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Project financing basics in the power sector. presentation to School of Engineering Columbia University A.J. Goulding New York, NY. October 24 th , 2014. Speaker background. My career, both before and after SIPA, has largely focused on the energy industry. - PowerPoint PPT Presentation
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Project financing basics in the power sector
presentation to School of EngineeringColumbia University
A.J. GouldingNew York, NY
October 24th, 2014
*** NOT FOR ATTRIBUTION ***
My career, both before and after SIPA, has largely focused on the energy industry
Speaker background 2
20142000199819971996199519931991 2003
Joined ICF Resources, focusing on natural gas resource base and Section 29 tax credit for non-conventional fuels production
Moved to New Delhi, ultimately joined USAID working on bagasse cogeneration and clean coal technologies
Commenced studies at SIPA
Summer associate at London Economics International
Led management buyout of North American operations of London Economics International LLC
Joined London Economics International as senior consultant
Worked with top ten power marketing company on asset restructuring
Control 16 MW of hydro at 11 sites
Set up private equity firm
*** NOT FOR ATTRIBUTION ***
Ampersand has been targeting one acquisition per year
Speaker background 3
Moretown1.2 MW
Burt Dam600 kW
Brooklyn Dam (under construction)600 kW
Peterborough690 kW
Gilman4.85 MW
Collins 1.5 MW
Brockway Mills500 kW
Sebec Lake876 kW
TTTTT
Hollow Dam900 kW
Mount Ida2.9 MW
Tannery Island1.875 MW
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Principles of project finance focus on risk isolation and financing efficiency
Somewhat independently of changes in global financial markets, project finance maintains its own framework of terms and conditions that set long-term expectations among project finance lenders
Project Finance is a specialized practice served by dedicated bankers and lawyers with subject matter expertise
Project Finance is a subset of the global financing markets designed to finance large infrastructure projects
Project Finance is structured to depend solely on the cash flows from the project, and is thus “non-recourse” or “limited-recourse” financing
Project Finance supports the development of new infrastructure projects
This means that the lenders have limited recourse to the owner of the infrastructure project if the project is unable to meet its financial obligations
Reduces the cost of capital for new projects with no operating history Allows developers and lenders to take calculated and managed risks in new or uncertain
markets that require a large upfront investment
4Intro to project finance
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Project Finance is available in many forms from a range of sources
Project Finance is available in many forms:
Senior Debt Mezzanine Financing Preferred Equity Tax Equity Project Equity
and from many different sources: Commercial Banks Life Insurance Companies Pension Plans Multilateral Institutions Export-Import Banks Taxable Bond Markets Municipal Bond Investors Infrastructure Funds Hedge Funds
With so many different forms and sources of project
finance, how do we choose?
The goal is always to reduce financing costs and maximize
the return to the Developer
The optimal structure depends
on the project’s details
Q
A
5Intro to project finance
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► Typically there will be a special purpose company formed to house one or potentially many projects Generally non-recourse financing is sought for the special
purpose entity The project itself must be creditworthy
► Engineering, Procurement and Construction Contract for the supply of the equipment and construction Consider direct purchase of equipment and performance
guarantee coordination as part of this process Direct purchase may be more economic but potentially sets up
developer to be at risk for non-performance Requires very close coordination
► Operations and Maintenance (O&M) contract Possible to self-perform some or all of the maintenance Economies of scale, geographic presence or specific expertise
► Negotiate site control: land lease or purchase
► Interconnection agreement with utility or grid
► Utility agreements for water and other site infrastructure
► Power Purchase Agreement (PPA)
► Financing Agreements
► Key terms of all of these agreements need to be closely coordinated
IPPs are essentially a stack of interrelated contracts
EPC contract
Loan agreement
Power Purchase
Agreement
Site control
agreement
Manufacturer
warranties
O&M agreement
Permits
SPV
6Intro to project finance
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► New projects lack operating history, leaving lenders unsure of performance
► Engineers opine on two key aspects:
► Opinions are critical in terms of new technologies or uncertain resource quality
► Experience suggests that resource quality estimates can be dramatically wrong; data may focus on an impact (wind speed) without knowledge of conversion effectiveness
