wind power innovation and financing

61
Università Commerciale Luigi Bocconi Corso di laurea CLEAM 2010 Financing innovation: a study on project financing issues in the wind power sector Lavoro finale di Marco Cavalli Matricola 1246883 1

Upload: sidecarural

Post on 03-Jul-2015

220 views

Category:

Documents


2 download

TRANSCRIPT

Page 1: Wind Power Innovation and Financing

Università Commerciale Luigi Bocconi

Corso di laurea CLEAM 2010

Financing innovation: a study on

project financing issues in the wind power sector

Lavoro finale di Marco Cavalli

Matricola 1246883

Giugno 2010

1

Page 2: Wind Power Innovation and Financing

Acknowledgment2

Page 3: Wind Power Innovation and Financing

A large part of the information and data utilized in the preparation of this work have been

gathered through meetings, interview and “Q&A sessions” with some ‘key players’ in the

field of project development, manufacturing, consulting and financing of renewable power

project (wind farm in particular).

I am extremely grateful to all the persons who have been available to help me in this effort:

Mr. William J. Heller – Managing Director – Falck Renewables Plc – London

Mr. Francesco Novelli – Principal - Grimaldi e Associati Law Firm – Rome

Mr. Gianni Gori – Head of Structured Finance – MPS Financial Services –

Florence

Mr. Thomas Barkman – South Europe Commercial Manager – Nordex GmbH –

Bremen

Mrs. Nadia Prando – Manager of Project Financing – Falck Renewables Italia –

Milan

Mr. Christof Stork – General Manager – Garrad Hassan Consulting – Bristol-Forlì

Mr. Maurizio Longini – Head of Structured Finance - Banca Infrastrutture

Innovazione e Sviluppo S.p.A. – Milan

Without their contribution this work would not have been possible.

I heartily thank them all.

Marco

3

Page 4: Wind Power Innovation and Financing

4

Page 5: Wind Power Innovation and Financing

INDEX

Introduction and Executive Summary

1. Brief overview of the industry’s historical path and sector’s characteristics

1.1 Wind power industry in a nutshell1.2 Wind power usage1.3 Wind power resisting the financial crisis

2. The market and the key players

2.1 The Wind Market in 20092.2 The top players

3. The wind turbine industry: peculiarities, trends, areas of technical innovation

3.1 Quick presentation of the technology’s characteristics3.2 Areas of Technical Innovation in the Wind Energy Sector, and relevant risks

4. Financing innovation in the Wind Power Sector: risk evaluation, allocation and mitigation, roles of the key players

4.1 Project Financing in the Wind Power Sector

4.1.1 Introduction4.1.2 The attitude of Lenders towards P.F. in a phase of “credit crunch”

4.2 Presenting a wind farm project to the Lenders 4.3 The role of the different players in the identification and allocation of the

technological innovation risks

4.3.1 The Sponsor4.3.2 The turbine Manufacturer4.3.3 The lenders4.3.4 The Legal Consultants 4.3.5 The Technical Advisors, and the Certifications

4.4 A typical contractual framework for the supply, erection and operation of innovative wind turbine model

4.4.1 Introduction4.4.2 Warranties and Bonds4.4.3 The ‘Type Certificate’

5

Page 6: Wind Power Innovation and Financing

4.4.4 Schedule of Payments4.4.5 Protection against “Serial Defects”4.4.6 Manufacturer’s Liabilities4.4.7 “Full Service” clause in the Operation Contract4.4.8 Availability guarantee

4.5 Main financial mitigants to control innovation risks

5. References

6

Page 7: Wind Power Innovation and Financing

Executive Summary and Conclusions

Wind turbines are a mature technology, and wind farms installation is rapidly growing

across Europe, US and Asia (China and India in particular), as shown in Chapter 1.

Today wind plant’s output is second only to hydroelectric power as renewable source for

the production of electric energy for national electrical networks; this underlines the

relevance and topicality of the subject discussed in this work.

Moreover, by 2012, the wind industry is expected to offer 1 million jobs, making it one of

the fastest growing industrial sector in the World and an exciting place to find a job in the

near future.

Wind power is a truly “clean/green source of energy”. In fact, in 2009 the energy produced

by European wind farms avoided 106 million tonnes of CO2 emissions, equivalent to

taking 25% of cars out of the EU roads. Green energies are, with very few exceptions, very

well accepted by the public opinion and strongly supported by the institutions, by means

of economic and fiscal incentives aimed to encourage the diffusion of wind based power

projects (topic further discussed in Chapter 1).

Technological innovation is a key factor for manufacturers of wind turbines to gain market

share, and investors are keen in adopting ‘state of the art’ turbines with higher efficiencies,

lower operating costs, high availability factors, good performances also in low-wind

applications as covered in Chapter 2 and 3.

However, wind farms are a capital intensive business, and – with the only exception of

very small size installations – the investors must rely on the availability of banks to provide

financial means to implement the projects, usually through ‘non-recourse project financing’

schemes.

In this kind of transactions, the risk evaluation and allocation (outside the lender’s

boundary) is a key factor, and the technological innovation risk (together with the

permitting risk) is the major concern for banks.

7

Page 8: Wind Power Innovation and Financing

The role of the different players (sponsor/owner of the wind farm, supplier of the wind

turbines, technical consultant, legal consultant, lenders), is discussed in this paper, on the

basis of interviews and Q&A sessions with some key players of the industry and banks

sectors.

Not surprisingly, the main candidate to bear the innovation risk is the manufacturer of the

wind turbines: suitable contractual provisions are in general required by lenders in order to

obtain from the supplier of the innovative equipment an adequate ‘security and

guarantees’ package. Main option to control and made risk acceptable for lenders are:

extended warranty period, suitable bond package, type certification, appropriate schedule

of payments, specific protection against serial defects, operation and maintenance

contracts with the supplier of the innovative equipment, including availability guarantee,

higher liability limits with suitable availability guarantee.

Also the terms of the financing contract (and in particular the debt/equity ratio –D/E -, and

the debt service cover ratio – DSCR -) may be affected by the technical innovation, as

further discussed – with reference to a ‘case history’ of a wind project utilizing a new

concept of wind turbine, without a sufficient ‘track record’ – in Chapter 4.

8

Page 9: Wind Power Innovation and Financing

9

Page 10: Wind Power Innovation and Financing

1 Brief overview of the industry’s historical path and sector’s

characteristics

1.1 Wind power history in a nutshell

Wind power is today second only to hydroelectric power as renewable source for the

production of electric energy for national electrical networks. It all begun in Denmark, at

the beginning of 20th century, when the first experimental wind electrical generators (with a

power of a few kW) were installed on towers some 25m tall, with four bladed rotors 1.

The first utility grid-connected wind turbine operated in the UK and was built by John

Brown & Company in 1954 in the Orkney Islands. It had a 18 meter diameter, three-bladed

rotor and a rated output of 100 kW.

The first model of ‘modern’ wind turbine (three-bladed, horizontal-axis, upwind, stall-

regulated turbine similar to those now used for commercial wind farms) was put in

operation in Denmark in 1957, with a rotor diameter of 24m, and was decommissioned 10

years later. From then on, Danish wind industry focused on progressive incremental

improvements in capacity and efficiency of wind turbines, and begun the serial production

of turbines based on the ‘Danish Model’: horizontal axis wind turbines (HAWT), with a

main rotor shaft and generator located on a ‘nacelle’ on top of a tower 2. Usually, the

nacelle also houses a gearbox, which turns the slow rotation of the blades into a quicker

rotation that is more suitable to drive the electrical generator. The turbine must always be

pointed into the wind, by means of a wind sensor coupled with a servo motor 3.

