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Energy Advancement & Private Debt | February 2020 |

Private Debt + 20 Minutes = New Thinking

At a Glance • Renewable energy projects are increasingly important in achieving a lower carbon

global economy. • Long-term, predictable cash flows from prudent renewable investments provide

valuable investment opportunities. • Significant sector-specific expertise and investment experience is required to

navigate a diverse set of projects, mitigate investment risks and ensure appropriate returns for investors.

• TD Asset Management Inc. invests in investment grade quality private renewable energy debt transactions through its private debt pooled fund trusts; providing clients with a genuine opportunity to ‘make a difference’ without compromising on yield enhancement objectives.

Energy Advancement & Private Debt

Headline environmental incidents like uncontainable wildfires and melting polar ice caps are reminders of the challenges posed by climate change and highlight the societal need to transition to a low carbon economy. Globally, climate change initiatives such as the Paris Agreement1 demonstrate an international

consensus regarding the need to reduce greenhouse gas emissions. As a result, renewable energy projects have gained increased popularity as a means of combating climate change while providing a high-quality, long-term investment opportunity.

1 The Paris Agreement is an agreement within the United Nations Framework Convention on Climate Change, dealing with greenhouse-gas-emissions mitigation, adaptation, and finance, signed in 2016. The agreement’s language was negotiated by representatives of 196 state parties at the 21st Conference of the Parties of the UNFCCC in Le Bourget, near Paris, France, and adopted by consensus on 12 December 2015. As of March 2019, 195 UNFCCC members have signed the agreement, and 186 have become party to it.

Bruce MacKinnon, Managing DirectorCraig Buckley, Vice President & Director


With this paper, TD Asset Management Inc. (“TDAM/We”) will describe the private debt investment opportunities available within the renewable energy sector and how to identify projects capable of meeting the yield enhancement requirement of our investors. We will also discuss why economic trends show that financing the right project is not only a ‘feel-good’ endeavor but a prudent economic decision which supports a cleaner environmental future.

A transitioning global energy mixFossil fuels represent 86% of the world’s energy supply and are therefore the predominant means by which the world’s energy needs are met.2 Though many experts agree that fossil fuels will be a part of the global energy

mix for the foreseeable future, as exhibited in Chart 1, their share of total power generation is expected to wane over time.

Chart 1

Source: Bloomberg, August 2019.

As society’s dependence on fossil fuel declines, renewable energy sources will become an essential pillar of a low-carbon economy. This gradual energy transition presents an opportunity for long-term private debt renewable energy investment due to the long useful life and stable cash flow profile of these renewable project assets. The TDAM Private Debt Team believes renewable energy projects align with the long-term objectives of our clients and through the the TD Emerald Private Debt Funds3, we have made a commitment to investments in this industry.4

Mainstream renewable energy generation using hydro, wind and solar resources offer a viable pathway to

reducing the carbon footprint of daily energy use. However, the sun doesn’t always shine, the rain doesn’t always fall, and the wind doesn’t always blow. The intermittency of renewable resources means that electrical grid operators still need to incorporate other forms of energy generation and storage to deliver on the dependable electrical grid expectations of today’s society.

In order to establish a perspective on energy generation options, the tables below list the various energy generation sources currently available and detail their respective pros and cons.

0%

20%

40%

60%

80%

100%

1970 1980 1990 2000 2010 2020 2030 2040 2050

Historical world power generation mix NEO2019 power generation mix

48% solar & wind

62% renewables

31% fossil fuels by 2050

Coal Gas Oil Nuclear Hydro Wind Solar Other

2 The international Energy Agency: https://www.iea.org/ 3 The pooled fund trust’s being referenced are TD Emerald Long Private Debt PFT and TD Emerald Private Debt PFT. 4 The TDAM Private Debt Team provides long-term investment grade quality debt financing across multiple industries, including but not limited to: Power & Energy, Infrastructure, Real Estate, Securitization and Corporate Debt.


