Q&A: How Risk Mitigation Finance Can Cut CSP Costs

ACWA Power and Shanghai Electric sign an EPC agreement for the large scale 700 MW CSP project for DEWA in the UAE  IMAGE @CSPFocus

Cutting risk in financing will be the next key to further cut CSP costs, according to the author of Non-recourse project financing for concentrated solar thermal power published in the journal Utilities Policy. Dr. Steven Geroe teaches Energy and Environmental Law and Contract Law at Melbourne’s La Trobe Law School, and became interested in China’s renewable energy finance and investment while working for a Chinese investment law firm involved in clean energy projects.

SP: I noticed some of the CSP research papers you cited are written in Chinese characters. Do you read Chinese?

SG: Yes, I lived in China and studied Chinese for about 20 years. I interviewed Chinese energy related institutions because one of my interests in the Chinese regulatory approach is how the Chinese are utilizing special expertise in drafting renewable energy-related regulation for consulting in the drafting process.

So my researching is partly in Chinese and my Chinese research assistants – my grad students help me in my understanding. I only practiced law briefly a long time ago: I’m more interested in research and writing on contracting law, energy and environmental law and international investment.

One of the aspects that I am interested in is the evolution of Chinese debt markets and forms of contracting and doing business. So what it appears at the moment as the Chinese go global strategy which has got several aspects most prominent now is probably the Silk Road the One Belt One Road project.

As they go global, strategic investments in developing countries around the world are giving Chinese businesses and financiers a lot of experience in international forms of contracting and doing business, so I think that is likely to be a driver in increasing integration of those kinds of contracting. For example in non recourse financing on a domestic basis.

And I think the evolution of the Chinese capital markets domestically is likely to support that as well and also a long-term trend of the reduction of foreign reserves as the proportion of GDP down from about 50% to about 28% now. it’s probably driving an increasing openness to international investors for large-scale domestic projects as well.

SP: Why is de-risking finance important now for CSP growth?

SG: Quite a lot of stars are aligning for CSP. It has already seen dramatically falling technology costs due to the learning curve and mass production, and then the recent spurt of large-scale deployment in emerging countries like Morocco and China. There is a confluence of factors so that a technology that has shown a lot of potential over the years but never really had its time in the sun maybe having its time in the sun now.

I think that there is now real potential emerging of contractual and de-risking strategies and technology maturity making CSP a viable investment carrier for institutional investors, as there’s a number of risks specific to CSP, according to the EU report (link to name) which did extensive surveys of a whole range of all the commercial stakeholders.

Policy stability was the biggest risk they cited. Technology risk was also key and so having performance guarantees was contractually better for suppliers and technology providers in the EPC contract. And revenue predictability, from having an adequate PPA, like in the 35 year DEWA contract, is important in a non-recourse loan.

SP: Your paper notes that non-recourse financing increased from 16% in 2004, to 52% by 2015. Why does this kind of financing lower CSP costs?

SG: Non-recourse loans are very good at spreading and allocating risks. You have got a lot of big players on both sides; on the financing side, typically syndicates of big international banks who are able to allocate risks across a number of large institutions and on the investment side, a consortium of investors who will also be pretty large-scale.

And then through the web of contracting risk you are spreading risk to all the contractors. And the contractors can be pretty large-scale as well in terms of the EPC contracting for the building of the plant and the operation and maintenance contracts in the PPA.

A specific purpose vehicle – or SPV, is the central aspect of non-recourse financing. The sponsors or investors set up a separate company as a project company which holds the assets, so what that means is the financiers can only sell off the assets of the project, but they don’t have recourse to the investors themselves who Invested in the project company.

International banks will do their due diligence and have extensive security agreements covering the collateral of the SPV and they may also have some direct contractual arrangements with the other contractors. They have to do their due diligence that the project has got enough in guaranteed cash flow so that they will get their money back from the cash flow of the project.

To have a bankable project – CSP or otherwise – you have to have very good risk allocation management contractually and also a good backup in terms of de-risking strategy.

So non-recourse financing is a fairly complex structure with fairly high transaction fees but it has proven effective in mobilizing very large-scale investments for high risk projects because of its risk allocation capacity.

SP: Where else has non-recourse finance been used?

SG: Initially it was used in the oil and gas industry in the United States, when there were fairly large investments in sort of hit-or-miss projects. Non-recourse historically has been for larger scale – higher risk projects so it is considered a useful structure four high risk projects which have got good revenue generation potential.

