The importance of Project Finance for Clean Energy Projects

The basic premise of project finance is that lenders loan money for the development of a project solely based on the specific project’s risks and future cash flows. As such, project finance is a method of financing in which the lenders to a project have either no recourse or only limited recourse to the parent company that develops or “sponsors” the project (the “Sponsor”). “

Project financing has been used in various ways for many years, but in the 1970s and 1980s, it emerged as a leading way of financing large infrastructure projects that might otherwise be too expensive or speculative for any one individual investor to carry on its corporate balance sheet.

While renewable energy investments have seen steady growth over the last decade, a more rapid scaling-up is necessary for developing countries to meet climate and sustainable development goals.

Renewable energy projects, especially in developing countries, face multiple challenges from the institutional, policy and regulatory level to the market and project level which can hinder the development and uptake of renewable energy. The latter include lack of market transparency, lack of financing and experience in project development, and lack of relevant information on regulations, markets and resource availability. This has led to a lack of bankable projects, making it difficult for investors to identify attractive projects, and therefore reducing available capital for those that are ready to be financed.

The financial evaluation of infrastructure and capital-intensive projects is complex. The implementation of project financing means the use of a specific technique of risk and uncertainty, which is what makes the design of the Monetary flow report extremely complex. Project financing is an applicable financing model even in the low credit worth countries, in case the project earns enough hard-currency income to regularly service the liabilities to creditors and in case there are legal and other guarantees that thus earned income will be used to service the debts incurred in project financing. The aim of project financing is not to conceal the debt from the creditors, credit rating estimating agencies or shareholders, but to share the project risk. We would attempt to assess the importance of project finance for renewable energy projects in investment-grade countries, and the underlying drivers to use this kind of finance.

Risk Distribution

One of the main benefits of project financing in renewable projects is risk distribution. A joint venture contributes and allows the sponsors to share the project risk. If the cost of capital is high as related to the capitalization the sponsor realizes, the decision on project financing by own funds can seriously imperil the sponsor’s future. Similarly, the project may be too large for the host country, in financial terms, to justify financing from the country’s sources. Consequently, to reduce the sponsor’s exposure to risk, the sponsor or the host country for the project may search for one or several partners to form a joint venture.

Increase in debt capacity

Another importance is the increment in debit capacity. The project financing of a company allows for the project sponsor to finance the project through the credit sources of financing. The funds for the project are raised based on the contracted liability, when: 1) the buyers close a long-term contract to buy a product/service and 2) when the contract provisions are set in such a way as to allow for the free cash flow for the project, providing for the debt to be fully serviced under reasonably acceptable conditions. In case any unforeseen costs arise, and the cash flow is not high enough to service them, additional credit support agreements are closed, or often a foundation is established to support the project financing. It should be pointed out that the company established for project financing is often in a position to be financed at a fairly higher level of indebtedness compared to the funds invested than it would be normal in the sponsor capitalization. The indebtedness level compared to the funds invested the project realizes depends on the collateral level, that is, the risk the creditworthiness participants are exposed to, the project type or the profitability

Reducing regulatory costs

Finally, Certain types of projects, such as joint investment, include legal and regulatory costs that are more easily handled by experienced sponsors; consequently, they are less expensive. Concretely, chemical and petroleum companies that enter a joint project may be faced with considerable costs that result from the ignorance of legal and regulatory provisions accompanying the investment. When the projects are run by a team of experts from the field, project financing may lead to the economy of scope, due to the expert control over legal and regulatory costs. The economic sustainability of the project will depend on the further cooperation of several external organizations that are not under the direct control of industrial organizations, whereas using the knowledge and experience of the expert team, reputed for having completed similar projects, will reduce operational costs to a considerable extent. More precisely, the project status independence that results from the desire to create a long-term profitable project will reduce the risk for the companies that jointly finance the production.

Project financing is more efficient in allocating the risk and the revenue in comparison with the direct corporate financing, therefore the contracts related to project financing are concluded in such a manner as to allocate the project risk and revenue most appropriately, in accordance to the participants in the project execution. It is for this reason that the project financing minimizes the credit impact upon the project sponsors, hence the contracts that support project loans are drafted to minimise direct financial obligations of the project sponsors.