COURSE CODE AND TITLE: CEE 714 (ELECTRICITY

ECONOMICS)

FULL NAME: AJAO KEHINDE OLOLADE

MATRIC NO: 233585

EMAIL: kennyajao08@gmail.com

IDENTIFY THE LIKELY MIX OF FINANCES AND

FINANCIAL INNOVATIONS THAT COULD DRIVE
CAPITAL TO RENEWABLE
PROJECTS/INVESTMENTS

Wednesday, 01 March 2023

Project finance?
The raising of finance on a Limited Recourse basis, for the purposes of
developing a large capital-intensive infrastructure project, where the borrower
is a special purpose vehicle and repayment of the financing by the borrower will
be dependent on the internally generated cash-flows of the project.

Financial Innovation?
Financial innovation is the process of creating new financial products, services,
or processes. Financial innovation has come via advances in financial
instruments, technology, and payment systems. Digital technology has helped to
transform the financial services industry, changing how we save, borrow, invest,
and pay for goods. The sustainable growth of the renewable energy investment is
impossible without the proper innovation management accompanied by the
knowledge, information, reputation and trust management. Innovations explains
that they appear when new ideas, solutions and instruments are implemented in
order to change the conditions of business entity and to improve its situation.
The application of innovations increases the competitiveness of a business entity
and creates value for its owners. The loci of innovations are in risk mitigation,
regulation, cash flow, contract, organizational, and capital sub-systems. Types of
innovations are classified as either integrated or modular and either sustaining
or disruptive.

DRIVERS
Risk management and client demand were the most prominent factors behind
Renewable energy investment.
Nevertheless, there are a number of practical preconditions to financing a project
on a Limited
Recourse basis:
1. Sustainable Economics: Whilst comfort can be gained from (a) undertaking
detailed financial due diligence and modelling to stress-test the projected cash-
flows of the asset and (b) contractually mitigating revenue risk, experienced
investors and bankers will ultimately look for a clearly identifiable demand for
the project’s goods or services in order to ‘rationalize the credit’

2. Identifiable Risks: An unidentified and unmitigated risk could potentially

jeopardize the stability of a project. An investment may possess high, medium, or
low risk, and the risk appetite of every investor and company is different.
Therefore, every investment requires a risk analysis

3. Accessible Financing: From both Sponsor and (if applicable) Procurer

perspectives, high leverage and long-tenor financing is a defacto requirement to
achieving attractive economics for large infrastructure financing

4. Political Stability: Even if political ‘force majeure’ risk is contractually born by

the government (as is common practise in many PPP programs), the efficacy of
that remedy to Lenders/investors would be negated by a strategic sovereign
default expropriation/nationalization of assets being one potential example.
Whilst such risks cannot be mitigated against in the insurance markets, varying
degrees of political risk insurance can be obtained through the use of financing
products available from multilateral and export credit agencies.

 Investment Objective: The purpose behind an investment determines the

short-term or long-term fund allocation. It is the starting point of the
decision-making process.
 Return on Investment and Return Frequency: Managers prioritize positive
returns they try to employ limited funds in a profitable asset or security. The
number of periodic returns an investment offer is crucial. Financial
management is based on financial needs; investors choose between
investments that yield monthly, quarterly, semi-annual, or annual returns.
 Maturity Period or Investment Tenure: Investments pay off when funds are
blocked for a certain period. Thus, investor decisions are influenced by the
maturity period and payback period.
 Tax Benefit: Tax liability associated with a particular asset or security is
another crucial deciding factor. Investors tend to avoid investment
opportunities that are taxed heavily.
 Safety: An asset or security offered by a company that adheres to regulatory
frameworks and has a transparent financial disclosure is considered safe.
Government-backed assets are considered the most secure.
 Volatility: Market fluctuations significantly affect investment returns and,
therefore, cannot be overlooked.
 Liquidity: Investors are often worried about their emergency funds—the
provision to withdraw money before maturity. Hence, investors look at the
degree of liquidity offered by a particular asset or security; they specifically
consider withdrawal restrictions and penalties.
 Inflation Rate: In financial management, investors look for investment
opportunities where returns surpass the nation’s inflation rate.

