Transcript Using REC’s, Federal PTC’s, Bonds, and Depreciation in

Using REC’s, and Depreciation in
Financing Wind
Trintek Energy Consulting, Inc.
Creating Competitive Advantage Thru Intelligent Development
Native Renewables Energy Summit
November 15-17, 2005
Discussion Outline
PART 1
•REC’s-Renewable Energy Certificates
•REC Markets
•REC Prices
•REC Ownership, Tracking, Certification, and Contracting
•Issues and Solutions for REC’s In Project Financing
•Comparison of Revenues and D/E Ratio with and
without REC’s
PART 2
•Depreciation
•Eligibility for Accelerated Depreciation on Tribal Reservations
•IRS 168(j) Depreciation Lives on Reservations
•Qualified Indian Reservation Property
•Qualified Infrastructure Property-Off Reservation
•CreatingValue in Allocation of Depreciation
•Creating Value in Using Accelerated Depreciation
PART 1 - REC’s-Renewable Energy Certificates
•1 REC =1 MWh of electricity production from a renewable resource
•In a REC, the renewable attributes are unbundled from
commodity energy
• Projects can generate two revenue streams
-one for commodity, one for REC’s
-Has implications for financing
•The market is still illiquid, but emerging
-A recent DOE report says the REC market is $145 MM/yr.
-DOE Forecasts that it will get to $900 MM/yr. By 2010
The Markets in which REC’s Trade
•There is not one single unified U.S. market for REC’s
- instead, there are a variety of fragmented State and regional markets
- Prices from market to market may vary considerably
• Mandatory Compliance vs. Voluntary Markets
- Some RPS States include mandates to purchasers of power
- Purchaser must either purchase REC’s, purchase renewable power,
generate renewable energy, or pay penalties
-The price of a REC in theory should approach compliance penalties
-Penalty ranges are $10-50/MWh varying by state and market
- Thirteen states have or are phasing in REC trading as a feature of
their State RPS
- Voluntary markets also exist in which purchasers desire to encourage
development of clean renewable energy sources through their purchases
RPS States As of 10/2005
From CRS
REC Prices-Voluntary Markets
•Higher Prices in MidAtlantic-Northeast than in Central and Western
States
Reasons:
-Lower Wind Class resources in MidAtlantic-Northeast
-Higher consumer demand for renewables with tight supply
-Growing number of State RPS policies in the region.
•In general, REC prices are a function of individual markets,
applicable law, supply, and demand
REC Ownership, Tracking, Certification, and Contracting
•Rules for earning REC’s, transfer, certification, and distribution vary
from state to state and are state specific or regional in nature
- Rules include tracking systems and expiration dates
- Banking of REC’s –Usually allowed 2-3 years out
- Certification systems such as Green-e can also apply
• REC Ownership
-Per FERC, REC’s belong to generator unless conveyed in PPA or
unless specified otherwise by the applicable State
-Ultimately, State law governs who owns REC’s
• PPA Structuring
-Change of law risk in PPA
-Purchasers want firm REC’s with LD’s for non delivery other
than for Force Majuere
-Mitigate risks via portfolio of REC’s/projects, alternate back-up supply of REC’s,
-Cap LD’s
Miscellaneous Financing and Structuring Considerations
•Carve out REC revenue from collateral in Security Agreements
•Royalty and Lease agreements-carve out REC’s from Revenue
Issues for REC’s In Project Financing
•Projects are financed over 10 to 20 years
•Due to the nature of the emerging market for REC’s, and
regulatory uncertainty, the Term for REC contracts is usually
no longer than 5 years, and usually 1-2 years
•Exceptions are States where as part of the State RPS, long
term contracts are required:
-New York 10 years
-Colorado 20 years
-California 10 years
Financing Issues and Solutions REC’s (Continued)
•For large projects -REC marketers are generally too small
and have insufficient credit to provide the necessary
security for guaranteeing or backstopping long term REC
purchase agreements
•In some markets, large creditworthy end-users, such as
universities or government agencies have committed to
make long-term commitments (i.e., 10 years or more) to
purchase stand-alone REC’s or REC’s bundled with energy.
•The same large entities may enter into a REC contract for
differences would provide price stability to the buyer and
revenue security to the seller
Financing Issues and Solutions REC’s (Continued)
•State renewable energy funds could offer a price floor
for REC’s to ensure minimum REC revenue, as one
component of a risk management strategy
Example:
-The Massachusetts Renewable Energy Trust offering to
purchase—or purchase options to buy—REC’s for a
period of up to 10 years
•These funds are limited, however, in the number of
projects they can support
• States could require long-term contracts for bundled
energy or stand-alone REC’s as a means of satisfying
an RPS
Financing Issues and Solutions REC’s (Continued)
•Forward Selling of REC’s
-REC’s that will be generated over the lifetime of a new or planned
renewable energy project can be sold in advance to consumers
before the project is constructed
-The present value of the future revenue stream can be used to
finance the project directly
Example:
Vermont-based NativeEnergy’s customers purchase REC’s that w
be generated during the expected operating life of renewable ener
projects.
