Obtaining Stimulus Funding § Monitor FOAs-comment if published in “Notice of Intent” or RFI form so the final FOA covers your proposal § DOE press releases, Fed. Connect, grants. gov § Register with Fed. Connect-usually takes at least one week § Think of DOE, EPA, USDA, etc as investors § Case needs to be made to them as to a VC or PE investor § Job creation impact-number, timing § Team-credibility with funding agency

Project Finance Basics (I) § Strong sponsor with proven track record of execution § Product deployed – proven commercial technology § Financial health of supplier § Field service support capability § Financing model-how does the math work? § Project financing startup and recurring (O&M) costs vs. sufficiency of revenue and equity investment § Project developer fees § Debt service § Creditworthy off takers § More difficult issue for commercial distributed solar – credit level must be investment grade or near investment grade § Regulated utilities

Project Finance Basics (II) § Loan interest rates (8, 9 12%); debt service ratios (1. 35 -1. 45) § Tax benefits vs. real revenue (cash) § Revenue (Cash) Sources § Power Purchase Agreement (PPA) payments § Cash grant in lieu of ITC: 2009 -2010 § State rebate-predictability of receipt; upfront or spread over a period § Renewable Energy Certificates (RECs): Tradable instruments of certification that one Mw. H of electricity was generated from a renewable source; owner of REC may claim to have purchased renewable energy

Project Finance Basics (III) § Tax Benefits § Investment tax credit not cash grant after 2010 § Depreciation: bonus for 2009 – double declining balance § Bottom line for making the math work is that some equity investment is likely needed. Revenues may not be sufficient § Financeability (bankability) is dependent on predictability of receiving the revenues and benefits. Greater the certainty the lower the financing risk

Project Finance Basics (IV) § Project location § Land acquisition (customer or third party), permitting, environmental and other government regulation § More complicated for utility projects § Proximity to transmission lines for interconnection § More complicated for utility projects § Wind power strength and reliability (site-specific wind data) § Sun strength and reliability § Feed stock supply and cost. § Inability to lock in a long term supply of feed stock § Stock and transportation cost § Storage and supply logistics § Water for solar thermal § Rebate amount: PG&E vs SMUD § Feed-in-tariff availability

Project Development Structure: Partnership Flip Equity Tax Investor 99% Developer/ Sponsor 1% Other Investors Contractor Construction Agreement Debt financing Special Purpose Vehicle (Project Owner) RECs REC Market Operation and Maintenance PPA Power Offtaker Operator

Partnership Flip (I) § SPV (LLC) is an investment vehicle which owns the REF on date it is placed into service § SPV equity owners are developer, tax investor, maybe others. Investor wants a tax advantaged investment; developer probably can’t use tax benefits § Revenues of project pay for operating expenses and debt service § Non-recourse debt which means lenders look only to the project revenue streams for repayment § Developers and investors liability is limited to their investment in the SPV

Partnership Flip (II) § All project agreements must be financeable including Site Host Lease Agreement § ROI for developer equity owner from appreciation, developer fees and possible downstream share of revenues. § Investor allocated substantially all tax attributes of ownership during first 5 years of operation § Term must be at least 5 years from the Commercial Operations Date to avoid recapture of tax benefits

Project Development Structure: Sale Leaseback Investor/ Lessor Sale Contractor Lease Agreement Construction Agreement Solar Developer LLC/Lessee PPA Power Offtaker Operation and Maintenance Operator

Sale and Leaseback § Developer sells REF to investor which then leases back to the SPV. Net lease with “hell or high water” lessee obligations. § Lessor allocated all tax attributes of ownership § Ownership must be for at least 5 years from the Commercial Operations Date to avoid recapture of tax benefits. § Placed in service timing difference (90 days)

Power Purchase Agreement (PPA) Types § Utility projects § Commercial distributed solar on roof tops, parking lots, etc. § Will describe and compare provisions in both types § Utility PPA forms usually start with many excuses for non-payment by utility which creates financing risk § Must be financeable: only a remote risk of non-payment to provide predictability for investors who may have different risk levels.

PPA Basics (I) § PPA is long term agreement for the purchase of electricity from the owner (SO) of a renewable energy facility (REF) by a host customer or offtaker (OT) § Price dependent on characteristics and location of OT § Wholesale vs. retail (utility or distributed commercial) § Feed in tariff (FIT) § Price fixed with annual increases based on an inflation factor. Provides predictable electricity price which is typically below retail price (5 -10%) in first year or several years, later increasing pursuant to a formula or schedule. § Any possible price volatility is an investor concern § Term – 20 -25 years; 25 -30 years for utility projects

PPA Basics (II) § Not all PPAs are the same. Each must be carefully reviewed and negotiated so it is financeable. Some high risk terms are apparent; others are more subtle. § Starting point for financeability is creditworthiness of the OT. Purchaser’s current credit rating, financial analysis and legal considerations because of the 20 year payments under a PPA. § If OTs credit is later downgraded, PPA requires a credit enhancement for the payment obligation by cash escrow, letter of credit or other security.