► While equipment performance can be guaranteed, engineering report influences cost of insurance
Engineers play an important role in project financing
7Intro to project finance
resource availability
technical capability
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Example project finance structure
Ampersand corporate structure reflects influence of project finance approach
8
Key
ABDH Ampersand Brooklyn Dam Hydro ASLH Ampersand Sebec Lake Hydro LLC
AGE Ampersand Gilman Energy LLC AMIH Ampersand Mount Ida Hydro LLC
AGH Ampersand Gilman Hydro LP ANHH Ampersand New Hampshire Hydro LLC
AHDH Ampersand Hollow Dam Hydro ANYH Ampersand New York Hydro
AHI-P American Hydro Inc. - Peterborough AOHH Ampersand Olcott Harbor Hydro LLC
AMH Ampersand Moretown Hydro LLC ACH Ampersand Collins Hydro LLC
ABMH
Ampersand Brockway Mills Hydro LLC ATIH Ampersand Tannery Island Hydro LLC
Notes:* shows only active subsidiaries** AMIH has similar ownership
structure to ANYH, but is owned directly by AHL
*** AGE has other subsidiaries which hold the former paper mill buildings and associated land
**** represents voting interest; partner holds residual 45% economic interest
Ampersand Energy Partners LLC
(“AEP”)
Ampersand Operations
Company LLC (“AOC”)
Ampersand Hydro LLC (“AHL”)*
ASLH ANHH AMH ANYH AGE***
AHI-P ABDH AGHAMIH** AOHH AHDH
100%
100% 100% 100% 80.1% 55%
51%100%
100%****
controlling interest with AJG
ACH
100%
ABMH
100%
ATIH
100%
► All debt at SPV level
► Operations separate from asset companies
► PPAs at asset companies
► Equity generally at holdco level
► HOWEVER: holdco guarantee in place
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Diversity of financing types available depends on stage of project development
Targ
et
Retu
rn
%Fin
an
cin
g
Typ
e
Conceptualization
PPA Signing Construction Operations Retirement
Equity
Preferred Equity
Mezzanine
Equipment
Senior
9Project life cycle and target returns
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Example returns to investor classes for highly leveraged project by small developer
-100%
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
-40%
-36%
-32%
-28%
-24%
-20%
-16%
-12% -8
%-4
% 0% 4% 8% 12%
16%
20%
24%
28%
Proj
ect R
etur
n
Returns to Investor Classes
Senior Debt
Mezzanine Capital
Preferred Equity
Developer Capital
-100%-90%-80%-70%-60%-50%-40%-30%-20%-10%
0%10%20%30%40%50%60%70%80%90%
100%
4% 8% 12% 16% 20%
Proj
ect R
etur
n
Returns to Investor Classes
Senior Debt
Mezzanine Capital
Preferred Equity
Developer Capital
Example returns to investor classes for
highly leveraged project by small developer.
(Note example uses simplified project returns and disregards investor-
level taxes)
Investor ClassProportion of Capital
Floor Return
Share of Upside
Targeted Returns
Senior Debt 65% 7% 0% 7%
Mezzanine Capital 10% 10% 10% 13%
Preferred Equity 24% 15% 81% 20%
Developer Capital 1% 0% 9% 25-50%
Total/Weighted Avg 100% 9.15% 100% 10.65%
10Project life cycle and target returns
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Project DebtCovenants, default, and guarantee
► Project debt is arranged under a core set of terms and conditions that are similar throughout the world
► The details will vary from project to project, but certain key features remain consistent
All of the collateral sits within the four corners of the project company
The project company is fully secured, including assets, shares and assignability of key contracts to lenders
Limitations on modifying key contracts or taking actions outside the ordinary course off business without lender approval
Reserve accounts for debt service, major maintenance or other project risks
► The loan provisions anticipate that an owner will “walk away” from a project once their resources are exhausted, but give lenders the time and tools to assume control of the project and continue operating it for the benefit of the lenders
Owners do in fact “walk away” from projects when prospects for a return on equity have been eliminated
As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive some return on their loans and ultimately for the project capital structure to be rearranged – original lenders may become the equity, with new lenders brought in
11Project debt considerations
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There are six key drivers to optimizing Project Finance structures
Changes in financial markets create swings in investor appetite
Euro crisis caused many prominent French project lenders to withdraw from senior debt market
Different generation types have different risk profiles
Larger projects have more options because of the greater liquidity of corresponding financial securities
Lenders ability to enforce remedies drives view of project risk
Many jurisdictions provide tax incentives for debt over equity
Presence of tax incentives for renewable energy projects
Investors and lenders are different in different regions
Management of currency risk
Local bankruptcy and foreclosure laws
Tax lawsCurrency and regional
markets
Global financial conditions
Project type Project size
12Project debt considerations
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Closing mechanics and closing costs