Financing Issues and Solutions REC’s Continued
•With its Windbuilder’s product, NativeEnergy helped support the
development of the 750-kW Rosebud Sioux wind turbine in South
Dakota by selling the REC’s that will be generated during the 25-year
expected life of the turbine.
•NativeEnergy discounts the REC’s price to account for the time value of
money and the avoided risk of the project not being able to sell all of the
future REC’s.
•Because NativeEnergy markets REC’s from prospective projects
the company guarantees that it will support an alternate project or
purchase REC’s from other new renewable facilities, in the event that the
initial project is not completed.
Financing Issues and Solutions REC’s Continued
• Note this kind of forward sale has only been done on a small
scale to date because of the challenge of forward selling the entire
output of a
large project.
• Although this product can help develop some small renewable energy
projects, it may be slow to generate financing for substantial
expansions in large scale renewable projects.
• Perhaps large credit worthy state agencies, trusts, and other
governmental
authorities can also assist in achieving larger scale forward sales.
Example of DSCR Calculation - BASE CASE
2008
2009
2010
2011
2012
2013
2014
Total Revenue
Total Operating Expenses
Operating Profit (Loss) Ebitda
Depreciation
State Tax
Interest Expense
Net Income (Loss) before taxes
12,480,880
1,905,165
10,575,714
31,787,151
0
7,164,980
-28,376,417
12,788,304
1,928,245
10,860,059
50,606,270
0
6,909,893
-46,656,104
13,103,414
3,076,674
10,026,740
30,532,544
0
6,636,185
-27,141,988
13,426,402
3,133,146
10,293,256
18,488,308
0
6,496,584
-14,691,636
13,757,464
3,195,204
10,562,260
18,488,308
0
6,180,610
-14,106,658
14,096,803
3,262,532
10,834,271
9,455,131
0
5,848,855
-4,469,716
14,444,625
3,334,951
11,109,675
421,955
381,102
5,599,501
5,469,322
Operating Profit (loss) Ebitda
Production Tax Credits
Administration of Project(Subordinated)
Total Cashflow Available For Debt Service
10,575,714
5,192,055
150,000
15,917,769
10,860,059
5,321,856
153,750
16,335,665
10,026,740
5,454,903
157,594
15,639,237
10,293,256
5,591,275
161,534
16,046,065
10,562,260
5,731,057
165,572
16,458,890
10,834,271
5,874,334
169,711
16,878,316
11,109,675
6,021,192
173,954
17,304,821
Total Debt Service
10,611,846
10,890,443
10,426,158
10,697,377
10,972,593
10,229,282
10,487,770
1.5
1.5
1.5
1.5
1.5
1.65
1.65
DSCR constraint
*For a 100 MW Project with 35% Capacity Factor
Example of DSCR Calculation With REC of $10/MWh
2008
2009
2010
2011
2012
2013
2014
Total Revenue
Total Operating Expenses
Operating Profit (Loss) Ebitda
Depreciation
State Tax
Interest Expense
Net Income (Loss) before taxes
15,241,143
1,905,165
13,335,978
32,004,699
0
8,671,090
-27,339,812
15,616,884
1,928,245
13,688,639
50,913,633
0
8,390,788
-45,615,782
16,002,018
3,076,674
12,925,344
30,744,104
0
8,086,749
-25,905,509
16,396,781
3,133,146
13,263,635
18,642,386
0
7,942,395
-13,321,146
16,801,413
3,195,204
13,606,209
18,642,386
0
7,585,841
-12,622,019
17,216,160
3,262,532
13,953,628
9,566,098
0
7,212,020
-2,824,491
17,641,277
3,334,951
14,306,326
489,810
514,918
6,941,684
7,389,749
Operating Profit (loss) Ebitda
Production Tax Credits
Administration of Project(Subordinated)
Total Cashflow Available For Debt Service
13,335,978
5,192,055
150,000
18,678,033
13,688,639
5,321,856
153,750
19,164,245
12,925,344
5,454,903
157,594
18,537,841
13,263,635
5,591,275
161,534
19,016,444
13,606,209
5,731,057
165,572
19,502,838
13,953,628
5,874,334
169,711
19,997,673
14,306,326
6,021,192
173,954
20,501,472
Total Debt Service
12,452,022
12,776,163
12,358,561
12,677,630
13,001,892
12,119,802
12,425,134
1.5
1.5
1.5
1.5
1.5
1.65
1.65
DSCR constraint
*For a 100 MW Project with 35% Capacity Factor
Comparison of REC Enhancements To Base Case
• A REC price of $10/MWh or .01/KWh increases
project revenue by $2.8 MM/yr. for a 100 MW project
• Available leverage or D/E ratio, holding DSCR constant goes up
by 12% from D/E ratio of 63% to 75%
• Project IRR also goes up
•Alternatively, with an extra REC revenue stream, the project may
choose to hold revenue and returns and D/E ratio constant and
bid more competitively on the PPA pricing
Financing Conclusions For REC’s
• It may eventually be possible to achieve higher D/E ratios if a REC
revenue stream meets certain criteria
-Lenders should consider issuing a separate tranche of debt with higher
