Methodology. Rating Wind Power Projects

Transcription

1 Methodology Rating Wind Power Projects january 2014 previous release: october 2012

2 CONTACT INFORMATION Eric Beauchemin, CFA Managing Director, Public Finance Kent Wideman, CFA Managing Director, Credit Policy DBRS is a full-service credit rating agency established in Privately owned and operated without affiliation to any financial institution, DBRS is respected for its independent, third-party evaluations of corporate and government issues, spanning North America, Europe and Asia. DBRS s extensive coverage of securitizations and structured finance transactions solidifies our standing as a leading provider of comprehensive, in-depth credit analysis. All DBRS ratings and research are available in hard-copy format and electronically on Bloomberg and at DBRS.com, our lead delivery tool for organized, Web-based, up-to-the-minute information. We remain committed to continuously refining our expertise in the analysis of credit quality and are dedicated to maintaining objective and credible opinions within the global financial marketplace.

3 Rating Wind Power Projects TABLE OF CONTENTS Introduction to DBRS Methodologies 4 Wind Power Project Overview 5 Construction Period Risk 8 Contract Structure 8 TSA Contract and Turbines 9 EPC Contract and Contractor 9 Construction Period Contractor Credit Enhancement 9 Independent Engineer s Report Construction Period 10 Operating Period Risk 11 Fundamentals of the Wind Resource 11 Site Selection 12 Measurement Plan 12 Conversion of Wind Resource Forecast to Power Forecast 13 Technology Risk 13 Operation and Maintenance 14 Independent Engineer s Report Operating Period 14 Resource Consultant Report 15 Sponsorship, Legal, Financial and Other Considerations 16 Sponsorship 16 Legal and Regulatory 16 Special Purpose Vehicles 16 Creditor Cure of Contract Defaults and Security Provisions 17 Dispute Resolution 17 Legal Opinions 17 Insurance 17 Expert Reports 17 Regulatory Matters 18 Power Purchase Agreement 18 Financial Risk 18 Metrics 18 Scenario and Break-Even Analysis 19 Key Debt Terms 19 Appendix Technical Description of Wind Resource Measurement, Data Quality and Forecasting 22 3

4 Introduction to DBRS Methodologies DBRS publishes rating methodologies to give issuers and investors insight into the rationale behind DBRS s rating opinions. In general terms, DBRS ratings are opinions that reflect the creditworthiness of an issuer, a security or an obligation. DBRS ratings assess an issuer s ability to make timely payments on outstanding obligations (whether principal, interest, preferred share dividends or distributions) with respect to the terms of an obligation. DBRS rating methodologies include consideration of historical and expected business and financial risk factors as well as industry-specific issues, regional nuances and other subjective factors and intangible considerations. Our approach incorporates a combination of both quantitative and qualitative factors. The considerations outlined in DBRS methodologies are not exhaustive, and the relative importance of any specific consideration can vary by issuer. In certain cases, a major strength can compensate for a weakness and, conversely, a single weakness can override major strengths of the issuer in other areas. DBRS may use and appropriately weight several methodologies when rating issuers that are involved in multiple business lines. DBRS operates with a stable rating philosophy; in other words, DBRS strives to factor the impact of a cyclical economic environment into its ratings wherever possible, which minimizes rating changes due to economic cycles. Rating revisions do occur, however, when more structural changes, either positive or negative, have occurred, or appear likely to occur in the near future. DBRS also publishes criteria, which are an important part of the rating process. Criteria typically cover areas that apply to more than one industry. Both methodologies and criteria are publicly available on the DBRS website. 4

