Using REC’s, and Depreciation in Financing Wind

Trintek Energy Consulting, Inc.

Creating Competitive Advantage Thru Intelligent Development

Native Renewables Energy Summit November 15-17, 2005

Discussion Outline

PART 1•REC’s-Renewable Energy Certificates•REC Markets•REC Prices•REC Ownership, Tracking, Certification, and Contracting•Issues and Solutions for REC’s In Project Financing•Comparison of Revenues and D/E Ratio with and without REC’s

PART 2•Depreciation•Eligibility for Accelerated Depreciation on Tribal Reservations•IRS 168(j) Depreciation Lives on Reservations•Qualified Indian Reservation Property•Qualified Infrastructure Property-Off Reservation•CreatingValue in Allocation of Depreciation•Creating Value in Using Accelerated Depreciation

PART 1 - REC’s-Renewable Energy Certificates

•1 REC =1 MWh of electricity production from a renewable resource

•In a REC, the renewable attributes are unbundled from commodity energy

• Projects can generate two revenue streams -one for commodity, one for REC’s -Has implications for financing

•The market is still illiquid, but emerging -A recent DOE report says the REC market is $145 MM/yr. -DOE Forecasts that it will get to $900 MM/yr. By 2010

The Markets in which REC’s Trade

•There is not one single unified U.S. market for REC’s - instead, there are a variety of fragmented State and regional markets - Prices from market to market may vary considerably

• Mandatory Compliance vs. Voluntary Markets - Some RPS States include mandates to purchasers of power - Purchaser must either purchase REC’s, purchase renewable power, generate renewable energy, or pay penalties

-The price of a REC in theory should approach compliance penalties -Penalty ranges are $10-50/MWh varying by state and market - Thirteen states have or are phasing in REC trading as a feature of their State RPS - Voluntary markets also exist in which purchasers desire to encourage development of clean renewable energy sources through their purchases

RPS States As of 10/2005

From CRS

REC Prices-Voluntary Markets

•Higher Prices in MidAtlantic-Northeast than in Central and Western States

Reasons:-Lower Wind Class resources in MidAtlantic-Northeast -Higher consumer demand for renewables with tight supply-Growing number of State RPS policies in the region.

•In general, REC prices are a function of individual markets, applicable law, supply, and demand

REC Ownership, Tracking, Certification, and Contracting

•Rules for earning REC’s, transfer, certification, and distribution vary from state to state and are state specific or regional in nature - Rules include tracking systems and expiration dates - Banking of REC’s –Usually allowed 2-3 years out - Certification systems such as Green-e can also apply

• REC Ownership -Per FERC, REC’s belong to generator unless conveyed in PPA or unless specified otherwise by the applicable State -Ultimately, State law governs who owns REC’s

• PPA Structuring-Change of law risk in PPA-Purchasers want firm REC’s with LD’s for non delivery other than for Force Majuere-Mitigate risks via portfolio of REC’s/projects, alternate back-up supply of REC’s,-Cap LD’s

Miscellaneous Financing and Structuring Considerations

•Carve out REC revenue from collateral in Security Agreements

•Royalty and Lease agreements-carve out REC’s from Revenue

Issues for REC’s In Project Financing

•Projects are financed over 10 to 20 years

•Due to the nature of the emerging market for REC’s, and regulatory uncertainty, the Term for REC contracts is usually no longer than 5 years, and usually 1-2 years

•Exceptions are States where as part of the State RPS, long term contracts are required:

-New York 10 years-Colorado 20 years-California 10 years

Financing Issues and Solutions REC’s (Continued)

•For large projects -REC marketers are generally too small and have insufficient credit to provide the necessary security for guaranteeing or backstopping long term REC purchase agreements

•In some markets, large creditworthy end-users, such as universities or government agencies have committed to make long-term commitments (i.e., 10 years or more) to purchase stand-alone REC’s or REC’s bundled with energy.

•The same large entities may enter into a REC contract for differences would provide price stability to the buyer and revenue security to the seller

Financing Issues and Solutions REC’s (Continued)

•State renewable energy funds could offer a price floor for REC’s to ensure minimum REC revenue, as one component of a risk management strategy

Example:

-The Massachusetts Renewable Energy Trust offering to purchase—or purchase options to buy—REC’s for a period of up to 10 years

•These funds are limited, however, in the number of projects they can support

• States could require long-term contracts for bundled energy or stand-alone REC’s as a means of satisfying an RPS

Financing Issues and Solutions REC’s (Continued)

•Forward Selling of REC’s

-REC’s that will be generated over the lifetime of a new or planned renewable energy project can be sold in advance to consumers before the project is constructed

-The present value of the future revenue stream can be used to finance the project directly

Example:

Vermont-based NativeEnergy’s customers purchase REC’s that willbe generated during the expected operating life of renewable energyprojects.