margins and DSCR’s, but allow REC’s to add some leverage over a term
matching the length of the REC purchase contract
-Lenders could allow funding of Debt service reserves with the REC
revenue stream
•For REC’s to be accepted as a financeable revenue stream:
-Lenders need a strong state and or regional legal and regulatory
environment
-REC purchasers and PPA counterparties must be creditworthy
-Longer term REC contracts and purchases are needed,
- More liquidity and bankable forward price curves need to develop
•For now, with state of markets, probably safer not to try to disaggregate
attributes
More “Due Diligence” is Always Better
Make sure your deal is a REC deal not a Wreck deal
PART 2 - Depreciation
•Industry MACRS tax depreciation norm is 200% declining
balance over 5 year depreciation life
• This is substantially shorter than the 15 to 20 year depreciation
lives of non-renewable power supply investments
•Faster depreciation results in tax benefits early in a project's life
because a dollar is worth more today than later on
•Depreciation Can be allocated disproportionately to ownership
•The Internal Revenue Code of 1986 (as amended) now
provides for additional accelerated depreciation of property
placed on tribal reservations
Eligibility for Accelerated Depreciation on Tribal Reservations
To be eligible, the property must:
•Be used by the taxpayer predominantly in the active conduct of a trade
or business within an Indian reservation on a regular basis
•Not be used or located outside the Indian reservation on a regular
basis
•Not be used in conducting or housing class I, II or III gaming as
defined in the Indian Regulatory Act
•Not be residential rental property
•Not be owned by a person who is required to use the "alternative
depreciation system".
IRS 168(j) Depreciation Lives on Reservations
Property Class Life
Accelerated Depreciation Life
5 years
7 years
10 years
15 years
20 years
39 years *
*(nonresidential real property)
3 years
4 years
6 years
9 years
12 years
22 years
Qualified Indian Reservation Property
•
The term “qualified Indian reservation property” means:
Property which is,
•
•
•
•
•
•
used by the taxpayer predominantly in the active conduct of a trade or
business within an Indian reservation,
not used or located outside the Indian reservation on a regular basis,
The above restriction shall not apply to qualified infrastructure property
located outside of the Indian reservation if the purpose of such property
is to connect with qualified infrastructure property located within
the Indian reservation.
not acquired (directly or indirectly) by the taxpayer from a person who is
related to the taxpayer (within the meaning of section 456 (b)(3) (C ), and
not property (or any portion thereof) placed in service for purposes of
conducting or housing class I, II, or III gaming (as defined in section 4
of the Indian Regulatory Act (25 U.S.C. 2703)).
The term “qualified Indian reservation property” does not include any
property to which the alternative depreciation system applies
Qualified Infrastructure Property-Off Reservation
“Qualified Infrastructure Property” means qualified Indian reservation
property which :
•
•
•
Benefits the tribal infrastructure,
Is available to the general public, and
Is placed in service in connection with the taxpayer’s active conduct
of a trade or business within an Indian reservation.
Such term includes, but is not limited to, roads, power lines, water systems,
railroad spurs, and communications facilities.
CreatingValue in Allocation of Depreciation
• Can disproportionately allocate to an investor or partner who
has the tax appetite to monetize the depreciation to offset their
taxable income
• Upon audit, an investor must show there was economic justification
for a disproportionate allocation of tax credits and be able to show
“differentiated risks”
• The downside is to risk disallowance and unwinding of the structure
entailing financial consequences to the investor and the project
• It may be best to get a letter opinion from the IRS
Creating Value in Using Accelerated Depreciation
• The benefit of accelerating depreciation is the present value
of the stream of avoided cash taxes when added taxable income
is offset in years 1-3 versus over a 5 year period
• The effect of combining disproportionate allocation and accelerated
depreciation can make a substantial value creation difference
and result in higher returns for investors and partners who can
monetize these benefits