From the mid 1970's - following the first oil crisis - through the mid 1980's, also the United

States Government worked with industry to advance the technology and enable large wind

turbines to become commercially available.

This effort was led by NASA at the Lewis Research Center in Cleveland, Ohio and was an

extraordinarily successful government research and development activity. With funding

from the National Science Foundation and later the United States Department of Energy

1 History of Wind Energy in Encyclopedia of Energy Vol. 6, page 4262 Paul Gipe Wind Energy Comes of Age, John Wiley and Sons, 1995, Chapter 33 www.windpower.org/en/tour/wtrb/comp “Wind Turbine Components”

10

Page 11: Wind Power Innovation and Financing

(DOE), a total of 13 experimental wind turbines were put into operation including four

major wind turbine designs. This research and development program pioneered many of

the multi-megawatt turbine technologies in use today, including: steel tube towers,

variable-speed generators, composite blade materials, pitch control (i.e, the ability of the

blades to automatically adjust their pitch in relation to wind speed), as well as

aerodynamic, structural, and acoustic engineering design capabilities 3.

The large wind turbines developed under this government supported effort set several

world records for diameter and power output. In 1987, the largest single wind turbine with

a rotor diameter of nearly 100 meters and a rated power of 3.2 MW was put in operation

(though as a prototype), demonstrating an availability of 95 percent, an unparalleled level

for a new first-unit wind turbine.

The large scale, serial production of wind turbines began in early 80’s, by Danish

manufacturers Kuriant, Vestas, Nordtank, and Bonus. These early turbines were small by

today's standards, with capacities of 20–30 kW each. Since then, they have increased

greatly in nominal capacity (the power than can be produced by each turbine, measured in

kW or thousand of kW, i.e. MW), dimensions, and the so called “power curve” (which is the

characteristic of a wind turbine to generate electric energy when hit by wind of a given

speed).

And, not surprisingly, wind power accounts today for nearly one-fifth of electricity

generated in Denmark, the highest percentage of any country.

1.2 Wind power usage

There are now many thousands of wind turbines operating, with a total nameplate capacity

(at the end of 2009) of 159,000 MW (with an increase of 38,000 MW on previous year) of

which wind power in Europe accounts for 48%. World wind generation capacity more than

quadrupled between 2000 and 2006, doubling about every three years. A large part

(>80%) of wind power installations are in the US and Europe. In 2009, the growth rate of

installed capacity showed a rate of 32%, the highest since 2001, continuing the trend that

wind capacity doubles every three years.

11

Page 12: Wind Power Innovation and Financing

By end of 2010, the World

Wind Energy Association 4

expects more than 200 GW

of capacity to be installed

worldwide, with an

impressive yearly

generating capacity of 340

TWh (equivalent to the total

electricity demand of Italy,

or to 2% of global electricity

consumption of the World).

The wind sector in 2009 had a turnover of 50 billion, employed 550’000 persons

worldwide. In the year 2012, the wind industry is expected for the first time to offer 1

million jobs, making it one of the fastest growing industrial sector in the World.

Also in 2009, China continued its role as the locomotive of the international wind industry

and added an outstanding 13’800 MW in one year, making it the biggest market for new

turbines, and more than doubling the installations for the fourth year in a row.

The USA maintained its number one position in terms of total installed capacity, but thanks

to its impressive growth China became number two in total capacity, only slightly ahead of

Germany, both of them with around 26’000 MW of wind capacity installed.

Thanks to the leading role of China, Asia accounted for the largest share of new

installations in 2009 (40,4 %), followed by North America (28,4 %) and Europe fell back to

the third place (27,3 %).

The role of wind power in China in the recent years is impressive: a Chinese

renewable energy law was adopted in November 2004 (following the World Wind Energy

Conference organized in China) and the Government originally set a generating target of

30,000 MW by 2020 from renewable energy sources, but the installed capacity already

reached 22,500 MW at the end of 2009 and could easily surpass 30,000 MW as early as

4 http://www.wwindea.org

12

Figure 1.1 - World Installed Capacity (MW) - Source: World Wind Energy Association

Page 13: Wind Power Innovation and Financing

end of 2010 ! Indigenous wind power could generate up to 253,000 MW.5 By 2008, wind

power was growing faster in China than the government had planned, and indeed faster in

percentage terms than in any other large country, having more than doubled each year

since 2005. Policymakers doubled their wind power prediction for 2010, after the wind

industry reached the original goal of 5 GW three years ahead of schedule. Current trends

suggest an actual installed capacity near 20 GW by 2010, with China shortly thereafter

pursuing the United States for the world wind power lead.6

India ranks 5th in the world with a total wind power capacity of 10,925 MW in 2009, or 3%

of all electricity produced in India 7. The World Wind Energy Conference in New Delhi in

November 2006 has given additional impetus to the Indian wind industry. Muppandal

village in Tamil Nadu state, India, has several wind turbine farms in its vicinity, and is one

of the major wind energy harnessing centers in India led by majors like Suzlon, Vestas,

Micon among others 8.

1.3 Wind power resisting the financial crisis

The global financial and economic crisis, all in all, had no significant negative impact on

the general development of the wind sector worldwide. Many governments sent clear

signals that they want to accelerate wind deployment in their countries and indicated that

investment in wind and other renewable technologies is seen as the answer to the

financial as well as to the still ongoing energy crisis.

Hence, politically stable and in many cases improved frameworks lead to more investment

in wind utilization around the globe. Two milestones in this context were the first feed-in

law in North America, adopted in Ontario, in the aftermath of the WWEC2008, and the

introduction of the first feed-in tariff in Africa by the National Energy Regulator of South

Africa. Similar incentive schemes (in the form of all-included, fixed feed in tariffs, or as

incentives payable on top of the regular electric energy market tariffs) are already applied

in different Countries, in particular in Europe.

Within this political environment the finance sector has started to understand that wind

technology is in principle a low-risk investment not only for the investors themselves, 5 Lema, Adrian and Kristian Ruby, ”Between fragmented authoritarianism and policy coordination: Creating a Chinese market for wind energy”6 Watts, Jonathan (2008-07-25). "Energy in China: 'We call it the Three Gorges of the sky. The dam there taps water, we tap wind'"7 World Wind Energy Association Statistics, 2009 8 Watts, Himangshu (November 11, 2003). "Clean Energy Brings Windfall to Indian Village"

13

Page 14: Wind Power Innovation and Financing

but also for lending institutions, given that right policies are in place. In addition to such

direct microeconomic benefits for wind investors, wind turbines stabilize the overall energy

prices and hence reduce general economic risks in a country, while reducing the

dependency on (in most cases imported) fossil and nuclear resources. Interesting

prospects for financing wind and other renewable technologies came up in the context of

the UN climate change discussions: The International Renewable Energy Alliance

proposed at the COP15 in Copenhagen a Global Fund for Renewable Energy

Investment, including a Global Feed-in Tariff programme. This proposal would enable

mainly developing countries to invest on a large scale in renewable energy and has

already attracted major interest amongst governments and international organizations.

Adopted in the frame of the United Nations Framework Convention on Climate Change

UNFCCC, it would pave the way for an accelerated huge and worldwide boom of

renewable energy deployment 9.

9 http://unfccc.int/2860.php

14

Page 15: Wind Power Innovation and Financing

15

Page 16: Wind Power Innovation and Financing

2 The Market and the key players

2.1 The wind market in 2009

In the year 2009, altogether 82 countries

used wind energy on a commercial basis,

out of which 49 countries increased their

installed capacity. China and the USA

established themselves as the by far

largest markets for new wind capacity,

together accounting for 61,9 % of the

additional capacity, a share which was

substantially bigger than in the previous

year (53,7 %)10.