5 Wind Power Project Overview While an active rated bond market for wind projects has only begun to develop in the last several years, the commercial application of wind power technology has become a more significant share of global power supply in the last decade. This methodology outlines key factors for rating on-shore utility-scale wind project bonds and covers both greenfield and operating wind assets. (A utility-scale wind project has an installed capacity greater than 50 megawatts (MW).) DBRS groups these factors into three sections in this methodology as follows: (1) construction period; (2) operating period; and (3) sponsorship, financial, legal and other considerations. Note that for projects that have a construction period, the weaker of either the construction or the operating period generally determines the rating. Wind project risk has many elements in common with other energy project finance transactions, but it also has unique aspects that must be separately considered. As such, this methodology should be considered within the general framework of the DBRS methodology Rating Project Finance (August 2013). The high total cost of wind power is an important economic reality underlying the legal and financial framework. Utility-scale wind generation is more competitive on a total cost per kilowatt hour basis than solar power. However, it is still generally more expensive than most traditional sources of electricity. The sector often benefits from some form of public-sector support in order to generate sufficient economic returns. Above-market tariffs have been one approach to the need for policy support and subsidy. Some jurisdictions offer favourable tax treatment, including tax credits or accelerated depreciation rates, in order to stimulate investment in wind assets. They may also have legislation requiring that a certain percentage of electricity generated must come from renewable assets, which is also supportive of wind project development. Wind Project Structure PPA Counterparty Electricity Payments PPA Electricity Dividends Debt Service Sponsors Equity Project Co Financing Lenders EPC Contract Turbine Supply Agreement Equipment Payments O&M Agreement Construction Payments O&M Payments EPC Contractor Turbine Supplier O&M Contractor Note: EPC stands for engineering, procurement and construction. 5

6 Wind projects, like most power project financings, are generally structured as special-purpose entities that service debt solely from project cash flow and have no recourse to their equity sponsors. In a typical wind power project, the project company (ProjectCo) enters into a power purchase agreement (PPA) to sell electricity to the PPA counterparty. For greenfield projects, an engineering, procurement and construction (EPC) contractor typically assumes responsibility for non-turbine balance-of-project completion by a certain date at a fixed price. A separate turbine supply agreement (TSA) commits a turbine vendor to a schedule of deliveries, also at a fixed price. During operations, an operating and maintenance (O&M) agreement engages a contractor (which may be an affiliate of the equity sponsor or a third-party provider) to operate the asset until contract maturity. Project finance lenders generally only have access to cash flows from project assets for debt servicing with limited or no recourse to the project s sponsors. This is different from a corporate debt holder who typically benefits from the cash flow of multiple product lines as well as the issuer s liquidity and other financial resources. Project finance structures rely on contracts to manage risk during construction and operation. Project assets are typically held in a special purpose vehicle (SPV), labeled ProjectCo in the diagram above. The EPC contract sets out the terms of construction of the project, usually at a fixed price, thereby passing down completion risk to the contractor. The TSA is also typically on a fixed price basis and is often separate from the EPC contract. The revenue contract (i.e., a PPA) permits ProjectCo to sell its output to the off-taker or revenue counterparty. The O&M agreement sets out the terms of services provided by the O&M contractor(s) and sub-contractors during the operating period. Finally, a variety of financial agreements (e.g., trust indentures or hedging agreements) and SPV constitution documents address certain financial, legal and other considerations. The terms of the contracts generally transfer, or partially transfer, a variety of risks from ProjectCo to its counterparties in the transaction. Such risks include the timely delivery of turbines, construction completion risks, credit risk of various counterparties, operational risks, price and inflation risks as well as catastrophic risks, with each risk typically transferred to the entity best able to bear them. These risks and others are discussed in detail in the sections that follow. Wind projects are generally distinguished by the following core risk elements: (1) low-to-moderate construction risk; (2) a variable wind resource, and energy production forecasts that have historically over-estimated output; (3) operating risk related to equipment performance; and (4) contracted revenue, typically with investment grade counterparties. Of these, the impact of wind volume projections and estimated turbine performance on the base case energy forecast are considered the primary project risks. Commercial applications for wind first developed in the mid-1970s but began to grow materially in the early 1990s. Early projects often included much smaller turbines (100 kilowatts capacity) that were prone to outages, undercapitalized vendors and problems with forecasting the wind resource. After several generations of equipment development, turbines have become more reliable, and rotors range in diameter from 70 metres to 120 metres on towers that are 65 metres to 100 metres high at the hub with nameplate capacities from 1 MW to 5 MW. 1 Rapid demand growth in the mid-2000s led to supply shortages. As a result, some manufacturers invested in new facilities or purchased major component suppliers, while others expanded and diversified their supply chains. 2 Since that time, rationalization of the market has led to consolidation of equipment suppliers, although there are still new entrants to the market. The operating histories of turbine types currently deployed are approximately ten years long, and turbines generally have estimated useful lives of 20 to 25 years Wind Resource Assessment: A Practical Guide to Developing a Wind Project, First Edition. Michael C. Brower, et al John Wiley & Sons Inc. Wind Energy Handbook, Second Edition. Tony Burton, Nick Jenkins, David Sharpe and Ervin Bossanyi John Wiley & Sons Inc. 2. Aubrey, Crispin. Supply Chain: The Race to Meet Demand. Wind Directions European Wind Energy Association. January/February 2007: 29-30, 34. Print.

