Project Financing, Wind Power

At the start of 2011, the Act on Production Subsidy for Electricity Produced from Renewable Energy Sources (1396/2010) came into force in Finland. The feed-in tariff introduced by this Act creates the framework for an increase in the current wind energy capacities to 2500 MVA. This means an increase from the current level of approximately 0.7% to approximately 6% of total production. Little attention has been given to the impact of the new law on the different groups of investors. It seems that private investment funds and institutional investors, both, domestic and foreign, become increasingly active, together with supplemental project financing.

The feed-in tariff

The system is managed by the energy market authorities. The amount paid to the operator for a maximum of 12 years for the wind energy produced equates to the difference between the legally fixed target price of €105.30/MWh (until the end of 2015) or €83.50/MWh (from the start of 2016) and the 3-monthly average market price.

When the quota of 2500 MVA has been reached, no further projects will be subsidised under the feed-in tariff. Although it is not currently possible to estimate with any certainty when this quota will be reached, taking currently planned projects into account it appears likely that the maximum subsidy will largely have been exhausted by 2016, or 2017/2018 at the latest. In order to take advantage of the feed-in tariff, it will therefore be necessary to act quickly on project development and on the financing and construction of the relevant wind farm.

Changes in the investment climate

The feed-in tariff offers sufficient incentive for the development of new wind energy capacities. Whether further projects will be possible once the 2500 MVA quota has been achieved depends on future political decisions which cannot at present be predicted.

New political decisions can be expected in just a few years, i.e. as soon as most of the 2500 MVA quota for the feed-in tariff has been exhausted. These pending decisions will presumably have a huge impact on the conditions for the production of wind energy. Dependence on political decisions represents a planning risk for companies operating in the energy sector. It is therefore not surprising that, for instance, Fortum has recently sold wind farm projects to investment funds.

Private investors, on the other hand, do not to the same extent worry about the future development of the sector. Their investment decisions are project driven. The economic feasibility of the relevant project can be calculated on the basis of the feed-in tariff. Until the 2500 MVA quota is reached, therefore, it is anticipated that further investment will principally be made by institutions holding private investor funds.

Increasing relevance of Project financing in Finland

Private investors can borrow funds only if the project as such is credit worthy. There are no recoverable assets other than the invested equity as private investors are not prepared to take over personal liability. Traditional financing based on personal creditworthiness is therefore not possible. Project financing has been successfully used in the international wind power sector for many years. In Finland, new ground is being broken.

A major project financing of a Finnish wind farm was agreed earlier this year. In June, Taaleritehtaan Tuulitehdas I, a private capital investment fund, announced the conclusion of a project financing framework agreement with SEB, Nordea and Pohjola banks. The three banks will provide credit in the sum of €130 million, which together with the equity will give the fund an investment volume of approximately €190 million. The construction of a plant with a capacity of approximately 120 MW is planned.

Financial feasibility (bankability) of wind farm projects

Project developers and investors seeking funding must present their project in a way which will convince the lenders. This includes, in particular, the following:

Presentation of the debt service coverage ratio

Evidence that the permits required under public law have been obtained

A suitable range of contractual relationships to secure the project resources

The security package.

The debt service coverage ratio, which is key to the loan decision, is calculated using the equity capitalisation, the expected earnings and the repayment plan.

The cash flow forecast must provide a sufficient reserve so that there is no question-mark over whether all liabilities will be met under any circumstances (stress test). For the fixed feed-in tariff, the cash flow forecast principally depends on the forecast for electricity production.

In order to prepare reliable forecasts, representative wind measurements must be taken over the course of at least a year on the proposed wind farm site itself. The measurements should be taken at a reasonable height in relation of the intended hub height. Long-term fluctuations can be analysed using measurements taken near the site.

Due diligence

A forecast is only possible if all legally required permits have been obtained and are valid. It is not to be expected that binding financial commitments will be entered into before this point in time.

The success of the project depends on all parties involved (sponsors, authorities, suppliers, insurance providers etc.) making their contributions in full and in accordance with the contract at the scheduled times. This means that:

The project participants must be known to be reliable

There is clear contractual definition of the obligations of the various participants and adequate compensation is stipulated in the event of breach of contract

The various contracts must be reasonably coordinated to ensure the project implementation according to the cash flow and profitability calculation.

Banks will instruct their own trusted technical experts and lawyers to analyse the technical and legal risks involved in the project. If this due diligence exercise throws up problems, this will certainly cause delay and it is possible that the loan conditions will become less favourable or that financing may not be forthcoming. In order to minimise risk, an operator should conduct its own technical and legal assessment as soon as possible and in any event before the start of the financing negotiations.

The securities

The security package plays a key role for the project financing loan decision as the sponsors do not assume any personal liability.

The typical requirements are:

Sufficient financial backing of the project with primarily liable equity capital (financing rate approximately 1/3 equity to 2/3 project financing).

Pledging of the operator company’s shares.

Pledging of project accounts assets.

Pledging/assignment of claims and contracts, including, in particular, insurance contracts.

Pledging of a bank account containing funds sufficient to cover capital and interest instalments for at least six to nine months.

The conditions under which the funds can be used will be more favourable if better security is provided. If, for example, the turbine supplier can make an export guarantee available this will be a very significant contribution to successful project financing.

Financing offers

There is great interest from domestic and foreign banks in the financing of suitable projects. From the banks’ point of view, projects with a financing volume of a minimum of 25 million euros are deemed suitable.

This financing volume requires the construction of a wind farm with a capacity of approximately 15-20 MW. In the case of an individual wind farm smaller than this, the conclusion of a financing framework agreement can be considered provided that the investor is also pursuing other projects in Finland. However, due to the high transaction costs, the use of project financing will only be worthwhile if funds of up to around €25 million will actually be used within a reasonable period of time.

Competition livens up business even when it comes to funding. It is therefore sensible to approach more than one financial institution. Only experience will show which bank is able to offer the best or most cost-effective financing solution in an individual case. This may be a domestic or foreign bank depending on the circumstances of the case. Consortiums made up of domestic and foreign banks may offer the greatest benefits. They can combine knowledge of the Finnish market with years of experience of foreign institutions in the area of project financing.