Renewable

Traditional power generation: Pros: Cons:

Nuclear

• No CO2 Emissions. • Baseload capacity. • Lowest operating cost per MWh.

• Nuclear waste produced. • Always on, not dispatchable. • Complicated to build and operate. • Cost variability predicated on price

of uranium.

Coal

• Baseload capacity.• Inexpensive generation, if fuel

source is easily accessible.

• Produces 2x the CO2 as gas generation.

• Produces other emissions and residual waste.

• Cost variability predicated on the price of coal.

Gas (Combined Cycle)

• Dispatchable, latest technology can ramp up production within 15 minutes.

• Produces CO2 but is relatively clean burning when compared to coal.

• Cost variability predicated on price of natural gas.

Renewable power generation: Pros: Cons:

Hydro (Reservoir)

• Non-carbon generation.• Dispatchable, turbines can be

ramped up using reservoir water to meet needs of grid.

• Low production cost.

• Difficult to permit new facilities due to environmental impact of upriver flooding to accommodate reservoir.

Hydro (Run-of-river)

• Non-carbon generation. • Low production cost.

• Subject to resource variability.

Wind (Onshore)

• Non-carbon generation. • Easy to construct.

• Subject to resource variability.

Wind (Offshore)

• Non-carbon generation.• Much more consistent power

generation profile than onshore wind.

• Subject to resource variability.• Large-scale, capital intensive

deployment.

Utility-Scale Solar

• Generation profile (during sunlight hours) aligns to peak needs of the grid.

• Non-carbon generation.

• Subject to resource variability. • Uses significant land for amount of

power produced.

From the qualitative factors listed above, renewable power generation, relative to carbon-based power generation, requires lower initial capital costs to establish. Given that renewable energy projects utilize naturally occurring resources (i.e. water, wind, sunlight), recurring resource costs are low to non-existent. In comparison, fossil fuel-based energy requires resources

such as coal to be mined, transported and converted to a state of use. There are incremental costs for each step. Beyond the low carbon footprint of renewable energy projects, the variable cost component of renewable power generation is measurably lower, relative to carbon-based power generation.


Lowering CO2 emissions by incorporating renewable energy into existing power gridsPower utilities in developed economies, pushed by regional or national regulations to lower carbon emissions, have begun a transition to replace baseload coal generators with a combination of renewable and other dispatchable generation.5 This is a very complex balancing act that must incorporate regional renewable resource availability within the existing generation base built out over the last century.

From an environmental perspective, coal generation produces about twice as much CO2 as natural gas generation.6 Hence, the move to pair up emissions-free renewables with dispatchable gas generation is hugely beneficial in lowering the carbon use per megawatt (MW) of electricity generation. Chart 2 below demonstrates the emissions output of both fossil energy sources and then incorporates the potential CO2 reducing benefit of adding renewables to the generation mix.

Chart 2: Carbon dioxide (CO2) for U.S. power plants (pounds per megawatt-hour)

5 Le Quéré, C., Korsbakken, J. I., Wilson, C., Tosun, J., Andrew, R., Andres, R. J., . . . P.van Vuuren, D. (2019). Drivers of Declining CO2 emissions in 18 developed economies. Journal Nature Climate Change, 1-66 U.S. Energy Information Administration: https://www.eia.gov/tools/faqs/faq.php?id=73&t=11

2,068

850

552

1,516

Lbs.

per

MW

/h

Average for New Plants

Coal Natural Gas Natural Gas + Renewable*

CO2 Emissions Reduction

*Renewable Energy does not emit Carbon Dioxide, hence emission is 0 Lbs. per MW/h. Renewable energy is assumed at a 35% capacity, consistent with quality onshore wind projects, with the balance made up by natural gas generation. Source: Coal and natural gas emissions inform from Platts Research and Consulting, based on data from the Environmental Production Agency’s Continuous Emissions Monitoring Systems, 2003. Geothemal information from U.S. Department of Energy 2000. TDAM.