7 However, forecasting wind resource and wind project power generation was a significant obstacle in the sector s early development. U.S. wind projects commissioned prior to 2008 underperformed their forecasts by 10% on average, owing primarily to wind resource variability, climate variability, plant availability and early operational issues. 3 DBRS notes that forecasting performance has improved with greater accuracy from better technologies and procedures for measurement, including improved verification of anomalous data values, estimating variations in wind at a particular height (wind shear), analyzing wake interference, optimizing turbine configuration and accounting for known performance deficiencies during the first-year start-up phase. A backcasting study by AWS Truepower LLC in 2012 estimated that wind project underperformance is 3.6% on average, ± 1.4% statistical error, 4 and that two-thirds of the discrepancy (based on the AWS project sample) is due to the variance of turbine production from their expected power curves and degradation of turbine blades. This suggests that wind resource forecasts and wind project power production forecasts remain two significant sources of estimation error. It is DBRS s view that wind power projects, if properly structured, can achieve investment grade ratings. However, wind projects have historically been vulnerable to underperformance relative to base case power production forecasts. This constrains wind power project ratings compared with the more mature hydroelectric and natural gas-fired projects. Accordingly, at this stage in the development of a rated market for wind projects, DBRS considers wind project ratings unlikely to exceed BBB. Investment grade project quality depends on the following: (1) An experienced wind resource consultant and an independent engineer (IE) with proven track records of providing credible forecasts of wind resource volume and power production. (2) A capable turbine supplier that is investment grade (or that benefits from structural enhancement to reach an investment grade level) providing and supporting proven and reliable wind turbine generators. (3) Low-to-moderate construction risk substantially transferred to an experienced contractor. (4) A robust PPA or similar revenue contract fully covering output with high credit quality counterparties. (5) Moderate operating risk retained by an experienced sponsor or contracted to a qualified third party. (6) An established and experienced equity sponsor. (7) Fully-amortizing debt with financial metrics and financing structures that accommodate resource variability and are capable of withstanding downside scenarios. 3. Deloney, Jennifer. Understanding U.S. Wind Fleet Underperformance. North American Windpower August 2008: 40. Print. 4. Statistical error is a measure of uncertainty that decreases with increased sample size, also called standard error of the mean. 7

