Six steps to reduce risks when investing in renewable energy projects
March 9, 2018
Big investments require confidence – however, caution in unlocking funds is perfectly reasonable. A thorough due diligence is the key to building investment confidence by identifying and quantifying the project’s risks, costs and benefits.
Due diligence is a broad term, and consists of technical, legal and commercial considerations. In practice, it means developing a full understanding of the proposed project, discovering any risks that could prevent its success, and capitalising on the project’s strengths. Not all risks will be ‘show stoppers’, but identifying any potential risks, judging the likelihood and impact of those risks, and identifying mitigations will enable greater confidence that the project is a viable investment.
Whatever the renewable energy project – a solar farm, wind farm, hydro scheme, hybrid solution, pumped hydro energy storage facility or other emerging option – technical due diligence considerations need to explore total energy yield, project uncertainties, technology choices, social and environmental implications, contractual terms, the business case and also non-financial goals.
1 – QUANTIFY ENERGY YIELD AND UNCERTAINTIES
For any project, a critical requirement of lenders is a bankable energy yield assessment. Renewable resources such as sunlight and wind generate power with a variable output that can be forecast, but is not necessarily available on demand. This leads to daily, quarterly and annual variations in generation and to uncertainties in revenue that need to be factored in. Despite this variable yield, renewable projects do not incur the risks of variable fuel costs which affect other energy projects.
To avoid lower-than-expected revenue generation, the project needs to be able to export power into the electricity grid without constraint. This makes the grid connection arrangements and understanding the risks associated with the eventual operational regime critical to the success or failure of a project.
2 – JUSTIFY TECHNOLOGY CHOICES
Project lenders require confidence in the capability and reliability of the proposed technology for the project. For wind farms and hydropower projects using equipment from a supplier with a long operational history or large install base, this is less likely to pose hurdles than for emerging renewable energy options such as hybrid systems using batteries.
A project developer would be well advised to obtain relevant documentation from suppliers, such as a solar panel’s assessments results from recognised testing institutes. Absence of information is likely to result in conservative assumptions for financing purposes, so efforts to extract and justify all parameters is typically well worthwhile.
3 – ENSURE SOCIAL ACCEPTANCE AND ENVIRONMENTAL REPUTATION
Renewable energy projects operate within communities. There will be a range of attitudes towards any project and many stakeholder relationships to manage. The relationship established with the project’s community can make a substantial difference to the success of the project.
A major risk to social acceptance of the project and development approvals is environmental impacts. Best-practice identification, mitigation and management of the environmental implications of the project is critical to the long-term success of a project and to corporate reputation.
4 – TAKE CARE WITH Contracts
Renewable energy projects require a large upfront capital expenditure. Depending on the investor’s risk appetite, exposure to risk can be managed through the contractual arrangements with the developer, equipment suppliers and the construction contractor.
Land-owner agreements; connection applications; engineering, procurement and construction contracts; supply and installation contracts; and operations and maintenance contracts of various forms will be required to develop, construct and operate the project. While a legal adviser will need to comb through these, many technical aspects can vary significantly in their favourability to a purchaser or investor. Identifying and quantifying these items will need input from a technical advisor.
Investments that are otherwise sound can suffer due to delays in construction, which can have significant impacts on expenditure and revenue profiles, and the terms of any debt provision. The investor can mitigate some risk through delay damages in EPC contracts, however, the adverse impacts of projects delays are rarely fully mitigated by contractual arrangements.
For operations and maintenance, comprehensive long-term agreements offered by the original equipment manufacturer are an effective method of transferring risk associated with plant reliability onto the supplier or EPC contractor. However, the certainty afforded will come with a cost premium, and it is critical to appreciate that a comprehensive operations and maintenance agreement does not guarantee energy output.
5 – UNDERSTAND MARKETS, POLICIES AND REGULATION
Renewable energy projects are often supported by government policies that recognise the environmental benefits of clean energy generation. It is essential to understand both the commercial market for the energy and the policy environment in order to negotiate power purchase agreements or to manage merchant risk if the energy is being sold on the spot market.
It is also vital to understand the relevant regulatory frameworks – planning, environmental, electricity grid, corporate governance, taxation, financial, employment, or occupational health and safety. All these factors need to be considered when assessing the cost of the project and the risks associated with the investment.
Another potential risk – or opportunity – is change in the market, both short term and longer term. Consider how foreseeable or unforeseeable market movements (such as changes in industrial loads, or shifting levels or patterns of demand) may affect performance and viability of the project over its life.
6 – ASSESS THE BUSINESS CASE AND OTHER GOALS
The ultimate motivations and goals of the investor will influence the assessment of risk. The project may not simply be all about financial return, but also a desire to limit carbon exposure or to increase corporate social responsibility. Understanding the goals of the project will provide a clearer perspective for the due diligence investigation.
Whatever the motivations of the investor, the financial realities of the business case will be critical. Technical viability and environmental benefits won’t be enough to get projects over the line if they can’t demonstrate their long-term financial soundness and ability to weather the competitive pressures of the market.
Businesses are likely to gain substantial benefits from making structured and systematic efforts to foresee and quantify risks across the spectrum of commercial, technical, social and environmental issues. The more detailed a due diligence process is, the more accurately risks can be quantified, and the less likely it is that potential risks will be overlooked. A thorough due diligence will take time and expertise, but it is a critical investment in the success and resilience of every renewable energy development.
To discuss how Entura can assist you with practical, expert technical due diligence services for proposed or operational projects in Australia and the Asia-Pacific region, please contact Akhil Pai on +61 406 874 101, Silke Schwartz on +61 407 886 872 or James Mason on +61 400 603 650.
About the author
Daniel Bennett is a renewable engineer at Entura. He has near a decade of experience investigating feasibility and due diligence energy yield assessments for renewable projects in Australia and around the world. He has worked on various wind farm projects in Australia, China, India, Sri Lanka and South Africa. Daniel has also worked directly for developers and suppliers.