► Project Financing is a legally intensive process
Each class of financing generally represented by its own law firm
Attorney for Senior Lenders frequently coordinates documents, signature pages, and the project does not “close” (i.e. fund) until signatures are released by everyone’s counsel
A typical project financing will include several hundred pages of documentation
Legal fees alone can range from $250K to $1 million depending on complexity
Because legal fees do not change much with the size of the project, larger projects enjoy economies of scale
► Lead financial arrangers also receive an upfront fee at close
Fees vary, but arranging senior debt can equal 2% of gross senior debt raised and mezzanine capital can be ~3-5% of gross subdebt
► Upfront fees and legal bills are funded out of proceeds at close and thus indirectly increase the all-in cost of debt
If closing costs are 2% of total debt raised for a 20-year term, this drives up the all-in cost of debt by ~0.37-0.50% (37-50 basis points)
13Project debt considerations
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Types of Project Finance availableMezzanine Financing
► Subordinated Debt, often referred to as Mezzanine Financing, sits between senior debt and equity
“Mezzanine” is “an intermediate or fractional story that projects in the form of a balcony over the ground story1”
Similarly, mezzanine financing is paid after senior debt (the ground story in the analogy) but before equity
Mezzanine is used to finance cash flows with too much uncertainty for senior lenders but supported by enough collateral for debt financing
► Funding sources are seeking higher financial returns and thus are willing to accept incremental risk
Cannot declare default without senior lender consent
During distress, senior debt often traps cash until project stabilizes or is refinanced
Mezzanine lender relies on likelihood of recovery in foreclosure process to protect downside risk and some sharing of upside economics
Lenders include specialized funds, hedge funds, insurance companies and some equipment manufacturers
1. Source: Merriam Webster Dictionary
14Project debt considerations
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Project DebtCovenants, default, and guarantee
► Project debt is arranged under a core set of terms and conditions that are similar throughout the world
► The details will vary from project to project, but certain key features remain consistent
All of the collateral sits within the four corners of the project company
The project company is fully secured, including assets, shares and assignability of key contracts to lenders
Limitations on modifying key contracts or taking actions outside the ordinary course off business without lender approval
Reserve accounts for debt service, major maintenance or other project risks
► The loan provisions anticipate that an owner will “walk away” from a project once their resources are exhausted, but give lenders the time and tools to assume control of the project and continue operating it for the benefit of the lenders
Owners do in fact “walk away” from projects when prospects for a return on equity have been eliminated
As long as revenues exceed operating costs, plant will remain open, allowing lenders to receive some return on their loans and ultimately for the project capital structure to be rearranged – original lenders may become the equity, with new lenders brought in
15Project debt considerations
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Project DebtEstablishment of Debt Service Coverage Ratios
► The Debt Service Coverage Ratio (“DSCR”) is one of the more
heavily negotiated terms
Calculated over a 12-month period as the sum of (i) cash generated
from operations net of any costs that are paid before debt service
divided by (ii) payments to lenders
The “Total DSCR” will include all payments to lenders, including
payments to mezzanine or other subordinated lenders
The ”Senior DSCR” only considers payments of principal, interest and
fees to senior lenders
► Debt is structured around Minimum DSCR and Average DSCR
There is generally a minimum DSCR before cash is trapped at the
project and payments to equity or subordinated lenders are prohibited
There is also a minimum DSCR that can trigger an Event of Default
(often a DSCR < 1.0)
The average DSCR is a measure of the degree of financial risk that the
lenders are willing to assume
► For projects with uneven project cash flows, the amortization
of the debt can be shaped to ensure sufficiently high
minimum DSCR throughout life of loan
Forecasted minimum and average DSCRs reflect amount of leverage project can support:
Highly stable and contracted projects, like Solar PV, might have minimum DSCR 1.125 and average of 1.5, which supports high debt proportion
Projects with higher technology or operating risk will have higher required minimum and average DSCRs and thus a lower proportion of debt (e.g. biomass could have a min DSCR of 1.4 and an average of 2.0)
16Project debt considerations
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Are PPAs necessary?