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

Developed

CO2 EmissionsIntensitySavings


Regulatory change and technological advancements have combined to lower the cost of renewable energy generation by improving economies of scale for equipment manufacturers. In turn, manufacturers have continued improving the renewable generation efficiency of their equipment through aggressive research and development. Lowering the cost per

MW of renewable generation capacity has resulted in the accelerating adoption of renewables by utilities, supporting a virtuous feedback improvement cycle. As illustrated in the chart below (Chart 3), the usage costs for solar and wind power globally have declined considerably since 2010.

USD

/kW

h

Time (Years)

0

2010 20142011 20152012 20162013 2017 2018

0.1

0.2

0.3

0.4

Source: IRENA (2019), Renewable Power Generation Costs in 2018, International Renewable Energy Agency, Abu Dhabi

Chart 3: Declining cost of solar and wind, globally

Wind (Onshore) Wind (Offshore)Solar

Investing in renewable energyThus far, the cost of producing renewable energy has been higher than traditional carbon-based production. However, governments around the world, particularly in Europe and North America, have supported the growth of the renewable energy industry through various support mechanisms ensuring the economic viability of renewable energy production projects for private owners.

Financing choices can benefit project economics. Traditionally, project developers have been able to fund projects with long-term bank debt. However, many banks have pulled back from offering long-term financing due to new regulatory changes (i.e. Basel III) stemming from the financial crisis and the resulting increase in capital costs.

This has left project owners with two options for project debt financing:

(i) Short-term bank debt, which may expose the project to interest rate risk over the expected lifetime; (ii) Long-term, fixed rate private debt project financing.

We believe that long-term, fixed rate private debt is an ideal source of capital for high quality projects because the long-term predictability of a renewable project’s energy production profile matches well with the long-term investment horizon and yield enhancement requirements of private debt investors.


Investment considerationsRenewable project financing is a complex field requiring specific understanding of industry trends, technology, financing structures, legal due diligence and independent engineering reports. TDAM has built an experienced private debt team that is deeply knowledgeable, having financed many renewable energy projects aimed at improving energy sustainability globally.7

Though each project is unique, a consistent investment framework is needed to evaluate the opportunity.

Effective due diligence on investment opportunities is highly technical but some key considerations remain basic:

I. How is power contractually paid for and what is the creditworthiness of the electricity purchaser;

II. Developer experience;III. The expected useful life of the equipment and how

effectively it converts the resource to electricity;IV. The availability and predictability of the

energy source.

I. Purchaser of energyGovernments of North America and Europe have taken steps to lower the cost per MW/hr of renewable energy generation through tax credit programs or fixed-rate feed-in tariff regimes.8 Feed-in tariffs or power purchase agreements provide a fixed price for power to producers, which allows cost certainty over the long-term and encourages stable equity and debt investments.

Each jurisdiction has its own underlying contract nuances, which can include the ability to curtail energy production or cap payments. As the cost of renewable energy gets closer to grid parity (i.e. the clearing price of the local market's cost of power), contracts have become more aggressive at transferring power purchase price risk to project owners. These new contract regimes may include reliance on third-party hedging providers or corporate buyers willing to contract directly to fix the long-term price of their power. These moves away from direct government support have heightened the importance of contractual counterparty assessment in addition to granular analysis of the payment terms of underlying contracts.

Hydro generation TDAM participated in a 40-year long term debt financing to construct and operate a hydroelectric generation facility on a major river that produces power under contract with the Independent Energy System Operator (IESO), a Crown corporation responsible for operating the electricity market and directing the operation of the bulk electricity system in the province of Ontario. This run of the river hydro facility generates enough power for 20,000 homes. Hydropower is an attractive long-term investment because the technology is very well understood and once built can operate for over 100 years.

In order to illustrate how a private debt transaction in this space is assessed, let us walk through each consideration in more detail.

GenerationThis picture is for illustrative purposes only.

7 Over the past 15 years, the TDAM Private Debt Team has financed over $5 billion in investment grade quality debt, focused on renewable debt transactions.8 Fixed-rate feed-in tariff is a policy mechanism designed to accelerate investment in renewable energy technologies. It achieves this by offering long-term contracts to renewable energy producers, typically based on the cost of generation of each technology.


