Editor’s note: This article is an excerpt from law firm and consultants Chadbourne Parke‘s Project Finance NewsWire. It includes part of a discussion between industry veterans on renewable energy and project finance. The full interview is available here.
More than 2,000 people listened in January as a group of project finance industry veterans talked about the current cost of capital in the tax equity, bank debt, term loan B and project bond markets and what they foresee for the year ahead.
The panelists are John Eber, managing director and head of energy investments at J.P.Morgan, Jack Cargas, managing director in renewable energy at Bank of America Merrill Lynch, Thomas Emmons, managing director and head of renewable energy finance for the Americas at Dutch bank Rabobank, Jean-Pierre Boudrias, managing director and head of project finance at Goldman Sachs, and Jerry Hanrahan, vice president and team leader, power and infrastructure, North American corporate finance at John Hancock.
MR. MARTIN: John Eber, what was the tax equity volume in 2015, and how did it break down among wind power, utility-scale solar, and rooftop solar?
MR. EBER: We estimate that about $11.5 billion in new wind and solar deals were mandated in 2015. Of that amount, about $6.4 billion was wind. There were 40 wind projects with an aggregate capacity of 5,700 megawatts, which is the same number of projects in the previous year, but an increase of about $700 million in tax equity raised in 2015 over 2014.
There were three leading sponsors in the wind sector that did about $1 billion each. They accounted for about 47% of the total wind tax equity raised.
The solar market is not as transparent as wind, but we estimate that about $2.6 billion in tax equity was raised in the residential rooftop market by the three leading residential rooftop companies. That is up from about $1.9 billion in 2014. The top three sponsors account for about 90% of the residential market.
MR. MARTIN: So there was only a modest increase in tax equity volume in 2015. In 2013, the total volume was $6.5 billion. In 2014, it was $10.1 billion. Why was there a slowing down in the rate of increase?
MR. EBER: The increase was still significant in absolute numbers because it comes off a huge year in 2014. These are historically significant numbers.
MR. MARTIN: How many active tax equity investors are there currently?
MR. EBER: We estimate about 20 in wind and 27 or 28 in solar. However, of the 20 in wind, we identified only 17 who actually entered into mandates in 2015.
MR. MARTIN: There is overlap between the two. How many total investors were there in 2015?
MR. EBER: No more than 30.
MR. MARTIN: Jack Cargas, what do you expect in the year ahead: deal volume, number of investors, mix of transactions, mix of structures?
MR. CARGAS: The volumes are likely to be similar to what we have seen in the last couple years. In terms of transaction types and structures, the partnership flip structure will continue to be the leading application. There are lots of variations in the basic structure.
We expect to see similar volumes as in 2015 in wind and residential solar and a possible increase in the volume of utility-scale solar as there are some significant utility-scale solar projects that are expected to come to the market in 2016.
It would not be terribly surprising to see a further increase in the number of tax equity investors. The number increased in each of 2014 and 2015. The tax credit extensions in December may bring other investors into the market.
MR. EBER: I agree. The market should remain very active in 2016. Wind developers will feel more pressure to get projects underway in 2016 to qualify for full tax credits. Wind projects that start construction in the next three years after 2016 still qualify for credits, but at reduced levels. Solar developers may not feel as urgent a need to act in 2016 as they have until December 2019 to start construction and qualify for full tax credits and another two years after that to qualify for reduced credits.
MR. MARTIN: Many people expect that there will be a reduction in 2016 deal volume due to the tax credit extension since there will be less pressure to complete projects in 2016. It does not sound like either of you agrees with that.
MR. EBER: A lot of the commitments by tax equity investors are made well before a project is completed. Developers who plan to begin constructing projects and investing money in them will be in the market seeking tax equity commitments even though a project may not be completed until 2017. That will keep us busy this year.
MR. CARGAS: Sponsors will not have to commit unnatural acts to complete projects in 2016. Some of what would have been completed in 2016 before the extension will now be spread into 2017.
MR. MARTIN: A lot of deals carried over into the start of 2015 as tax equity and due diligence shops had too little capacity in late 2014 to handle the volume. Did you see the same thing happen at the end of 2015?
MR. EBER: Not so much. It helped that more firms were offering engineering services. Many of us were better staffed last year in anticipation of the need. We were very busy all through the year and especially in the fourth quarter, but we managed to get everything processed that our clients wanted to close in 2015.
MR. MARTIN: Jack Cargas, tax equity yields were trending down last year after several years of remaining stable. Do you think there is still downward pressure on yields?
MR. CARGAS: We are cautious about discussing pricing in public forums. Tax equity is unlike debt where you can look up accurate prices with a couple keystrokes.
There is also a more important point. Yields were a function for a long time of supply and demand. But as the deals themselves become more complicated, many more things bear on yield. You have projects with different cost mechanics, in different states, with different cash distributions and different credit buckets. There can be different offtake arrangements: corporate PPAs, PPAs with sponsor affiliates, puts, hedges, merchant tails. In the wind market, there can be various kinds of pay-go arrangements.
The point is that it has become much more difficult to generalize about yields. They are a function of a more sophisticated credit analysis based on numerous interactive risk and reward parameters.
MR. MARTIN: John Eber, let me ask the question differently. Falling yields are usually a sign of a buyer’s market. Are you seeing more deals put out for bid among two or more tax equity investors?
MR. EBER: Yes. That was not uncommon before the financial crisis. It became less common after the financial crisis. Everything is settling down now. There are more investors. It is not unusual today to see sponsors ask for proposals from more than one tax equity investor.
I agree with what Jack said. Yields have trended down somewhat if you look at a mainstream wind deal with a 20-year power purchase agreement with a solid utility using well-known wind turbines in a stable part of the country.
However, as Jack pointed out, there is more variation today in deals. Only a small subset of the potential tax equity market may be interested in a deal with some merchant characteristics or unusual turbines. We are seeing a lot more corporate PPAs.
MR. MARTIN: How much of a yield spread is there among the principal asset classes: wind, utility-scale PV, residential solar, C&I rooftop?
MR. CARGAS: Offering generalized data points for each asset class is difficult for the reasons John and I just mentioned.
MR. MARTIN: John Eber, same answer?
MR. EBER: Pretty much. I think you can say utility-scale wind and utility-scale solar look alike from a return standpoint, but rooftop solar is a different market.
MR. MARTIN: Jack Cargas, what percentage of the capital structure is covered by tax equity in the typical wind or solar deal?
MR. CARGAS: For wind, a third to two thirds of the capital stack is tax equity. For solar, the figure is probably a third to half.
MR. MARTIN: John Eber, are there any other noteworthy trends in the market as we enter 2016?
MR. EBER: The most noteworthy is the significant increase in the number of commercial PPAs for wind projects. The commercial and industrial solar market has always relied on them. The fact that they are showing up in wind is changing the dynamics of the marketplace.
It is great for wind. It is causing more megawatts to get built. However, we have to analyze a different kind of risk when underwriting deals. Bloomberg reported that more than 3,000 megawatts of commercial PPAs were signed in 2015.
For the full discussion, the entire Project Finance NewsWire article is available here.
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