Nine further countries could be seen as major

markets in 2009, with turbine sales in a range

between 0,5 and 2,5 Gigawatt: Spain, Germany,

India, France, Italy, the United Kingdom,

Canada, Portugal, and Sweden.

As a consequence of this sharp growth in 2009,

the Country Share of total installed capacity at the

end

of 2009 showed 17 countries with more than

1’000 Megawatt installed, compared with 11

at the end of 2005.

Worldwide, 35 countries had wind farms with

a capacity of 100 Megawatt or more

installed, compared with 32 countries in the

previous year and 24 countries just four

years ago, showing that more and more Countries enter the wind power market with

10 World Wind Energy Association,“World Wind Energy Report 2009”, March 201016

Figure 2.1 – Top 10 Countries Total Capacities (MW) – Source: World Wind Energy Association Report 2009

Figure 2.2 – Country share of new capacity 2009 – Source: World Wind Energy Association Report 2009

Figure 2.3 – Country share of total capacity 2009 – Source: World Wind Energy Association Report 2009

Page 17: Wind Power Innovation and Financing

significant investment on medium- and large-scale wind farms. In some Counries, wind

energy has become one of the largest electricity sources, the highest shares being

Denmark (20%), Portugal (15%), Spain (14%), Germany (9%); the present installed

capacity in Europe would produce, in a normal wind year, 4.8% of the EU’s electricity

demand 11.

In 2009 (a “slightly above average”

windy year), the energy produced by

European wind farms avoided 106

million tonnes of CO2 emissions,

equivalent to taking 25% of cars out

of the EU roads !

The table on the left 12 shows the wind market growth rates over a period of 5 years (2004-

2009), both in terms of new power

installed, and of cumulative power growth. The average expansion of the market (more

than 36% increase on average over the previous year) characterizes the wind energy

sector as one of the most fast and steadily growing market.

2.2 The Top Players

In terms of manufacturer’s market share, in 2009 the top ten suppliers accounted for

more than 81% of the market share. Vestas (www.vestas.com) of Denmak managed to

cling onto its position as the world’s number

one manufacturer. One very interesting

feature of 2009 has been the growing role of

chinese manufacturers: Vestas’ market

share has fallen from 19.8% in 2008 to

12.5%, and second placed GE Wind

(www.gewind.com) has fallen from 18.6 to

12.4, while at the same time three Chinese

manufacturers (Sinovel, www. sinovel.com ,

11 EWEA – The European Wind Energy Association – Fact Sheet 201012 BTM Consult ApS - Denmark

17

Figure 2.4 – World Market Growth Rates 2004-2009 – Source: BTM Consult ApS - Denmark

Figure 2.5 – Top 10 Suppliers In 2009 – Source: BTM Consult ApS

Page 18: Wind Power Innovation and Financing

GoldWind www. goldwind.cn , and DongFang www.dongfang.com.cn) now feature in the

top 10.

The other major manufacturers are Enercon (www. enercon.de ) from Germany, the

Spanish company Gamesa (www.gamesacorp.com/en ), Suzlon (www.suzlon.com )

based in India (which recently bought the control of the German manufacturer Repower,

www.repower.de ), and Siemens (www.energy.siemens.com ).

A quick overview of these major players is given below.

Vestas Wind Systems

Vestas was founded in 1898 in Denmark as a manufacturing company of steel windows for

industrial buildings.

In the early 1970s, during the second oil crisis, Vestas began to examine the potential of

the wind turbine as an alternative source of clean energy, and in 1979 Vestas delivered

the first wind turbines. The industry experienced a genuine boom at the start of the 1980s,

but in 1986 Vestas was forced to suspend payments because the market in the United

States was destroyed due to the expiration of a special tax legislation that provided

advantageous conditions for the establishment of wind turbines. A large sections of Vestas

were sold off and a new company called Vestas Wind Systems A/S was founded at the

end of the year to concentrate exclusively on wind energy.

After the merging with another Danish wind turbine manufacturer, NEG Micon A/S, Vestas

acquired a growing role in the wind manufacturing sector, becoming leader of the market

in the 2000s.

Today Vestas is present in 65 Countries in 5 continents, with an installed portfolio of more

than 40000 wind turbines. Vesta’s R&D centre is the largest in the world, with the

capability of real-time monitoring of all the portfolio of operating wind farms.

18

Page 19: Wind Power Innovation and Financing

Enercon

German giant Enercon was founded in 1984. Since then a small team of engineers has

developed its first E-15/16 wind turbine with a rated power of 55kW. The changeover to

gearless technology was made in 1992 with the first Enercon E-40/500kW.

This technology, with its innovative drive system and few rotating components, enables

the direct connection of the rotating blades with the generator, without a gearbox. The

advantages are a lighter, simplest construction, less components, lower friction, reduced

mechanical stress and operating and maintenance costs. The ‘no-gear-box’ construction is

a true peculiarity of Enercon, as is the ‘vertical integration’ of this Company, which

develops and manufactures all the components of its turbines (including, of course, the

‘purpose designed’ gearless-generator), while almost all the competitors utilize industrial

components manufactured by third parties.

Today there are more than 13,000 Enercon machines installed worldwide in over 30

countries, with a combined capacity of more than 15GW.

Gamesa

Gamesa Corporación Tecnológica was established in 1976, developing new technologies

for application in emerging sectors with a promising future such as robotics,

microelectronics, environment, composite materials, etc.. Its corporate headquarters are

located in the Autonomous Community of the Basque Country (Spain).

The wind turbine manufacturing unit was set up in 1994, while promotion, construction and

sale of wind farms was started in 1996. In 1997, Gamesa began a process of

concentration on activities considered as strategic, culminating in 2006-2008 in withdrawal

from aeronautics and solar sectors, and focusing on wind energy, where Gamesa is active

not only as a manufacturer, but also as a developer/investor/owner of wind farms. 

The company has been listed on the Stock Exchange of Madrid since October 31, 2000

and has been included in the top Ibex-35 index since April 24, 2001.

GE Energy

19

Page 20: Wind Power Innovation and Financing

GE is one of the world's leading wind turbine suppliers and boasts more than 13,500 wind

turbine installations worldwide with more than 218 million operating hours and

127,000GW/h of energy.

With wind manufacturing and assembly facilities in Germany, Spain, China, Canada and

the US, GE's product portfolio includes wind turbines with rated capacities ranging from

1.5 to 3.5MW and support services ranging from development assistance to operation and

maintenance.

The top selling GE wind turbine is the GE 1.5 MW model, originally developed by General

Electric in cooperation with the United States Department of Energy - DOE.

Three models in the series (the 1.5se, 1.5sle, and 1.5xle) had been developed and are

commercially available. Their rotors ranged in diameter from 70.5 m to 82.5 meters,

accommodating variable wind speeds, and making it one of the most popular turbine

model, in particular in the US (more than 10,000 installations in the US, or 50% of the

national commercial wind energy fleet.

GE's offshore wind business recently acquired Norwegian company ScanWind to increase

its product offering even further to serve the expanding offshore wind turbine segment.

Repower

Repower was founded in Germany in 1994, when the first in-

house developed 500 kW turbine was presented to the market, later developed into a 600

kW (0.6 MW) turbine. Four years later the series production of the BWU 1000/57 model

begun, the first turbine in the “One MW” class.

The increase of unit power continued with the MD77 model, a 1.5 MW turbine with 77 m

rotor, designed to ‘capture wind’ also in low-wind sites, which become the most popular

model of Repower.