► Greenfield merchant plant is very difficult to finance, unless on balance sheet
► Project financing is non-recourse to sponsors; if non-recourse, need something to prove credit-worthiness
current market will support 5 to 7 year contracts; is this in turn enough to support new construction?
depends on whether equity will accept back-ended returns
► Question of whether contracts are necessary depends on what bank will accept and whether you believe that prices will be allowed to signal supply shortages
► Plenty of other capital intensive industries show massive capital investment without long term contracts
► Clearly, however, larger facilities are less likely to proceed without some sort of long term contract backing
► So called “gentailer” models pairs retailer with IPP; retailer load may substitute for PPA
Key PPA clauses
parties involved
output guarantees
length of contract
cost allocation of interconnection facilities
tariff rate
billing, invoice, and payment terms
force majeure conditions
settlement of disputes and arbitration
termination of contract
Role of offtake agreement 17
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Well designed PPAs effectively allocate risk and reward in an administratively straightforward fashion
TABLE OF CONTENTS TABLE OF CONTENTS(continued)
18Role of offtake agreement
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Structure of the PPA incorporates number of key terms
3025
15
2520 20
05
101520253035
Brazil California Connecticut India Saudi Arabia -WEC
Quebec
► PPAs can be lengthy – upwards of 60-80 pages (including schedules)
► Two parties: Buyer and Supplier (Developer) Payment period length varies between different jurisdictions, but typically in the range of
20-25 years r Buyer’s eligible renewable technologies PPA length is intended to match up with expected useful life of equipment and
repayment period for project financing In Ontario, the length of all renewable power PPAs is 20 years, except for hydroelectric
power which has a 50-year payment period (better aligning to the life of hydro assets)
► Main objective is to establish price paid to the Supplier for electricity
► PPA also defines the allocation of risks and responsibilities between Buyer and Supplier
Language from draft PPA:
20-year length: “ending at the beginning of the hour ending 24:00 hours (EST) on the day before the 20th (twentieth) anniversary of the date that is the earlier of (A) the Milestone Date for Commercial Operation and (B) the Commercial Operation Date”
Energy-only structure: “For each hour in a Settlement Period, the Contract Payment shall be an amount expressed in $US and equal to the Hourly Delivered Electricity multiplied by the Indexed Contract Price applicable during the corresponding calendar year”
Examples of PPA length
19Role of offtake agreement
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Initial screening model evolves into project pro forma to support financing
Develop estimates of all project parameters based on experience, industry data and vendor quotations
Multiple sites and technologies will be considered at this stage
Narrow alternatives through iterative process
Initial Screening Model
Discounted cash flow model that assists project team from initial screening through project financial close and even into operation
All projects contain common risks Capital cost overruns O&M cost overruns Production shortfalls Force Majeure risks Schedule delays Conversion efficiency
Evaluate what resources should be expended to mitigate risk
Communicate to investors key aspects of the project
Project Pro Forma
Initial Screening
Model
Resource Evaluation
Site Acquisition
Cost
Technology and Vendor
cost estimates
Vendor performance guarantees
Operation and
Maintenance Cost
Interconnect Cost
Revenue
Cost of Development
Financing Assumptions
20Project financial modeling
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Pro forma underpins range of contract negotiations
Finance» Leverage Ratio» Debt Rate / Term» ROE» Reserve Req’t
Project Specific» Capacity» Capacity Factor» Degradation
Factors
Construction» Term» Debt Cost
Capital Costs» Pre-construction» Construction» Technology Cost
Improvement Rates
Operating Costs» Fixed O&M» Variable O&M» Fuel Costs, inc.
