The development and rapid growth of renewable energy projects in the U.S. have been driven largely by government incentives, most of which take the form of a tax credit. Investors in wind farm projects have benefited from production tax credits (PTCs), and investment tax credits (ITCs) have offered solar project investors the ability to claim a certain percentage of their investment in the capital cost of the project as an immediate credit. Such tax credits opened up investments in renewable energy projects to a class of investors known as tax equity investors. Immediately following the financial crisis, corporate profits declined significantly and reduced the number of tax equity investors who could benefit from such tax credits. To mitigate this, the Obama administration introduced the 1603 Cash Grant in Lieu of Tax Credits program to fill the gaps left by tax equity investors who exited the market. (The program expired at the end of 2011.) Statistical evidence has shown that the administration’s cash grant program kept the pace of renewable energy development in the U.S. active throughout 2009, 2010, and 2011.
With the gradual stabilization of the U.S. economy and a corresponding increase in corporate profits, we have witnessed the return of some tax equity investors and the emergence of new entrants in the renewable energy market. It is unclear, however, whether the new entrants will have sufficient capacity to fill the gap left by the expiration of the cash grant program. Added to this is the uncertainty surrounding the extension of the PTC for wind, which is scheduled to expire at the end of 2012. Additionally, there are concerns regarding the availability of debt to finance renewable energy projects in light of the continuing Eurozone crisis. Despite the uncertainties, the wind and solar markets are robust, and there is an increasing interest in tapping the capital markets and investors in the private placement markets for funding needs.
In January 2012, the American Wind Energy Association (AWEA) reported that, at the close of 2011, there were over 100 wind projects under construction across 31 states in the United States and Puerto Rico, representing a generating capacity of approximately 8,320 megawatts (MW). With the impending expiration of the PTCs, there is a great rush in the early part of 2012 to either break ground on wind projects or complete those that broke ground in the fourth quarter of 2011. According to Bloomberg New Energy Finance, the U.S. invested $55.9 billion in solar development in 2011, up 33% from the previous year. The pace of solar development is expected to continue, although it too faces the prospect of the expiration of ITCs by the end of 2015.
“The wind and solar markets are robust, and there is an increasing interest in tapping the capital markets and investors in the private placement markets for funding needs.”
Of note, Terra-Gen Power recently launched a bank-only $600 million financing scheme to support the next 300 MW of development at its Alta Wind Project. BrightSource Energy also announced that it may seek more than $1 billion in bank debt and bonds for its concentrating solar project in California. In addition, Topaz Solar Farms, LLC (Topaz) — a project company owned by MidAmerican Energy Holdings Co. (MidAmerican) through its subsidiary MidAmerican Renewables, LLC — issued $850 million of investment grade-rated bonds in a private placement for its solar photovoltaic (PV) farm in California.
TOPAZ SOLAR FARM CASE STUDY
The Topaz transaction demonstrates that there is a new group of investors who are willing to provide long-term financing for renewable energy projects. The 550 MW Topaz project is under construction in San Luis Obispo County, California and will use thin film PV panels manufactured by First Solar. Topaz’s indirect parent, MidAmerican, will contribute
40% of equity for construction costs. Topaz had initially approached the market with a $700 million issuance of Series A Notes set to mature in September 2039 to finance the project. It was reported that the initial issuance was oversubscribed and was ultimately enlarged to $850 million. The Series A Notes were reportedly priced at 5.75% and were issued at par, with 90% of orders from insurance companies. Topaz obtained investment-grade ratings for its Notes from three rating agencies: Fitch (BBB-), S&P (BBB-) and Moody’s (Baa3).
“There is a new group of investors who are willing to provide long-term financing for renewable energy projects.”
The Topaz bonds are interesting because of their long, 25-year tenor, maturing just 6 months prior to the maturity date of the power purchase agreement (PPA) entered into by Topaz with Pacific Gas & Electric Co. (PG&E). Such tenor would generally be too long for the bank loan market. For example, in late 2011, as the credit markets in Europe began to tighten, an existing longterm bank loan on a wind project was restructured and the tenor was reduced from 18 years to 10 years, with pricing at LIBOR + 275 bps (up from 237.5 bps), with increased up-front fees. By tapping the capital markets, Topaz was able to reach a new group of investors, such as insurance companies, who were able to make long-term investments. The 25-year PPA, under which Topaz will sell 100% of its output to PG&E, provides the project with a defined long-term revenue stream, and its fixed-price feature mitigates price risk. The strong credit quality of the purchaser PG&E (rated A3 by Moody’s) also supported the rating on the bonds.
Other features of the transaction that facilitated Topaz in obtaining an investment-grade rating on the Notes included:
- Strong support from a credit-worthy sponsor (MidAmerican is rated BBB+ and had committed to provide up to 100% of the construction cost if no debt could be raised, thus ensuring that construction could be completed even if no Notes were sold);
- The extensive experience and good reputation of First Solar as the panel manufacturer and of its division, First Solar California, Inc., as the engineering, procurement, and construction contractor and operator (EPC Contractor); and
- The fact that the PPA would be effective for any amount of capacity that achieved commercial operation prior to its guaranteed commercial operation date.
The transaction demonstrates an increasing interest in renewable energy projects that provide long-term, stable revenues from the sale of power to utilities.
Another potential market that renewable energy sponsors could tap is the securitization market. From an issuer’s perspective, securitized debt — similar to the privately placed bonds in deals such as Topaz — has the potential to provide better pricing and a longer tenor than bank loans. For investors, securitized debt backed by revenue payments linked to renewable energy assets could provide higher yields than the securitized debt of on-the-run assets. Unlike project bonds like those in the Topaz case, however, securitization offers the sponsor the ability to ring-fence the renewable energy assets into a separate, limited-purpose, debt-issuing entity and to obtain financing through bonds that are rated higher than those of the sponsor or the operating company. Note that in the Topaz transaction, MidAmerican was rated BBB+, whereas the project bonds were rated BBB- (and its equivalent of Baa3 by Moody’s).
Previous securitization of renewable energy assets has involved wind farms, but a securitization of solar assets has yet to be completed. Even though solar may be a new asset class, securitizations of operating assets generally are not new to the rating agencies or investors in asset-backed securities. There have been several prior securitizations by operating lessors of aircraft, freight railcar, and shipping container portfolios, and such transactions offer guidance as to appropriate structures for potential issuances of securitized debt in the solar area.
It is important to note however, that there are several challenges to bringing a successful securitized deal to market. In addition to risk retention rules under Dodd-Frank, there could potentially be substantive disclosure requirements for various ABS asset classes, and it should be expected that disclosure of historical performance data will be a requirement for any such rules. This could be challenging for most sponsors since long-term operating data for solar facilities in the U.S. are not yet available.
* This article was originally published in the Spring Newsletter (US-China Market Review) of the American Council On Renewable Energy (ACORE)