Today the product ranges include turbines from 1.5 up to 5MW . The latter turbine – one of

the largest turbine’s in the world, with a rotor diameter of 126m – has been designed

primarily for offshore wind farms and the company is currently installing three of its new 6

MW 6M turbines onshore in Germany.

20

Page 21: Wind Power Innovation and Financing

REpower has offices in Germany along with subsidiaries and associated companies in

France, Spain, the UK, Greece, Australia, China, Portugal, Italy. In 2007 a majority share

of the Company has been acquired by Suzlon, the leader an Indian wind turbine

manufacturer.

Suzlon

Conceived in 1995 in India with just 20 people, Suzlon is now a leading wind power

company with over 14,000 people in 21 countries, and operations across the Americas,

Asia, Australia and Europe.

The Company’s portfolio of models includes wind turbines from 600 kW (0.6MW) to 2.1

MW, and the supply chain is fully integrated with manufacturing facilities in three

continents. In 2007, also thanks to the acquisition of Repower, Suzlon expanded its

operations in Europe, and presently has R&D capabilities in Belgium, Denmark, Germany,

India and The Netherlands

Market leader in Asia, Suzlon market share (Combined with Repower) rose to 9.8%

thereby making Suzlon 3rd largest wind turbine manufacturing company in the world

Sinovel Wind Corporation

Sinovel is among the world’s top-ten largest turbine manufacturers

and is taking advantage of the massive growth in its home market of China.

The leading manufacturer of large-scale wind turbines in China, it was the first company to

introduce 1.5MW and 3MW machines into the country. Sinovel has produced more than

1,500 units of its 1.5MW machine and has a production capacity of more than 1,000 units

a year.

21

Page 22: Wind Power Innovation and Financing

3 The wind turbine technology: peculiarities, trends and attitude

towards innovation

3.1 Quick presentation of the technology’s characteristics

Wind turbines, including the costs associated with blades, towers, transportation and

installation, constitute the largest cost component of a wind farm, usually accounting for

around 75% of the capital cost.

Basically, a wind turbine is composed by the following components :

a) a steel tower, housing the electrical components like the power transformer, the

control and safety systems, as well as the

elevator or stairs for accessing the top of

the tower.

b) a nacelle, including the electrical

generator, a gearbox (which transforms

the slow rotation of the shaft to the speed

requested for the generator to produce

electric energy), the yaw and pitch

systems (required to rotate the turbine to

follow the direction of wind, and to adjust the pitch of the blades in accordance of

wind speed).

c) the rotor hub, that holds the blades in position on the ‘nose’ of the nacelle.

d) the rotor blades, varying in length up to more than 60 m each, are manufactured in

specially designed moulds from composite materials, usually a combination of glass

fiber and epoxy resin.

3.2 Areas of Technical Innovation in the Wind Energy Sector, and relevant risks

Wind Turbines industry today can be considered a mature technology, after a very

significant growth in terms of installed capacity in Europe, in USA and Asia (amazing

growth in China over the past 4 years), as discussed in Chapter 2.

22

Figure 3.1 – A Wind Turbine – Source: US DOE

Page 23: Wind Power Innovation and Financing

This technology is, however, still characterized by a fast evolution and, due particularly to

the very high capital cost structure of the wind industry, technical innovation is of critical

importance, because very slight improvements in wind energy capture and plant

availability can provide huge returns.

Technical innovations have focused in the recent past to three main areas:

a) Capturing more energy out of the wind resource, by installing turbines with

larger blades, fine-tuned blades design, more efficient generator/gear boxes:

the ‘hub height’ (i.e. the length to the tower on top of which the ‘nacelle’

containing the electric generator is installed) reaches now 100 m (in comparison

with 40-50m of just a few years ago). The length of the blades has also grown

significantly: the rotor diameter was in average of 15m in 1980, 40m in 1990,

110m in 2000 and 150m and more in 2010 (the comparison with the dimensions

of a ‘Jumbo Jet’ is

amazing…). This increase of

the overall dimensions is

instrumental to the objective

of ‘capturing’ more wind, and

therefore producing electric

energy also with lower wind

speeds. While this trend will

allow the installation of wind

parks also in location which

were not economically

attractive until a few years

ago, the increase of overall dimension may pose issues in terms of structural

strengths, use of more sophisticated materials, more complex transportation and

installation processes.

b) Increasing unit power, which passed from a few hundred kW in the early ’90 to

several hundred kW in the early 2000’s (for several years, the ‘standard’

capacity has been the very common 850 kW size), to a few thousand kW (i.e.,

23

Figure 3.2 – Size Evolution Of Wind Turbines – Source:

Page 24: Wind Power Innovation and Financing

MW) today. The main manufacturers are now offering as standard turbines

having unit power of 2-2.3-2.5 MW, and newest machines are already offered

with a nominal capacity of 3 MW for on-shore applications. Off-shore wind

turbines with unit capacity of 5 MW and more are offered by some

Manufacturers, although this cannot be considered a ‘mature’ and ‘commercially

available’ technology yet, due to the rather limited track record of these turbines

and the limited number of units actually installed. Higher unit power means a

lower number of bigger turbines to ‘capture’ the same quantity of wind,

optimizing use of land and reducing overall infrastructure costs.

c) Obtaining better availability, by ensuring that turbines are operating when the

wind is blowing the most. The availability factor of modern wind turbines (i.e. the

percentage of time when the turbine is ‘available’ to produce electric energy)

exceeds today easily 97% (guaranteed value of most manufacturers), with a

sharp increase with respect to just a few years ago, when values just above

90% where standard.

In addition to these three ‘main goals’, as with other

manufacturing industries improving operation

costs is important as well; clearly, since the ‘wind

resource’ is free, optimizing the maintenance

procedures (and therefore lowering the operating

costs) has a direct, important effect on the

revenues, and consequently on the project cash

flow, as well as in reducing and potentially closing

the ‘gap’ between the generation costs of wind

energy with respect to conventional fossil fueled

power plants.

One area of innovation which is unique to wind

energy is the need to reduce noise produced by

the wind turbines: as more wind farms are built,

they get closer to housing and noise rules often

24

Figure 3.3. – The Construction Of A Wind Turbine – Source: Internet

Page 25: Wind Power Innovation and Financing

become a limiting factor. Having a ‘low noise’ turbine in the portfolio may be an excellent

chance for a manufacturer to beat competition, and gain market share.

Another area of potential innovation is the Distributed Control System (DCS), which

governs the operation of each wind turbine, and of the wind park as a whole. The DCS

technology enjoyed significant technologic innovation over the past 5 years, with important

positive feedback on plant efficiency and availability. Also in this field there are

perspectives of further development with the implementation of more sophisticated

software/hardware systems: however, since the risk associated with this kind of

technological innovation is rather low (it is always possible to quickly ‘switch’ from a new,

but unreliable SW/HW system to an older, more stable system), this is not usually

considered as a ‘critical’ aspect by Lenders. This aspect will not, therefore, be further

discussed in this paper.

25

Page 26: Wind Power Innovation and Financing

4 Financing innovation in the Wind Power Sector: risk

evaluation, allocation and mitigation, roles of the key players

4.1 Project Financing in the Wind Power Sector

4.1.1 Introduction

Project Financing (P.F.) is the key tool to provide financing means to the development,

construction and operation of wind farms. By means of P.F., new wind farms can be

financed on the basis of the projected cash flows of the project rather than the balance

sheets of the project sponsors. Usually, a wind farm project financing structure involves

one (rarely more) equity investor (the Sponsor or Owner), as well as a syndicate of

banks providing the financial means to the operation.

