Energy Project Finance: An Overview

Energy Project Finance: An Overview

Energy project finance is a far more intricate process than it might appear to be at first glance. Not only are there numerous participants in the market, but their decisions are also frequently interdependent. Participants must also decide how to share the risks involved in energy projects.

Energy Project Finance Market Participants

The typical participants include project sponsors, operators, managers, contractors, suppliers, consumers, governments, banks, and financial investors. The initiators develop the initial idea for the energy project and provide funds for the first steps, such as feasibility studies. Once the project is sufficiently well developed, it will be able to attract proprietors, who might be part of a single corporation or form a partnership.

Operators need to run the project after it is completed, and they are often established companies in the energy sector. Companies must also employ managers to supervise the project's completion, and they need to hire contractors and suppliers as well.

Governments and agencies play more significant roles in larger energy projects, which range from regulation to ownership. Agencies, many of which are international, may also provide credits and contracts to projects that support their goals, such as sustainable energy development. For example, support from an international agency can be crucial in getting a significant consumer of energy, such as an auto parts maker, to commit to buying electricity. Strong relationships with banks help to facilitate arrangements for debt issuance. They can be vital source to access financial investors.

In the simplest business model, the proprietors continue to own and operate the energy project. Another group of basic models has the proprietors eventually transferring ownership to a government in exchange for assistance along the way. In other arrangements, ownership is transferred, but the proprietors continue to operate the energy project.

Conversely, the proprietors may retain ownership and transfer the operating rights. There are also business models for specific situations. For instance, a forward sale occurs when an energy project sells most of the output in advance to a third party, such as a manufacturing facility.

Risks for Stakeholders

All energy projects have specific risks that they assign to participants, and those participants must be compensated accordingly. Every energy project has some environmental risk associated with potential negative externalities and the regulations designed to minimize them. There are also risks related to the host country, such as political risk and the social impact of the project in the country.

Energy projects still need to be concerned with ordinary business risks, such as lower than expected demand, technical issues that may delay project completion, higher than expected operating costs, and difficulty obtaining supplies at reasonable prices. Then there are financial risks, such as rising interest rates or declining exchange rates. Finally, there are legal risks, especially regarding which jurisdiction's laws cover agreements.

Standardized Financing Structures Are Needed

There are far more types of energy financing than just debt and equity. Within debt financing, senior financing provided by banks and other financial institutions ranks first and is usually secured by property and equipment. Senior debt often involves short-term loans to pay initial construction expenses and long-term secured loans to repay short-term loans. Once the energy project is up and running, senior debt may also include a secured revolving credit facility that allows the project to borrow against its assets as needed.

Mezzanine financing has a lower priority than senior debt but still ranks higher than equity. Junior debt is either unsecured or only has claims to assets after the repayment of all senior debt. Naturally, lower grade debts pay higher interest rates, and they also tend to be short-term.

Convertible bonds, which can be exchanged for equity under some circumstances, and preferred shares are sometimes available. Preferred shares often pay fixed dividends and have higher priority claims on the energy project's assets than common shares.

At the lowest levels, subordinated debt is expressly placed after all other debt obligations and is a type of high-yield debt. Common equity and leveraged leasing arrangements are also high-risk types of energy project financing. Click here to learn more.