II. Project developer experience As project ownership has increasingly attracted mainstream investors, an understanding of the actual development and operating capabilities of specific owners is becoming important. Project developers need to understand the local jurisdiction and the pathway to obtaining construction and operating permits. There have been cases where these investors have purchased project developments at an early stage assuming that it will be simple to move forward, only to have them languish and never reach construction stage. Similarly, some developers are very strong at permitting but do not have the financial wherewithal to bring a project all the way through to completion.

While operating a facility may appear straightforward, some owners are much better at it than others. There is evidence that suggests there are significant economies of scale in operating large fleets of wind or solar projects. With the maturing of the renewables industry, competition is intensifying between established players.

The consolidation of operating assets is underway, as assets are traded to owners with the lowest cost of capital. For private debt investors, it is important to ensure that throughout the development, construction and operating periods, project owners have the technological capability, resources and experience to manage the project optimally.

III. Renewable power technology supplyHydrogeneration technology is mature and its equipment supply chain is relatively concentrated. However, in the solar and wind industry, competition between equipment suppliers has intensified as the race to achieve lower per MW build costs rewarded industry players with significant increases in market share.

Until recently, solar and wind manufacturers were able to lower their production costs while improving product efficiency. This has allowed them to maintain profitability while passing along gains to project developers. But as efficiency and lower production costs have become harder to achieve, some suppliers have experienced financial difficulties which has complicated the choice around technology selection. While it may be attractive to lock in wind turbine or solar panel pricing at the lowest possible cost, prudent investors need to be aware of the potential pitfalls associated with supplier bankruptcy or non-performance.

Project developers navigate the tightrope of choosing the latest technology that generates the most electricity while balancing the cost and dependability of the equipment. Having an understanding of the industry’s technological advancement over time helps provide context when selecting which projects offer the best investment profile. TDAM uses independent engineers to help assess the risks in the developers’ supplier decisions.

Solar generationTDAM financed a portfolio of solar farms producing power under 20-year contracts with the Independent Energy System Operator (IESO), a Crown corporation responsible for operating the electricity market and directing the operation of the bulk electricity system in the province of Ontario. While resource variability is a risk in renewable financing, having the benefit of geographic diversification helps improve the stability of the portfolio’s solar resource leading to a more stable generation profile.

AdvancementThis picture is for illustrative purposes only.


IV. Renewable resource assessment Hydro, wind and solar generation rely on the interpretation of historical resource data to determine the expected generation for a proposed project site. Whether it is waterflow measured by a hydrometer in a river, windspeed captured by a temporary tower erected to mimic a wind turbine’s hub height or insolation levels measured at the theoretical ground-level of a solar farm, engineers are able to use data collected over years to predict the average energy production and its potential variability over a long-term investment period.

In the early days of wind and solar generation there were some documented shortfalls in predictive success. However, the methods and accuracy of predictions have steadily improved to the point that it is rare for renewable energy projects to fail to deliver expected generation levels. Project debt is sized to ensure that there is sufficient cash flow to meet debt repayments in extreme generation scenarios such that lenders face negligible resource risk.

As renewable generation is often seen as a solution for climate change, informed investors often ask: “what is the impact of climate change on renewable investments?” While there has been some early documentation of climate change impacting a project’s renewable resource in a minor way, these impacts are generally the concern of equity owners.

The conservative debt sizing criteria used in renewable financing offers significant coverage against the effects of gradual climate change. An experienced investment team would consider these factors when creating the bespoke repayment schedule of a private debt investment.

Offshore generation TDAM participated in the financing of the largest offshore wind project in the world. The project was developed by the leading offshore wind developer who has been operating offshore wind turbines for over 20 years. Offshore wind technology has been proven out in the harsh conditions of Europe’s North Sea. Many offshore wind projects offer a more stable financial profile in operations than onshore wind projects because offshore wind tends to blow more consistently than onshore wind regimes.