The loans are usually “non recourse” loans (or ‘limited recourse’ loans, in case of

riskier or more expensive projects, requiring surety from Sponsors), which are secured by

the project assets and paid entirely from project cash flow generated during the operation

of the wind park through the sale of the produced electric energy (plus ‘green certificates’

as applicable in some Countries, like Italy and UK), rather than from the general assets or

creditworthiness of the project Sponsors.

In general, a Special Purpose Vehicle – SPV (or ‘Project Company) is created for each

project, thereby shielding other assets owned by the Sponsor from the detrimental effects

of a project failure, and at the same time protecting the Lenders from problems or issues

involving the Sponsor and not related to actual wind project performances (the SPV has no

assets other than the project).

Thanks to a suitable ‘security package’, the lenders are given a lien on the projects

assets (physical assets like the wind turbines and other relevant wind farm infrastructures,

or contractual assets, like the supply and erection contracts or the ‘power purchase/supply’

contracts), and are able to assume control of a project if the project company has

difficulties complying with the loan terms (the suppliers are usually required to

acknowledge this right, by executing a specific “Direct Agreement” with lenders).

26

Page 27: Wind Power Innovation and Financing

Capital contribution by the owner of the SPV are in general necessary to ensure that the

project is financially sound, and to prove to the lenders the ‘commitment’ of the

sponsor/owner of the project.

4.1.2 The attitude of Lenders towards P.F. in a phase of “credit crunch”

The 2008 crisis had a dramatic impact on credit to industry: the so called ‘credit crunch’

had important consequences on both the availability of loans for new industrial

transactions, and on the lending conditions requested to the borrowers.

While this scenario has been valid in the latest years in general terms, the financing of

renewable energy projects through the instrument of ‘project financing’ has been less

penalized: several major lending institutions have diverted towards P.F. more founds than

in the ‘pre-crisis’ times. In fact, P.F. has been much less affected by the crisis than

‘standard’ corporate financing, and has been preferred also to other financing opportunities

for lenders, like acquisition financing. The reason behind this is the specific peculiarity of

P.F., which is to base the capability to repay the loan not on the financial strength of the

borrower (nor on the highly risky ‘multiples’ of the acquisition finance….), but on the actual

performances of the project.

What is important to lenders in a P.F. transaction is the project itself, and not the Sponsor

promoting it: even a Sponsor having contingent balance sheet difficulties due to the recent

financial crisis may – in principle – promote a project and find lenders willing to finance it,

regardless to the possible (and hopefully temporary) financial difficulties of the Sponsor

itself. From the other side, the Sponsor may find through P.F. the means to implement its

project, without burden on its corporate balance sheet.

One immediate effect of the financial crisis has been the increase of the overall costs of

the transaction, either in terms of higher spread, or more conservative project ratios

(DSCR, debt/equity): this situation contributed to ‘discourage’ the “purely financial

sponsors” (characterized by a more speculative approach) with respect to the “industrial

sponsors” (those having a real industrial role, track record and background in the specific

sector).

Lending to renewable energy projects (namely in the wind and solar sectors) is particularly

attractive for lenders, for two main reasons:

27

Page 28: Wind Power Innovation and Financing

(i) the incentive mechanism (‘green certificates’, or incentivized ‘feed in’ tariffs)

applicable in several Countries, has a positive effect on the cash flow, and on

project’s security;

(ii) the legislative framework (in almost all developed Countries) gives to

renewable energies a ‘priority’ in the production of energy with respect to

fossil fuel power plants: renewable power plants are allowed to deliver to the

electrical network all the electrical energy that they can produce, regardless

the actual energy request of the electrical system, leaving to the conventional

power plants the ‘modulation’ role.

As a consequence, the sector of the renewable energies is much more appealing to banks

than other more traditional areas, like the infrastructural one, characterized by a

significantly lengthy and complex permitting process, higher investment levels, less secure

returns.

4.2 Presenting a wind farm project to the Lenders

Risk identification, allocation and mitigation are key components of all P.F., and wind

projects are not exceptions. A wind farm project may be subject to a number of technical,

environmental, economic risks, and in addition to specific risks like those associated with

the wind resource availability and uncertainty.

To cope with these risks, before approaching the perspective lenders, the project

Sponsor(s) take a number of actions, namely:

a) Complete the permitting process, and secure all required rights on the parcel of

lands where the wind farm will be built, in order to avoid (or significantly limit) the

perception of permitting risks of the Lenders

b) Carry out a comprehensive wind resource assessment, by installing one or more

anemometer (‘met masts’) to measure wind speed and direction. Such wind

measurement campaign must be carried out over a period of at least 12 months,

but a longer campaign (two-three years) can significantly reduce the risk associated

by lenders to the wind resource availability, and make bankability easier and,

therefore, less expensive.

28

Page 29: Wind Power Innovation and Financing

c) Approach turbine manufacturers, to verify the

suitability of the wind turbines to the wind

characteristics (not only wind speed, but

especially wind turbulence which may affect

turbine performances and operating life), and

obtain (if possible) the declaration of ‘purpose

suitability’ (“fitness for purpose”) of that specific

wind turbine model/class.

d) Approach a reputable, specialized company or

consultant to carry out a comprehensive ‘Energy

Production Estimation Report’. The main result

of this Report is an estimation of the ‘Equivalent

Hours’ of the wind farm and the expected yearly

energy production (MWh per year), which

constitute one of the main input to the ‘business

plan’ of the project.

e) Prepare a comprehensive ‘PIM – Project Information Memorandum”. This

document includes the main information, data and results of the studies carried out,

as well as (in general) a section on ‘risks allocation and mitigation’, in a way that

should allow lenders to provide an offer to finance the deal.

All the above steps are performed by the Sponsors (or its consultants), and are a condition

for the Banks to consider lending to a new wind farm project.

4.3 The role of the different players in the identification and allocation of the

technological innovation risks

4.3.1 The Sponsor

The Sponsor may have an important, but ‘indirect’ role in the mitigation of the risk

associated with technological innovation. While Sponsors always seek to maximize bank

debt on projects, they may accept to add more equity, and borrow less debt, in relation

with a higher technological risk perceived by Lenders.

However, while the Sponsors are generally willing to accept to take responsibility (and

therefore accept to bear the cost) of risks related to the permitting process, or to wind

29

Figure 4.1 – A Wind Turbine – Source: Internet

Page 30: Wind Power Innovation and Financing

characteristics uncertainty, they are in general reluctant to provide such liabilities to

Lenders in relation to risks which are beyond their control, like technological hazard.

A preliminary phase during which the SPV/Sponsor play a decisive role in mitigating the

technological risk of innovation is the selection and appointment of their contractual

counterparties. In particular, the manufacturers’ credit worthiness and technical expertise

are crucial for the purpose of a positive evaluation of a project, in terms of bankability, by

the relevant financial institutions.

In project financing transactions the Lenders must ensure that the assumption by the

Sponsor/Borrower of a high technological risk is counterbalanced by the relevant

Manufacturer’s technical, economic and

financial standing. Such characteristics

put the contractor in condition (at least in

theory) to duly and promptly respond to

requests for technical intervention and/or

relief from damages in case of

malfunctioning or not fully performing

equipments and facilities.

4.3.2 The turbine Manufacturer

Not surprisingly, wind turbine Manufacturers are the lead candidates to sustain the risk

associated with technological innovation: suppliers and contractors are well aware that the

introduction in the market of new products with particularly innovative technical elements

would be hardly accepted by investors and financial institutions unless a relevant portion of

the associated technological risk is borne by such suppliers and contractors.