Start-up
Contract» Term» Escalation
Taxes» Income Tax Rate» Foreign Owner’s» Depreciation
INPUTS OUTPUTS
Levelized Cost of Energy First
Year Contract
Price
Post-Contract» Asset Life» Terminal Value
Debt Service Coverage Ratios
Weighted
Average Cost of Capital
21Project financial modeling
*** NOT FOR ATTRIBUTION ***
Such models can be extremely detailed, and examine the project from a variety of perspectives
► Discounted cash flow model
► Main cost inputs are the capital, O&M and financing costs
Updated iteratively as inputs change from assumptions to actual numbers
► Coverage ratios are critical element
► Primary output is expected bid price
► Can be calculated for different sensitivity scenarios (contract term, technology, and size of project)
► Accounts for relevant taxation regimes
Indicative Snapshot of the Output Sheet of a Solar PV Financial ModelLevelized Cost of Generation CalculatorInputs
Assumptions [Units] [Value] Outputs Levelized Cost of EnergyType N/A Polycrystalline Weighted Average Cost of Capital 9.2% SAR/MWh USD/MWhProject Capacity MW 10 NPV for Equity Return (SAR '000) 0.0 Total 782.5 208.6 First Year Capacity Factor % 20.0% Levelized Contract Payments (SAR/MWh) 777.4 Fuel - - Year 1-5 Degradation Factor % Decline 0.50% Levelized Contract Payments (USD/MWh) 207.3 O&M 79.5 21.2 Year 6-10 Degradation Factor % Decline 0.50% Year 1 Contract Price (SAR/MWh) 743.2 Debt 504.0 134.4 Year 11-15 Degradation Factor % Decline 0.50% Year 1 Contract Price (USD/MWh) 198.2 Zakat 2.5 0.7 Year 16-20 Degradation Factor % Decline 0.50% Minimum Debt Service Coverage Ratio 1.31 Equity 196.5 52.4 Year 21-25 Degradation Factor % Decline 0.50% Average Debt Service Coverage Ratio 1.36 Year 26-30 Degradation Factor % Decline 0.50%Year 31-35 Degradation Factor % Decline 0.50% Uses of FundsAsset Life Years 30 SAR ('000) SAR/kW USD/kWPre-Construction Expenses 2012 US $/kW 299 Pre-Construction Expenses 11,437.7 1,143.8 305.0 Construction Expenditures 2012 US $/kW 2,300 Construction Expenditures 81,119.4 8,111.9 2,163.0 Financing Fees % of Debt 2.0% Interest During Construction 2,433.58 243.4 64.9 Closing Costs % of Debt 2.0% Financing Fees 1,527.2 152.7 40.7 Minimum Closing Costs 2012 US $ '000 1,000 Closing Costs 3,750.3 375.0 100.0 Maximum Closing Costs 2012 US $ '000 10,000 O&M Reserves 457.7 45.8 12.2 O&M Reserves % of Y1 O&M 50% Initial Debt Service 4,103.7 410.4 109.4 Initial Debt Service % of Y1 DSC 50% Total Capital Expenses 104,829.5 10,483.0 2,795.2 Fixed O&M 2012 US $/kW 23.0Percent of Fixed O&M Escalated % 100% Income StatementKSA or USA Inflation for Fixed O&M KSA or USA KSA COD 1 2 3 4 5 10 15 20Variable O&M 2012 US $/MWh 0.00 Project Capacity (MW) 10.0 10.0 10.0 10.0 10.0 10.0 10.0 10.0 Percent of Variable O&M Escalated % 100% Capacity Factor (%) 20.0% 19.9% 19.8% 19.7% 19.6% 19.1% 18.6% 18.2%KSA or USA Inflation for Variable O&M KSA or USA KSA Annual Generation (MWh) 17,520.0 17,432.4 17,345.2 17,258.5 17,172.2 16,747.2 16,332.7 15,928.4 Heat Rate Btu/kWh 0Fuel Type N/A N/A Contract Payments (SAR/MWh) 743.2 747.1 751.3 755.6 760.2 787.1 822.0 867.1 Start-up Fuel Consumption MMBtu per