So its been a very common form of financing infrastructure in the energy sector but it is being used in other large infrastructure construction projects and more generally in a large range of areas; ports, hospitals, roads, airports. A PPP structure – a public-private partnership structure – quite often has a non-recourse aspect as well.

SP: In your paper you identified complementary debt guarantees as a good pairing with non-recourse loans, noting its success in bringing down costs in offshore wind financing. Which countries have tried debt guarantees?

SG: Debt guarantees were pretty prominent in American solar generally where the Obama administration stepped up in response to the debt crisis. There was also a debt guarantee in one of the largest CSP plants in the world, the MASEN contract for the 580 MW Noor CSP plant in Morocco, and in that case the debt guarantee was to cover the difference in prices between coal and CSP.

{The details are in the paper:
“The 170 MW Phase 1 of the project utilised a BOOT structure between the Moroccan Agency for Solar Energy – MASEN, and ACWA Power Ouarzazate, a special purpose vehicle incorporated under Moroccan law. ACWA is under a turnkey contract to design, finance, construct, operate, and maintain the power station. Its experience in solar investments in the Middle East and Africa was also seen to limit the risk involved with MASEN’s relative lack of experience in complex projects as the primary off-taker. The debt financing of the project included a €200m traditional loan by the African Development Bank (“AfDB”) to MASEN, plus a €165m concessional loan by the African Development Bank Clean Technology Fund (“CTF”) to MASEN.

Both loan amounts will be on lent by MASEN to ACWA Power, which has primary responsibility to repay AfDB. The first or intermediary off-taker is MASEN. As the intermediary off-taker, MASEN re-sells the power generated to the Office National de l’Electricité et de l’Eau Potable (“ONEE”), Morocco’s sole electricity distribution utility. The first PPA between ACWA and MASEN is twenty-five years based on production costs, at US$ cents 18.9 per kWh. The second PPA, also for twenty-five years, applies to the on-selling by MASEN to ONEE, and is based on the net rates applicable in Morocco. As net rates applicable in Morocco (for coal-fired power) were expected to be lower than (CSP) production costs, this created a revenue risk for the project vehicle ACWA. This risk was addressed by a guarantee over both loans by the Kingdom of Morocco to the extent of the 
diferential between the two PPA rates.”

China's pilot CSP projects 2016-2020

China’s pilot CSP projects 2016-2020 IMAGE@Chinese Academy of Sciences

SP: Policy stability is the other de-risking factor; I guess that is China’s advantage?

SG: Yes, the central government in China has had long-term targets which it has taken seriously. That’s really been the official position since I think since the 2007 Chinese National Climate Change Plan when the central government clearly recognized both the future and existing impacts of climate change..

Environmental concerns are very different in China because it is a key area of public concern as it has direct health consequences, more with particulate pollution of water and air, but that feeds through to the governments approach to environmental issues. The Chinese are genuinely committed to reducing emissions and to doing so with the most efficient technology in a cost-effective manner.

The whole political dynamic around renewable energy is very different from countries like North America and Australia where we have had powerful incumbent fossil fuel industries with fairly substantial political clout that makes them resistant to change. Although there are both private sector and state-related fossil fuel interests in China too, such interests are less intractable in China, particularly at the central government level. So I don’t think there are any comparable political obstacles from the fossil fuel industry.

However, there’s clearly also a downside in terms of central planning and overall coordination. They have serious coordination difficulties. I think a pretty common example of that is the trailing grid connection for wind turbines: they structured their wind subsidies for construction rather than production. So there are policy shortcomings. 

Generally what happens in China across a lot of industries anywhere from automotive to solar power is there tends to be generous government subsidies and programs which create a rush into industries and there is a kind of a stampede into industry followed by a a very rapid shakeout so it’s a lot of pain for a lot of companies and that happened in solar PV.

SP: Do you expect the Chinese government will do anything to avoid winding up with just one or two giant CSP firms left standing as weaker players are weeded out?

SG: I think they’ll genuinely allow or try to facilitate direct competition between rival technologies and choose the best. They are taking an experimental and empirical approach: using their learning from these experimental projects and making decisions down the line.

Market liberalization is their official state policy driven through the central planning process, so more competition between market-based entities, and breaking up entities and encouraging competition. However that is a fairly stalled process, so there does tend to be a lot of market domination by the big players.

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