Companies without a sound track record, or willing to launch a new model of wind turbine,

will be required to provide a significant package of securities and guarantees to Sponsor

and Lenders. This is one of the main reasons why there are only around 10 major

manufacturers of wind turbines in the world. All but one of those large Companies

(Enercon, www.enercon.de is the exception: they develop all of their technology) buy

technology from smaller suppliers, and incorporate the benefits into their overall product.

30

Figure 4.2 – Interior Of A Nacelle – Source: Internet

Page 31: Wind Power Innovation and Financing

Those big Manufacturers/assembly Companies are large enough to satisfy the banks with

suitable corporate guarantees, which are very often necessary to secure financing in

presence of technological innovation, and may be available – to promote a new

technology, gain Sponsor’s and Lender’s confidence and therefore, in perspective,

increase market share – to accept a stringent contractual structure (as further discussed in

chapter 4.4).

As an alternative, Manufacturers may try to gain a ‘track record’ for a new model of wind

turbine by selling at least a first set of machines to costumers financing their project on the

balance sheet, so avoiding the complexity and the heavy liability/guarantees needs of a

typical Project Financing scheme. However, given the high capital cost structure of wind

industry, this should definitely be considered the exception to the rule.

In fact, in project financing transactions, risks such as:

construction costs higher than expected (so called “cost overrun”);

completion after the expected date (so called “delayed completion”);

realization of a plant with performances significantly lower than those declared

and/or guaranteed (so called “performance deficiency”);

decreased reliability and availability of equipment and machineries,

cannot be left (or, at least, not only) upon the project company and, indirectly, its financing

institutions, and the Manufacturer/Supplier is the best nominee to take care of these risks

and relevant costs (alternatively the sponsors may be required to cover such unexpected

costs by injecting equity into the project company through capital increases, shareholders

loans, etc. upon occurrence of the above negative events connected with innovative

technological elements of the project; such circumstance is – however – less common

than the assumption of risks by the manufacturer).

Needless to say that the more innovative is the technology adopted in the project, the

greater would be the associated risks and, consequently, the Lenders reluctance to

finance the relevant project, and their willingness to procure that such risks are duly

transferred upon the contractors: a modification of the turbine blades profile, or an

increase of their lengths in order to “capture more wind” is clearly a much more substantial

(and risky) innovation than, for example, an improvement of the turbine control system or

of the wind direction/speed measurement device.

31

Page 32: Wind Power Innovation and Financing

On this basis, and for the purpose of these new products to acquire a minimum track

record in the market, some manufacturers have expressed their availability to accept a

certain numbers of contractual burdens, both during the construction and operation

phases, which may encourage investors to adopt new technology and lenders to finance

such technology.

The proposed allocation of the technological risk’s upon the constructor would then take

place by adopting a range of contractual precautionary measure, providing, inter alia:

a) an extended product’s warranty period;

b) full service O&M contract with a tenor longer than market standard for non-

innovative technology; and

c) a higher manufacturer’s liability in terms of liquidated damages for delayed

completion or failure to meet the agreed standards of performances and/or

availability.

These aspects will be further discussed on paragraph 4.4, making reference to a specific

case.

4.3.3 The lenders

A very large share of project financing transactions in the private sector closed or in

development in 2009-2010, in Italy and in most of Europe, are relevant to renewable

energy projects. Banks active in this field are members of a ‘small club’ (less than 10 lead

banks active in the whole Europe, and probably not more than 5 or 6 in Italy), and are

therefore extremely more selective today than just two or three years ago. This is

particularly true today and in Italy, after the financial crisis of 2008, with the ‘consolidation’

of the lenders and the decision of some of the major foreign banks active in financing of

renewable energies to leave the Italian market.

In principle, financing institutions are generally reluctant to finance initiatives with

particularly innovative technical elements.

32

Page 33: Wind Power Innovation and Financing

As a matter of fact, from a Lender standpoint the neutralization or at least mitigation to the

maximum possible extent of any risks that may adversely affect the borrower’s repayment

obligations constitutes its very major objective in project finance transactions.

However, the market knows of a certain number of projects based on innovative

technology, especially taking into account the indisputable benefits in terms of efficiency

and production that the industrial progress is providing to operators. The financing of

innovation by banks is much simplified when the technology supplier has an established

and well recognized reputation in the market, as well as a solid technical and financial

structure allowing it to promptly and properly respond to any requests for:

intervention/restoration/replacement of defective facilities or equipments;

relief from damages arising out in connection with the supply of malfunctioning or

not fully performing facilities or equipments.

Furthermore, as anticipated above, in structuring a project financing transaction the

Lenders tend to allocate the technological risk to entities (other than the borrowing

company) willing to assume such risk in whole or in part, and to be granted with legal

instruments allowing full or partial repayment of the financing upon occurrence of

particularly detrimental events.

4.3.4 The Legal Consultants

The main role of the Lenders’ Legal Advisor in the context of a project financing

transaction is to identify, analyze and allocate all (or, at least, the most significant) risks

and critical issues which may be even potentially capable of adversely affecting a project’s

capability to generate sufficient cash flow for the full reimbursement of the financing

granted by the Lenders, and/or the Borrower’s (the Sponsor, or the SPV) ability to fulfill its

obligations under both the financial and project documents.

More specifically, the activity rendered by the Lenders’ Legal Advisor mainly consists of

providing the financial institutions with remedies and solutions aimed at “ring fencing” the

project from any potential critical issue that may negatively affect the banks’ interest in the

financing.

33

Page 34: Wind Power Innovation and Financing

The above mentioned “ring fencing” principle generally applies throughout the whole

structuring phase of the financing, by affecting in particular the following activities of the

Banks Legal Counsel:

a) the legal due diligence exercise, during which the Lenders Legal Advisor outlines

the actual legal framework of the project (e.g. at a corporate, permitting and real

estate levels) by identifying any possible issue which may affect its bankability, on

the one hand, and suggests the relevant legal countermeasures deemed

appropriate for mitigating the relevant risks, on the other hand;

b) the drafting of the finance documents, which is generally carried out with the

support of other independent consultants (e.g. market and technical advisors, see

paragraph 4.3.5 below) with the purpose of allocating any risks arisen during the

due diligence process – as well as those that may subsequently arise during the

loan’s life – on entities other than the banks (e.g. sponsor, borrower’s

counterparties under project contracts, insurance companies, third party providers

of guarantees, etc.).

Through a careful analytic work, on the one side, and the structuring of an adequate

defensive perimeter of the project, on the other side, the Legal Counsel

allows its Clients (the Lenders) to have full access to, and comprehensive

knowledge of, all risks they are assuming by granting the financing to the

prospective borrower, and

provides them with the legal instruments to protect their respective interest in

the transaction should the abstract risks be converted into concrete

prejudicial or potentially prejudicial events or circumstances.

4.3.5 The Technical Advisors, and the Certifications

Wind turbines are a mature, but also relatively ‘young’ technology, characterized by a fast

technological evolution. This means that no turbine currently on the market has actually a

‘track record’ close to the expected life time of 20 years. Therefore, third party certification,

34

Page 35: Wind Power Innovation and Financing

providing comfort in particular on performance, reliability and project revenues, is key for

investors and banks.

A fundamental role, in this respect, is played by the Technical Advisor of the Sponsor

and of the Lenders. Its role is to assess the likely energy production of the project (see

point 4.2 (b) above), the cost in terms of Capex and Opex and the project time schedule.

There are a number of issues that represent a risk for not meeting one or more of the

above aspects (i.e. higher project costs; lower energy production due to low wind or low

turbine performances, and consequently lower project revenues; higher operating costs,

badly affecting the project revenues as well; longer construction times involving higher

costs and delayed revenues, etc).