Financing Issues and Solutions REC’s Continued

•With its Windbuilder’s product, NativeEnergy helped support the development of the 750-kW Rosebud Sioux wind turbine in South Dakota by selling the REC’s that will be generated during the 25-year expected life of the turbine.

•NativeEnergy discounts the REC’s price to account for the time value of money and the avoided risk of the project not being able to sell all of the future REC’s.

•Because NativeEnergy markets REC’s from prospective projectsthe company guarantees that it will support an alternate project or purchase REC’s from other new renewable facilities, in the event that the initial project is not completed.

Financing Issues and Solutions REC’s Continued

• Note this kind of forward sale has only been done on a smallscale to date because of the challenge of forward selling the entire output of alarge project.

• Although this product can help develop some small renewable energy projects, it may be slow to generate financing for substantial expansions in large scale renewable projects.

• Perhaps large credit worthy state agencies, trusts, and other governmentalauthorities can also assist in achieving larger scale forward sales.

2008 2009 2010 2011 2012 2013 2014

Total Revenue 12,480,880 12,788,304 13,103,414 13,426,402 13,757,464 14,096,803 14,444,625Total Operating Expenses 1,905,165 1,928,245 3,076,674 3,133,146 3,195,204 3,262,532 3,334,951Operating Profit (Loss) Ebitda 10,575,714 10,860,059 10,026,740 10,293,256 10,562,260 10,834,271 11,109,675Depreciation 31,787,151 50,606,270 30,532,544 18,488,308 18,488,308 9,455,131 421,955State Tax 0 0 0 0 0 0 381,102Interest Expense 7,164,980 6,909,893 6,636,185 6,496,584 6,180,610 5,848,855 5,599,501Net Income (Loss) before taxes -28,376,417 -46,656,104 -27,141,988 -14,691,636 -14,106,658 -4,469,716 5,469,322

Operating Profit (loss) Ebitda 10,575,714 10,860,059 10,026,740 10,293,256 10,562,260 10,834,271 11,109,675Production Tax Credits 5,192,055 5,321,856 5,454,903 5,591,275 5,731,057 5,874,334 6,021,192Administration of Project(Subordinated) 150,000 153,750 157,594 161,534 165,572 169,711 173,954Total Cashflow Available For Debt Service 15,917,769 16,335,665 15,639,237 16,046,065 16,458,890 16,878,316 17,304,821

Total Debt Service 10,611,846 10,890,443 10,426,158 10,697,377 10,972,593 10,229,282 10,487,770

DSCR constraint 1.5 1.5 1.5 1.5 1.5 1.65 1.65

Example of DSCR Calculation - BASE CASE

*For a 100 MW Project with 35% Capacity Factor

2008 2009 2010 2011 2012 2013 2014

Total Revenue 15,241,143 15,616,884 16,002,018 16,396,781 16,801,413 17,216,160 17,641,277Total Operating Expenses 1,905,165 1,928,245 3,076,674 3,133,146 3,195,204 3,262,532 3,334,951Operating Profit (Loss) Ebitda 13,335,978 13,688,639 12,925,344 13,263,635 13,606,209 13,953,628 14,306,326Depreciation 32,004,699 50,913,633 30,744,104 18,642,386 18,642,386 9,566,098 489,810State Tax 0 0 0 0 0 0 514,918Interest Expense 8,671,090 8,390,788 8,086,749 7,942,395 7,585,841 7,212,020 6,941,684Net Income (Loss) before taxes -27,339,812 -45,615,782 -25,905,509 -13,321,146 -12,622,019 -2,824,491 7,389,749

Operating Profit (loss) Ebitda 13,335,978 13,688,639 12,925,344 13,263,635 13,606,209 13,953,628 14,306,326Production Tax Credits 5,192,055 5,321,856 5,454,903 5,591,275 5,731,057 5,874,334 6,021,192Administration of Project(Subordinated) 150,000 153,750 157,594 161,534 165,572 169,711 173,954Total Cashflow Available For Debt Service 18,678,033 19,164,245 18,537,841 19,016,444 19,502,838 19,997,673 20,501,472

Total Debt Service 12,452,022 12,776,163 12,358,561 12,677,630 13,001,892 12,119,802 12,425,134