Start 0 Post-Contract Payments (SAR/MWh) - - - - - - - - Start-up Fuel Type N/A N/A Gross Operating Revenue (SAR '000) 13,020.3 13,023.8 13,030.7 13,040.9 13,054.7 13,182.4 13,425.3 13,811.6 Start-ups per Year # 0Construction Term Months 9 Fixed O&M (SAR '000) 915.4 963.9 1,015.0 1,068.8 1,125.4 1,457.0 1,886.2 2,441.9 Construction Debt Rate % 8.0% Variable O&M (SAR '000) - - - - - - - - Leverage Ratio % 80% Total O&M Expenses (SAR '000) 915.4 963.9 1,015.0 1,068.8 1,125.4 1,457.0 1,886.2 2,441.9 Debt Rate % 8.0%Debt Term Years 20 Start up Fuel Costs (SAR '000) - - - - - - - - Finance Structure Mortgage or Shaped Mortgage Operating Fuel Costs (SAR '000) - - - - - - - - Target Equity Return % 15.0% Total Fuel Expenses (SAR '000) - - - - - - - - Depreciation Structure Straight-line or Tax Straight-lineDepreciation Term Years 20 EBITDA 12,104.9 12,060.0 12,015.7 11,972.1 11,929.3 11,725.4 11,539.0 11,369.7 Contract Term Years 20Portion of Contract Escalated % 10% Depreciation (SAR '000) 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 KSA or USA Inflation for Contract Escalation KSA or USA KSAInclude Post-contract Revenue Yes/No No EBIT 7,091.5 7,046.6 7,002.3 6,958.7 6,915.8 6,712.0 6,525.6 6,356.3 Terminal Value 2012 US $/kW 0Reserve Account Interest Rate % 5% Debt Interest Payments (SAR '000) 6,709.1 6,562.5 6,404.1 6,233.1 6,048.5 4,878.3 3,159.0 632.7
Debt Principal Payments (SAR '000) 1,832.6 1,979.2 2,137.6 2,308.6 2,493.2 3,663.4 5,382.7 7,909.0 Total Debt Expenses (SAR '000) (83,863.6) 8,541.7 8,541.7 8,541.7 8,541.7 8,541.7 8,541.7 8,541.7 8,541.7
Debt Service Coverage Ratio 1.42 1.41 1.40 1.40 1.39 1.37 1.34 1.31
Zakat Tax Base (SAR '000) 382.4 484.1 598.1 725.6 867.4 1,833.7 3,366.7 7,389.3 Total Zakat Expense (SAR '000) 9.6 12.1 15.0 18.1 21.7 45.8 84.2 184.7
NET INCOME 372.9 472.0 583.2 707.4 845.7 1,787.8 3,282.5 5,538.8
Free Cash Flows
Net Income (SAR '000) 372.9 472.0 583.2 707.4 845.7 1,787.8 3,282.5 5,538.8 + Depreciation (SAR '000) 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 5,013.4 - Debt Principal Payments (SAR '000) (1,832.6) (1,979.2) (2,137.6) (2,308.6) (2,493.2) (3,663.4) (5,382.7) (7,909.0) + Disbursement of Reserves (SAR '000) - - - - - - - 4,561.3 + Terminal Value (SAR '000) - - - - - - - - Free Cash Flow to Equity (SAR '000) (20,965.9) 3,553.7 3,506.2 3,459.1 3,412.3 3,365.9 3,137.9 2,913.2 7,204.6
SOLVE for LCOE
Indicative Snapshot of the Output Sheet of a Solar PV Financial ModelIndicative Snapshot of the Output Sheet of a Solar PV Financial Model
22Project financial modeling
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Concluding remarks
► Project finance is the norm rather than the exception for new infrastructure projects
► When markets are liquid, sponsors can achieve greater amounts of non-recourse financing
► Unexpectedly low gas prices caused many merchant project financings to fail; rising interest rates will pose refinancing risk
► Successful project financings require creativity and flexibility from participants
► Teams of bankers, lawyers, engineers, and developers with strong working relationships help to reduce costs
23Conclusion