The Technical Consultant must be in a position to identify and (where reasonably possible)

mitigate such risks, providing advice and support to the Sponsor, during the project

development phase, and to Lenders during the structuring of Project Financing. One of the

most authoritative Technical Consultants in the wind industry sector is Garrad Hassan

(www.garradhassan.com), which has provided his consultancy services to most of the

wind project transactions closed in the recent years in Europe.

When financing new wind turbine models, there will be not significant track record, and

therefore Lender’s comfort must be based on track record of similar models from the same

manufacturer, or more

generally on the turbine

manufacturer historical track

record. Since the Lenders are

‘conservative’ by nature, and

are not technical expert, they

usually rely on their Technical

Consultants to approve new

technologies. This role is

therefore extremely critical:

without a strong

recommendation from one of the top two or three Technical Consultants, Banks will very

hardly accept to loan to new technologies.

35

Figure 4.3 – A Wind Power Plant – Source: Internet

Page 36: Wind Power Innovation and Financing

In particular, the assistance rendered by the Technical Advisor to the Lenders covers four

main phases:

the technical due diligence exercise , when the Technical Advisor outlines the actual

technological framework of the project by identifying any technical issue which may

weaken its bankability, on the one hand, and verifying that the technical

assumptions comprised in the ‘business plan’ base case are consistent with the

actual layout of the project, on the other hand;

the drafting of the finance documents by the Legal Advisor, where the Technical

Advisor supports the Lenders in addressing the technical issues;

the construction of the plant , where its role is critical in the context of the approval of

(A) the works carried out by the relevant contractors; (B) any change to the

technical design of the works; and (C) the invoices issued by contractors;

after the commencement of the commercial operation, during which the Technical

Advisor renders monitoring services.

Throughout a comprehensive and ongoing analysis of the technical elements of the

projects, especially those having specific innovative nature, the Technical Advisor allows

the Lenders to have knowledge of the technical risks which may affect the successful

completion and operation of such projects and supports the Legal Advisor – during the

drafting of the finance documents – in evaluating, excluding or mitigating such risks.

From a technical view point, in addition to the ‘thumb up’ of the Technical Consultant to a

turbine model enjoying an innovative technology, it is also very important the “Type

Certificate” issued by an international recognized classification body. Such entity (among

others, Det Norske Veritas, www.dnv.com) will review in detail the design and testing of

any new model, before releasing the relevant Type Certificate (i.e. a certificate of quality

and performance, which will be applicable to all wind turbines of the same model).

Besides technical innovation, it is worth to mention the role of the Tariffs Consultant,

which has an important responsibility in providing both Sponsors and Lenders with an

estimate of the tariff structure and – when applicable – renewable energy incentives (like

the ‘Green Certificates’ in Italy, or R.O.C. in UK) which will be applied during all the life of

the project (and in particular during the period of reimbursement of the loan to the banks).

The tariff survey and relevant projections provided by these Consultants (among others,

36

Page 37: Wind Power Innovation and Financing

Poyry – www.poyry.com has a reputation in this specific field) are a strategic input data for

the ‘business plan’ of the project.

4.4 A typical contractual framework for the supply, erection and operation of

innovative wind turbine model

4.4.1 Introduction

As already pointed out, the Lenders have a very ‘conservative’ approach towards

innovation in a project financing transaction, and use to say that ‘the best mitigant to a

technologic innovation risk to refrain from financing the project’. This has always been the

case, but is particularly true under the present ‘credit crunch’ situation. On the other hand,

the P.F. market is today ‘short’: there are more projects on the market than lending

capabilities of the banks. There is therefore much less appetite from lenders to be involved

in more risky transactions, while they prefer to concentrate and use their resources on

more traditional, less complex and risky deals.

As discussed previously, neither the Sponsor, nor the Technical Consultants, can provide

sufficient contractual mitigants to the lenders, and inevitably the support to a new

technology must be provided by the Supplier, through a suitable set of contractual

obligations and liabilities provided to Sponsor and lenders. The Supplier will, in general,

accept such support to its new technology in order to gain the status of “bankability”, and

therefore increase its profits and market share.

These contractual provisions have a key role in reaching the ‘bankability’ for an innovative

project: financial mitigations are of course important as well, but are definitely of secondary

importance with respect to contractual aspects.

A ‘case history’ is discussed in this section, relevant to a ‘non-recourse project

financing’ of a wind farm based on a new model of wind turbine, incorporating

significant technical innovation (new blades dimension and design, higher unit power, new

cooling system, modified gear boxes, etc.), without a track record and not yet provided

with ‘Type Certificate’.

The turbine is supplied by a top rank European Manufacturer. The Lender’s Syndicate is

composed by five primary Banks, led by a major Italian Bank.

37

Page 38: Wind Power Innovation and Financing

Details on Manufacturer, Lenders Syndicate and Sponsor cannot be disclosed at this

stage, but some of the fundamental contractual provisions of the ‘Turbines Supply’ and

‘Wind Park Operation’ contracts will be discussed, providing an overview of the innovation

risk allocation and mitigation strategies being applied in order to secure ‘non recourse’

project financing.

4.4.2 Warranties and Bonds

The Warranty Period is the period of time during which the manufacturer is committed to

repair, or replace at its own expenses, all defective equipment. The Warranty Period in the

wind industry is typically 24 months from the beginning of Commercial Operation of the

wind farm.

In this specific case, the Lenders have requested, and the Manufacturer has accepted, to

extend such Warranty Period to 60 months (5 years).

The manufacturer has also accepted to issue a set of bonds, as a guarantee to the SPV-

Sponsor-Lenders that the Manufacturer will adhere to the provisions of the terms of the

Supply and Operation contracts. The main guarantees are the performance bond

(guarantee that the turbine manufacturer/contractor will perform the work as specified by

the Owner) and the operation/maintenance bond (guarantee that the contractor will

provide wind park repair and upkeep, maintaining a minimum guaranteed plant availability,

for the duration of the operation contract).

In addition, the bonds are ‘first demand’: this is an additional protection for the SPV-

Sponsor-Lenders, since the guarantee is payable upon the beneficiary’s written first

demand, notwithstanding any defense of the manufacturer/contractor (in other worlds,

proof of default or underperformance of the manufacturer is not needed, and the bond can

be cashed by the beneficiary without discussions or delay).

The validity of these guarantees has been extended from the first payment made in favor

of the Manufacturer, up to the end of the Warranty Period of the wind park (5 years).

4.4.3 The ‘Type Certificate’

The wind turbine model is not yet provided with a complete set of ‘Type Certificates’,

ensuring its quality and performance as certified by an independent certification body. It 38

Page 39: Wind Power Innovation and Financing

has been agreed to consider the issuance of the complete set of ‘certificates’ as a major

‘milestone’ of the project, with an associated important payment. This contract clause

confirms the importance attributed to the instrument of the ‘Type Certificate’, and the key

role played by the certification bodies for the commercialization of innovative models and

products.

4.4.4 Schedule of Payments

In general, the payment of the contractual price of a wind park is performed on a ‘step by

step’ fashion, with settlement of the price of each single turbine at successful completion of

operating test of that turbine. In this case, the Lenders have requested, and the

Manufacturer accepted, to perform a significant portion of the payment at the acceptance

of the overall wind park, after successful completion of a rigorous set of tests on the

performance of the whole facility.

4.4.5 Protection against “Serial Defects”

This aspect is extraordinarily important for innovative wind turbine models. In case the

same ‘defect’ is identified in a certain number of units (three or more, for example) during

the operation of the wind farm, then this defect is deemed to be a ‘serial defect’, and

corrective measures must be taken not only on the units already affected by the problem,

but on all the wind turbine supplied.