DSCR constraint 1.5 1.5 1.5 1.5 1.5 1.65 1.65

Example of DSCR Calculation With REC of $10/MWh

*For a 100 MW Project with 35% Capacity Factor

Comparison of REC Enhancements To Base Case

• A REC price of $10/MWh or .01/KWh increases project revenue by $2.8 MM/yr. for a 100 MW project

• Available leverage or D/E ratio, holding DSCR constant goes up by 12% from D/E ratio of 63% to 75%

• Project IRR also goes up

•Alternatively, with an extra REC revenue stream, the project may choose to hold revenue and returns and D/E ratio constant and bid more competitively on the PPA pricing

• It may eventually be possible to achieve higher D/E ratios if a REC revenue stream meets certain criteria

-Lenders should consider issuing a separate tranche of debt with higher margins and DSCR’s, but allow REC’s to add some leverage over a term matching the length of the REC purchase contract

-Lenders could allow funding of Debt service reserves with the REC revenue stream

•For REC’s to be accepted as a financeable revenue stream:

-Lenders need a strong state and or regional legal and regulatory environment

-REC purchasers and PPA counterparties must be creditworthy

-Longer term REC contracts and purchases are needed,

- More liquidity and bankable forward price curves need to develop

•For now, with state of markets, probably safer not to try to disaggregate attributes

Financing Conclusions For REC’s

More “Due Diligence” is Always Better Make sure your deal is a REC deal not a Wreck deal

PART 2 - Depreciation•Industry MACRS tax depreciation norm is 200% declining balance over 5 year depreciation life

• This is substantially shorter than the 15 to 20 year depreciation lives of non-renewable power supply investments •Faster depreciation results in tax benefits early in a project's life because a dollar is worth more today than later on

•Depreciation Can be allocated disproportionately to ownership

•The Internal Revenue Code of 1986 (as amended) now provides for additional accelerated depreciation of property placed on tribal reservations

Eligibility for Accelerated Depreciation on Tribal Reservations

To be eligible, the property must:

•Be used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation on a regular basis

•Not be used or located outside the Indian reservation on a regular basis

•Not be used in conducting or housing class I, II or III gaming as defined in the Indian Regulatory Act

•Not be residential rental property

•Not be owned by a person who is required to use the "alternative depreciation system".

IRS 168(j) Depreciation Lives on Reservations

Property Class Life Accelerated Depreciation Life

5 years 3 years 7 years 4 years 10 years 6 years 15 years 9 years 20 years 12 years 39 years * 22 years

*(nonresidential real property)

Qualified Indian Reservation Property• The term “qualified Indian reservation property” means:

Property which is,

• used by the taxpayer predominantly in the active conduct of a trade or business within an Indian reservation, • not used or located outside the Indian reservation on a regular basis, • The above restriction shall not apply to qualified infrastructure property located outside of the Indian reservation if the purpose of such property is to connect with qualified infrastructure property located within the Indian reservation. • not acquired (directly or indirectly) by the taxpayer from a person who is related to the taxpayer (within the meaning of section 456 (b)(3) (C ), and • not property (or any portion thereof) placed in service for purposes of conducting or housing class I, II, or III gaming (as defined in section 4 of the Indian Regulatory Act (25 U.S.C. 2703)). • The term “qualified Indian reservation property” does not include any property to which the alternative depreciation system applies

Qualified Infrastructure Property-Off Reservation

“Qualified Infrastructure Property” means qualified Indian reservation property which :

• Benefits the tribal infrastructure, • Is available to the general public, and • Is placed in service in connection with the taxpayer’s active conduct of a trade or business within an Indian reservation.

 Such term includes, but is not limited to, roads, power lines, water systems, railroad spurs, and communications facilities.

CreatingValue in Allocation of Depreciation

• Can disproportionately allocate to an investor or partner who has the tax appetite to monetize the depreciation to offset their taxable income

• Upon audit, an investor must show there was economic justification for a disproportionate allocation of tax credits and be able to show“differentiated risks”

• The downside is to risk disallowance and unwinding of the structure entailing financial consequences to the investor and the project

• It may be best to get a letter opinion from the IRS

Creating Value in Using Accelerated Depreciation

• The benefit of accelerating depreciation is the present value of the stream of avoided cash taxes when added taxable income is offset in years 1-3 versus over a 5 year period

• The effect of combining disproportionate allocation and accelerated depreciation can make a substantial value creation difference and result in higher returns for investors and partners who can monetize these benefits