If the factors above are satisfied, there is good chance that a project financing for
an infrastructure asset is achievable and R.E can be ventured into.
Nevertheless, the complex legal, technical and financial structures inherent to a
Limited Recourse financing generally necessitate higher upfront transactional
costs than traditional corporate lending (through advisors fees and higher debt
pricing) as well as a longer execution timetable. However, additional
transactional costs are usually capitalized into the overall project budget to be
financed and will therefore represent a minor percentage of total Project Costs
for a large infrastructure endeavour. Moreover, Project Finance debt facilities are
typically structured with long repayment tenors (to better match the economic
life of the underlying asset) and hence all capitalized costs are amortized over a
long period of time; and although the execution timeline for a greenfield project
financing can be anything from 12-18 months (from inception to financial close),
this is principally a function of the sophisticated risk allocation and lender due
diligence processes of Limited Recourse finance processes which, it can be
argued, provide a critical governance mechanism to the Sponsors/Procurer.

Let's say you are interested in finance, mergers and acquisitions, and investment
banking, then finding the sources of capital will be a great way to find interesting
careers.
What are the types of money that generally fund utility-scale renewable energy
projects? There are four (with some squeezing) main buckets but of course
plenty of nuance and variety within each. But let's stick with four to keep it
simple.

1) Equity: Equity capital plays a part in the entire life cycle of a project. Think of
equity as the project owner at any given time. In the renewable energy world, the
equity investor often changes throughout this life-cycle. Let's break it down by
stage:

Development: There are many types and sizes of companies that are
doing the development of renewable energy projects. Some smaller
(sometimes < 5 people) development companies use their own money or
friends and family investment to fund the very early parts of
development.
Construction: Once a project reaches the point where it is ready to be
built then it is not uncommon for a sophisticated development company
to sell the project to the long-term owner who will take on the
responsibility of building the project. In this case, the equity capital shifts
to the new owner of the project.

Operations: Once a project is operational then the equity capital in the

project will be funded by the long-term owner of which there are three main
categories: 1) Utilities - companies that own power plants and
distribution/transmission lines or one or the other depending on the market, 2)
IPPs, and 3) Infrastructure Funds. However, in some cases, the developer of the
project is capitalized well enough that they will actually get the project built and
then sell it once it is operating. Also, projects get bought and sold after they have
operated for a number of years

2) Development Capital-Debt/Mezzanine Financing: in the last 5+ years there

has been an emergence of capital sources that are interested in helping
developers fund development activities so that the developer can advance their
solar, wind, or storage project further towards the start of construction. This can
increase the value of the project because it helps de-risk the project. Owners of
development companies like this because it means they also don't necessarily
have to raise capital by selling equity in their company but rather at the project
level.
Development debt (a form of mezzanine financing) is usually structured with a
combination of debt-like money and equity-like money. Since this capital is
funding development work which is more risky then construction financing or
long-term project debt, the cost of the debt is higher.

3) Construction/Term Debt: They are together not because they are the same
debt instrument but because it's common that the lender providing the
construction financing to build a project is also the lender that converts the
construction financing into a long-term loan to the project once the project is
built.
At this point in the project life cycle, the big dollars are being spent - as in
hundreds of millions of dollars depending on the size of the project. So, it's
common for companies to seek R.E construction loans to help buy equipment
and pay for the installation of the equipment. This type of debt has much lower
interest rates than development debt because there is physical collateral for the
loan. Since the dollars are often big at this point, much of this financing is
provided by big banks.

4) Tax Equity: One of the unique parts of the "capital stack" for wind and solar
projects is tax equity. For a number of years, there have been federal tax credits
in place that help incentivize the build-out of more renewable energy projects.
So, to fill this gap very large companies (banks and insurance companies for the
most part) with plenty of tax liability have worked with renewable energy
project owners and figured out a way to invest in the project for a finite period of
time (~ 5 years) and in exchange they receive the tax credits as compensation
alongside some small amount of cash and any depreciation tax benefits. This is
tax equity.
Tax equity has been a great solution for the industry in many ways but because
these types of investments are very complex, it has been dominated by only a
few of the largest companies. This has created bottlenecks in access to tax equity
and has slowed construction of projects.
The main sources include equity, debt and government grants. Financing from
these alternative sources have important implications on the project's overall
cost, cash flow, ultimate liability and claims to project incomes and assets.

REFERENCES
(compare: Dabic, Cvijanovic and Gonzalez-Loureiro, 2011, p. 196;
Grudzewski, Hejduk, Sankowska and Wań tuchowicz, 2010, p. 116).
https://www.wallstreetmojo.com/investment-decision/