The acceptance of this obligation by the Manufacturer is very important, and represents a

key factor for the ‘bankability’ of a new model of turbine. From one side this protection

against ‘serial defects’ actually shields the Lenders and the SPV from design defects or

manufacturing problems; from the other side, the acceptance of this obligation by the

manufacturer is a prove of its ‘confidence’ on the new technology/innovation, and can be

extremely useful in gaining support for the new technology.

4.4.6 Manufacturer’s Liabilities

The level of liabilities that the manufacturer is willing to take is another key factor to

demonstrate its trust in the new model of turbine launched on the market. Also the ‘cap’ on

the liability of manufacturer is usually much higher in case of innovative technologies. In

general: the wind turbines Supply contract for a wind park includes penalties for (i)

39

Page 40: Wind Power Innovation and Financing

completion time, and (ii) performance; both those liabilities have a cap (usually a

percentage of the contract value) that cannot be exceeded. In general, these liabilities are

capped respectively at 5% (completion time), 10% (performances), with a cumulative cap

at 10-15%. In case of innovative technologies, these values may grow significantly, up to

15%-15%-20% or even more. Again, this is considered an indication of the ‘confidence’ of

the manufacturer towards its ‘new’ technology. Clearly, in any case the manufacturer’s

liabilities (due to the unavoidable ‘cap’ on its contractual obligations, and to the exclusion

of any ‘consequential damages’) can only marginally cover the risk of economic losses due

to (unlikely, but still possible) ‘dramatic’ underperformance of a new model of wind turbine

(the actual damages that SPV and Lenders may suffer would in this case be massive, and

much higher than the ‘capped’ damages paid by the Contractor).

4.4.7 “Full Service” clause in the Operation Contract

The supplier of the wind turbines (in particular in the case of a innovative model) are

requested – at the end of the construction phase – to enter into an ‘operation contract’,

including all maintenance costs and a guarantee of ‘plant availability’. The clause of “full

service” includes “all” costs, both for planned and unplanned maintenance, as well as the

cost for replacement of all defective equipment (with the only exclusion of ‘force majeure’

events). This is – ‘de facto’ – an extension of the warranty period (which is, in the specific

case, of five years) for a fixed annual fee, and constitute a very significant protection for

the Sponsor/SPV/Lenders against the technological risk, and its possible consequences

on the cash flow.

Also the duration of the Operation Contract has been extended from the ‘market standard’

(two or five years) to twelve years, corresponding to the duration of the loan, as requested

by banks.

4.4.8 Availability guarantee

A guaranteed availability of the wind farm is a standard clause in all ‘Wind farm Operation’

contracts. In the case under discussion, however, in the light of the technical innovation of

the new turbine model, the manufacturer/Operator of the wind farm has accepted the

following specific conditions:

40

Page 41: Wind Power Innovation and Financing

a) A duration of the availability guarantee (97% minimum on yearly basis) equivalent

to the duration of the Operation Contract (12 years).

b) A penalty for not reaching the guaranteed availability significantly higher than the

standard practice.

c) A ‘cap’ on the above liability equivalent to the amount of two years of operation fee

(this cap is normally one year of the operation fee)

The above availability guarantee package is extremely attractive from the Lender’s view

point, and the willingness of the Manufacturer to accept this scheme had an important role

in the decision of the syndicate of lenders to consider ‘bankable’ the innovative technology.

4.5 Main financial mitigants to control innovation risks

In addition to a suitable contractual framework, ensuring the commitment of the Supplier in

supporting its innovative technology, the banks may (and usually will) require the Sponsor

to accept “conservative” and prudent (from the lenders view point) lending terms, in

particular in relation to the Debt Service Coverage Ratio - DSCR, the Debt to Equity

Ratio – D/E and the Spread, as briefly discussed below.

The Debt Service Coverage Ratio (DSCR), is the ratio of cash available for debt

servicing to the sum of interest, principal and lease payments: a DSCR over 1 means that

(in theory, as calculated to bank standards and assumptions) the entity generates more

than sufficient cash flow to pay its debt obligations, while a DSCR below 1.0 indicates that

there is not enough cash flow to cover loan payments. This is the key benchmark used in

the measurement of the wind project ability to produce enough cash flow (through the sale

of electric energy and ‘green certificates’) to meet interest and principal payments on debt:

in order to consider a project ‘bankable’ and suitable for a P.F. transaction, the lenders

usually require that the project’s business plan shows a minimum DSCR (clearly, always

higher than 1) that makes the banks comfortable about the ability of the project itself to

produce the cash flow necessary to repay the loan. Breaching a DSCR covenant can, in

some circumstances, be an act of default under the contract (incidentally, the risky attitude

of “too aggressive” – or better reckless – banks to accept DCSR values close or even

lower to the 1 in the commercial real estate finance has been one of the main reasons for

the financial crisis of 2008-2010).

41

Page 42: Wind Power Innovation and Financing

Under normal circumstances, with no permitting risk, a good and stable wind resource, a

trustworthy Sponsor and a reputable turbine manufacturer supplying a turbine model with

a proven ‘track record’, values of DSCR in the range of 1.22, 1.25 have been standard in

transactions closed in the recent years. However, in the presence of technological risk

related to innovative turbine model, the banks may require an increase of this ratio to 1.3

and even more. This is clearly an heavy condition for the sponsor, since a quite significant

amount of cash must be kept inside the SPV, as a guarantee for the banks, and cannot be

distributed to shareholders as dividend.

A possible compromise (which has been quite popular in recent transaction in the wind

sector) is to have a ‘variable DSCR’ over the operative life of the wind farm: higher (1.3 or

even more) in the first period (three to five years), when the risk associated with the

technological innovation is greater, and lower in the following years (1.2, or slightly less)

up to the full repayment of the loan.

The Debt-to-Equity Ratio (D/E) – also known as Gearing or Leverage - is the ratio

indicating the relative proportion of SPV shareholders' equity and debt used to finance a

project in a project financing framework.

Before the recent financial crisis, typical D/E ratios for wind energy projects in the range of

85/15 were usual practice. More recently, transactions have been closed or are in final

stage of negotiation with ratios in the range of 80/20 down to 75/25; the latter in presence

of perceived higher risk, due to a overall project’s complexity and the utilization of turbines

with limited track record.

However, instead than increasing the gear it is often possible - and definitely preferable -

to negotiate with Lenders a commitment of the Sponsor to pay a “Contingent Equity” to

the SPV in case of cost overruns related to the innovative technology selected by the

Sponsors: it is clearly a form of “indirect guarantee” by the Sponsor in support of the

business of the SPV. Such ‘conditional cash injection’ into the SPV may be performed

through a SPV’s capital increase, or a shareholders loan. By taking the commitment of

such ‘conditioned’ guarantee, the Sponsor may succeed in controlling lender’s perception

of risk towards an innovative technology, avoiding – at the same time – a too low gearing

of the project (low D/E), or too much cash ‘trapped’ in the SPV (high DSCR).

42

Page 43: Wind Power Innovation and Financing

On the contrary, an increase of the ‘spread’ (which reflects the additional net yield the

lenders wish to earn in relation to the yield on a “risk-free” benchmark security or

reference rate) is not usually considered a way to mitigate a risk; in fact, the spread is in

general seen as an indicator of the overall risk of the project as perceived by the bank (and

is therefore a ‘premium’ paid to accept such risk), and not – in general – a ‘tool’ to mitigate

it. In fact, an increase of the ‘spread’ does not mitigate the risk for the bank..…but may well

dampen the enthusiasm of the Sponsor in adopting a new technology which is perceived

as too risky!

5 References

43