Winning the Language War of Clean Energy Finance
By Hannah Hunt and Mike Jerue “Vocabulary is the principal way that wars are won.” This observation by Jonathan Silver, CEO of Greenbanc Global, came near the end of an engaging discussion with CELI fellows about the fundamentals of clean energy finance. Mr. Silver expertly pointed out that it is crucial for clean energy leaders to understand the terminology that is associated with project finance because it is such a significant and rapidly changing part of the clean energy industry. Mr. Silver drew from experiences in a distinguished career, which included stints as both the head of the Department of Energy’s (DOE) Loan Guarantee Program and also as a Distinguished Senior Fellow at Third Way, to help explain finance principles and terminology.
Mr. Silver highlighted the two primary ways in which clean energy projects are financed: equity investment and debt. Projects such as solar arrays and wind farms require a large amount of capital, or upfront funding, to be constructed. Project developers acquire this capital either through equity investment, which indicates ownership in the project, or through debt, which is repaid over time and involves less risk. The prevalence of tax equity investment, which is created when large institutions, such as banks and insurance companies, provide equity for a clean energy project in exchange for the tax incentives that are eligible to the projects. Investors are often more interested in these benefits than project developers because they have a greater “tax appetite,” which simply refers to the amount of profits to which a company can apply the tax incentives. The primary federal tax incentives available to clean energy projects are the Investment Tax Credit (ITC) and the Production Tax Credit (PTC), along with accelerated depreciation deductions.
Beyond the basics of tax equity investment, Mr. Silver also explained the more detailed features of clean energy finance agreements. One feature is a flip structure that is included in many tax equity agreements. In this flip agreement, outside investors will initially own the project in order to collect the cash and tax benefits. After a set number of years, ownership will revert to the project developer or subsequent owner, typically after tax incentives are no longer available to the project. If executed correctly, all parties win -- outside investors earn decent returns on their investments, while project developers and customers thrive on either side of a profitable power purchase agreement (PPA) that is built on a foundation of clean, reliable power.
After a clean energy project secures funding and becomes fully operational, it might then become involved in the growing financial market of project securitization. Here, the cash flows generated by the project can be sliced into various groups according to risk and return profiles. In addition, the project might become part of a YieldCo, which is a bundle of operating assets (i.e. power plants) whose cash flows generate dividends for shareholders. YieldCos appeal to project developers because their assets are monetized and the resulting profits can be used to focus on what they do best – invest in more energy assets. Mr. Silver observed that the use of YieldCos for renewable energy projects is relatively new and therefore there are still several unknown quantities with respect to long-term risk. For now, however, clean energy YieldCos deliver stable returns that make them attractive options for an investor’s bond portfolio.
Having explained these fundamentals of clean energy finance, Mr. Silver finally challenged the notion that they are any different from those of mainstream finance. In particular, he singled out so-called “green bonds” by asking If it looks like a bond and can be valued like a bond, does it really need to be called ‘green’ bond? He makes a valid point. If clean energy leaders are to meet the environmental and economic challenges of our time, we must escape the perception that it merely occupies a small niche the marketplace. We must also become fluent in the terms surrounding clean energy finance so that we may highlight these insights. In doing so, winning the language war is possible.