Resources

This picture is for illustrative purposes only.


The futureHow renewable generation gets adopted in different jurisdictions is as varied as the individual resource attributes associated with each project. There are now numerous projects across the globe that have a long operating history. The proven success of these projects justifies allocating scarce capital to the construction of renewable projects and displacing carbon intensive generation.

While wealthier nations have chosen to help subsidize the move toward lower carbon generation, the resulting cost reduction plays an even greater role in helping developing nations include renewable generation in their energy mix. For rapidly expanding nations, implementing new smart grid technology capable of incorporating the variability of renewable power into its grid dispatch protocols may allow them to leapfrog others in building a low carbon generation footprint. Also, without the low-cost fleet of depreciated carbon-emitting generation plants, developing countries can more easily make the decision to develop renewable generation, as cost parity is on the verge of being achieved in many areas.

For example, certain tropical and desert regions possess very high insolation levels which could allow for very efficient solar generation. With respect to

coastal regions, the European successes with the mass deployment of offshore wind farms have proven that, from a technology perspective, offshore wind generation is a viable and mature technology. With the cost of developing offshore wind projects rapidly falling, other jurisdictions like Taiwan and Japan are promoting the use of their prolific offshore wind resources to develop near grid parity projects. What is especially attractive for these nations is that implementing this kind of sustainable energy generation improves their geopolitical position by reducing chronic dependence on fossil fuel imports.

Full scale substitution of renewable generation over carbon emitting energy production is not realistic in most jurisdictions until the problem of intermittent renewable generation is feasibly addressed. Corporate and government research and development funding of battery and other energy storage technology is critical to allowing utilities to execute a greater transition to carbon-free generation for electrical grids. As a private debt investor, TDAM constantly monitors technological change to ensure that when the opportunity to conservatively deploy private debt arises, we will be well positioned to assist in the world’s transition to sustainable energy use.

9 TD Bank Group. TD Low-Carbon Economy Progress Report, 2017-2018. https://www.td.com/document/PDF/corporateresponsibility/2018-LC-Economy-Report.pdf

The information contained herein has been provided by TD Asset Management Inc. and is for information purposes only. The information has been drawn from sources believed to be reliable. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. All products contain risk. Important information about the pooled fund trusts is contained in their offering circular, which we encourage you to read before investing. Please obtain a copy. The indicated rates of return are the historical annual compounded total returns of the funds including changes in unit value and reinvestment of all distributions. Yields, investment returns and unit values will fluctuate for all funds. All performance data represent past returns and are not necessarily indicative of future performance. Pooled Fund units are not deposits as defined by the Canada Deposit Insurance Corporation or any other government deposit insurer and are not guaranteed by The Toronto-Dominion Bank. Mutual fund strategies and current holdings are subject to change. TD Emerald Funds are managed by TD Asset Management Inc. Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS. TD Asset Management Inc. is a wholly-owned subsidiary of The Toronto-Dominion Bank. All trademarks are the property of their respective owners. ® The TD logo and other trade-marks are the property of The Toronto-Dominion Bank.(0220)

ConclusionFinancing renewable energy projects using private debt offers investors long-term, predictable cash flows while helping to promote the global transition to lower carbon generation. TDAM’s private debt clients are participating in the frontline development of the future’s energy ecosystem. However, not all renewable energy investments are created equally. As such, it is crucial to ensure that risks are fully understood, and the transaction is appropriately structured by an experienced investment team.

TDAM has also financed energy efficient real estate (i.e. LEED-standard buildings) and public transit infrastructure which demonstrate that the opportunity to reduce greenhouse gas emissions in concert with obtaining attractive yields is achievable across a wide number of industry sectors.

As an organization, the TD Bank Group recognizes the importance of transitioning to a low-carbon economy and has committed $100 billion by 2030, through lending, financing, asset management, and internal corporate programs.9 TDAM, as a wholly-owned subsidiary of the TD Bank Group, is fully aligned with this commitment in its everyday quest to source attractive investment grade quality debt transactions for our clients.

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