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Risk Sharing A major incentive for many investors is the fact that project financing undertakings (e.g., IPP projects) can be made to stand alone as a self-financing entity, so that the investor can benefit from its success and can be isolated from its failure. Project finance allows the (potential) investor to transfer specific risk to the lender of the debt. The purest, but least common, method of financing offers the lender no recourse against the project owners. Depending on the “recourse-possibilities” of the lender against the owners “non-recourse financing” or “limited financing” are synonyms for project finance. Off-Balance-Sheet Financing The ultimate goal in IPP projects is to arrange a borrowing for a project which will be beneficial for the private investor and at the same time be completely non-recourse to the other activities of the parent company and in no way affecting their credit standing or balance sheet. Indeed, project financing is sometimes called off-balance-sheet financing. However, there is a popular misconception that the project financing means off- balance-sheet financing to the point that the project is completely self-supporting without guarantees or undertakings by the parent company of the investor. A short summary of the advantages and disadvantages of the different financing ownership structures is depicted in Table 1. RISK MANAGEMENT Successful financing will continue to be a major challenge for all renewable power projects. The key to successful project financing is to structure the financing with as little recourse as possible to the private investor while at the same time providing sufficient credit support through guarantees of project investors or third parties that the lender of the debt will be satisfied with the credit risk. Typical applications for project financing are capital-intensive projects associated with high risks. There are certain risks which investors and lenders have to take into consideration: • Country risk • Political risk • Foreign exchange risk • Inflation risk • Interest rate risk • Appraisals • Availability of permits and licenses • Operating performance risk • Fuel prices • Force majeure risk • Legal risk At the end, the lender will gauge the project’s ability to withstand the risks involved, especially critical ones, by looking primarily at the different debt service coverage ratios (DSCR). The DSCR is a function of the specific project risk. Corp. Fin. / Utility-Owned Project Fin. / IPP ADVANTAGES • • • • Offset of project risk Better credit rating lower interest rate debt lower equity costs Less arrays of restrictive • Brings fresh capital • Introduces market force and competition to keep consumer prices down • Diversifies energy supply sources • Longer debt amortization period • Takes risk from public entities and distributes risk under project sponsors. loan covenants high debt leverage DISADVANTAGE • Projects with sophisticated or new technologies will not be realized. • Complicated contractual relationships large transaction costs high legal fees Public projects tend to be more expensive than private ones • Need to generate a decent dividend to private shareholders Table 1. Comparison of Corporate Finance/Uitility-Owned and Project Finance/Private-Owned Power Projects Debt service coverage ratios are designed to analyse the financial charges of a project to its ability to serve them. In any project financing the payments on the loan should correspond as closely as possible to the ability of the project to generate cash. Lenders want to be sure that during the entire project lifetime the generated cash always covers the required debt service. One of the most important loan covenants is the annual debt service coverage ratio (ADSCR), which is simply the ratio of pre- finance cash flow after tax to the amount of interest payment and principal repayment for the period. Lenders normally claim that during every stage of the project the ADSCR never falls short of the minimum required ADSCR. A typical value for the minimum annual debt service coverage ratio (ADSCR) required by most lenders is between 1.2 and 1.5, but depends on the specific project risks and the way they are handled by the web of contractual arrangements. In addition to the ADSCR, other coverage is important, including the project life coverage ratio (PLCR) and the loan life coverage ratio (LLCR). The PLCR is the ratio of the present value (PV) of cash available for debt service over the entire project lifetime to the outstanding debt. The LLCR is only interested in the financial vitality of the project for the time period of the loan life. The mathematical formulas used in the above-mentioned cash-flow model are shown in the attached equation box (equations 1-3). The equity investors, on the other hand, will be interested in the Internal Rate of Return (IRR) offered by the project. The minimum acceptable rate will depend on the project’s risk as Copyright © 1999 by ASMEPDF Image | Financing Solar Thermal Power Plants
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