Key PPA Provisions (Effective Date/ COD) § Effective Date: date PPA is signed and SO is obligated to construct REF § OT may require credit enhancement if construction milestones missed or REF is not commercially operational by specified date § SO has obligation to construct, install, operate and maintain § Commercial Operations Date: date the SO has met all conditions required to deliver electricity to OT § Certification by SO, independent professional engineer, REF acceptance by utility § PPA term begins and REF placed into service

Key PPA Provisions (REF Specifications) § REF Specifications § Size and expected production (Watts DC and AC). More rigid requirements by utility OT. § Modules, inverters, BOS: proven technology with track record § Metering capabilities at point of delivery (POD)

Key PPA Provisions (Quiet Enjoyment/Expiration) § Quiet Enjoyment § Customer premises or third party property § REF is property of SO not OT; fixtures. § OT will defend SO from any and all claims by third party landlords or creditors. § Expiration of PPA Term § Renewal term § OT purchase REF at fair market value § SO remove REF

PPA Basics (Purchase Option) § Offtakers REF purchase option driven by tax requirements § Five year recapture period for tax credit benefits § Periodic (at pre-determined times not continuous) after 5 years of being placed in service and at end of term § Purchase price must be at least FMV

Key PPA Provisions (Default) § Default provisions are detailed § Risk allocation from REF to point of delivery (POD) § Risk allocation related to transmission access and cost of transmission upgrades § Material misrepresentation or material failure of either party to meet its obligations § Cross default on site host lease agreement § Many default conditions have a notice and cure period so parties can discuss and try to resolve before termination becomes effective § Upon SO failure to perform. investor may want step-in rights to assume project control and correct default before termination

Key PPA Provisions (OT Default) § SO Rights upon OT Default § Cure period for failure to pay should be no more than 10 days § Termination payment obligation for default or convenience must be at least present value of SO losses and adequate to cover debt service obligations § SO may remove the REF upon OT termination § No election of remedies

Key PPA Provisions (O&M/Tax/Insurance) § Operations and Maintenance § SO must operate and maintain the REF in good working order § O&M costs must be part of the financing math § Sales tax on power purchase paid by OT § Property tax for REF itself paid by SO but may be exemption under state law § Insurance Requirements § Commercial general liability, property and casualty, builders risk, business disruption. SO listed as an insured on OTs property and casualty insurance on premises § Performance warranty insurance § Investors requirements

Key PPA Provisions (Indemnification/ Consequential Damages) § Indemnification § Mutual indemnification for damages to third parties for breach of contract and material misrepresentations § Consequential Damages Disclaimer § Neither party subject to consequential damages resulting from a breach on its part even if aware of the possibility of such damages § Damage caps

Key PPA Provisions (Curtailment) § Curtailment: utility stops purchases because of grid load balancing, transmission system issues or emergency conditions. Financing issue is risk allocation for continuing payment during such periods. § Strongest position for being financeable is OT pays SO for the electricity the facility could have delivered to the point of delivery (POD) but for an ordered curtailment (“Take or Pay”). Risk beyond POD is often allocated to OT although this allocation is not likely to be offered and will have to be negotiated. § In a proposed PPA, curtailment may only provide an excuse for SO non-delivery of electricity without any corresponding obligation for OT to pay SO during the curtailment. Definition is key when OT must continue to pay SO during a curtailment. If outside the definition, SO may have an excuse to avoid a default but OT would not have to pay SO

Key PPA Provisions (Force Majeure and Assignment) § Force majeure: when a party cannot meet its obligations as a result of a cause not within its reasonable control (“Acts of God”). No standard definition so needs to be carefully defined to minimize payment uncertainty § Third party supplier acts or omissions (biomass, no water, etc) § Economic hardships, labor problems, land use problems, rising costs § Assignment/REF Transfer Limitations § SO may assign for financing, portfolio sale, other reasons § OT may assign in sale of business provided assignee credit rating is satisfactory and assignee expressly assumes all PPA obligations

Summary § Project financeability depends on reducing the circumstances that may create uncertainty in payment § Predictability (certainty) of receiving project revenues and benefits is key to the financing math § There is no such thing as a “standard” PPA § Utility PPAs will have stronger requirements for meeting schedules, production output and other performance standards from construction through operation § Bottom line for making the project math work is that some equity investment is likely needed