8 Construction Period Risk The construction of a utility-scale wind power facility is less complex than for traditional project-financed power assets, such as natural gas-fired power plants, which have multiple, highly specified moving components with more complex construction, or hydro assets, which have complex design, excavation and civil construction requirements. The construction task has more in common with other types of renewable projects, such as solar, involving reasonably simple civil works and the assembly of components manufactured off site, although DBRS does consider it to be somewhat more complex than solar, given the scale of the turbines and requirement for the precise assembly of moving parts. Construction risk increases for more remote locations because of logistical difficulties and availability of labour and equipment. Bottle-necks for turbine or balance-of-system equipment can be an issue in timely construction; securing of queue position may seem an administrative burden, but effects can be material if turbine-generator deliveries are delayed, and the risk should be assessed by a project s IE. The natural preventative for queue position delays is to negotiate the TSA six to nine months in advance, secured by an advance payment. Wind projects have construction periods that are relatively short at approximately one to two years (depending on project size and ease of access), versus three- to five-year construction periods for other types of power assets. The shorter time requirement and low complexity of the work are key rating considerations. However, a shorter construction period can also create greater pressure for the timely replacement of a defaulted contractor or equipment manufacturer, although in general, the risk of cost overrun and delays is considered low. CONTRACT STRUCTURE The construction of a wind project typically involves two key agreements: a TSA and an EPC contract. The TSA is a fixed-price, date-certain undertaking from a turbine supplier to provide the turbines and often the ancillary equipment to the site, with an associated warranty period. The TSA is usually 60% to 70% of total project cost. The EPC contract generally involves construction of roads into the site, civil work to provide concrete foundations, positioning of towers, installation of turbines and balance-ofplant components, and may also involve connection to the transmission grid. These contracts are usually separate, but occasionally the TSA scope includes the balance-of-system contract. (It is very uncommon to see the reverse where the EPC contract scope would include the TSA.) DBRS notes that the contract structure should pass down (i.e., sub-contract) essentially all construction period risks to the TSA and EPC contractors. In some cases, interconnection risk may be retained by ProjectCo. Where this is the case, DBRS will assess the likelihood of delays arising from the grid connection process and will also consider the IE s review. DBRS notes that this could have a material impact on the rating. Clear scope definition in each of the two contracts is required to reduce the potential for interface miscues and commercial disputes between the turbine supplier, EPC contractor and ProjectCo. DBRS notes that a track record of on-time, on-budget completion by the same EPC and turbine supply team is positive for credit quality. A gap review by the IE to determine the adequacy of scope definitions between the two suppliers reduces the risk of coordination errors. It is a material analysis that is reviewed by DBRS and is considered as essential for investment grade projects. 8

9 TSA CONTRACT AND TURBINES The procurement of turbines and their installation costs are the largest construction period expenses, and the reliable delivery of turbines is critical to on-budget, on-schedule completion of the project. Some turbine suppliers have very long operating histories, including some with over 20 years of experience. Some of the larger turbine manufacturers are investment grade, whereas others, while possibly quite capable, may exhibit non-investment grade creditworthiness. DBRS will pay particular attention to the length of the warranty period and the extent of warranty obligations (especially with newer turbines). Where the credit quality of a turbine supplier is below investment grade, or its track record of timely delivery and turbine performance is weak, structural enhancements may be required to support its delivery and warranty obligations in order for a project to achieve an investment grade rating. Warranties are usually offered for a two-year period and encompass defects in workmanship and installation. In projects involving a new generation of turbines, longer warranties are typically offered (and expected by DBRS), given the higher likelihood of encountering unexpected problems or teething issues. However, in such cases, turbine manufacturers are generally incentivized to quickly deal with any problems to ensure a successful product launch. Teething issues are typically addressed in the first two years. The IE s scope should include assessment of higher risk from new models, and DBRS may penalize projects involving new technology with a short history. EPC CONTRACT AND CONTRACTOR The EPC contractor performs low complexity construction on a lower value contract than the turbine supply and is given less weight than the turbine supply contractor in the construction phase rating. While the balance-of-system tasks performed by the EPC contractor may be of lower total value, the EPC contractor s technical and financial capabilities to complete the work are important and require a proven track record. In addition, interconnection requirements can be a source of delay, and DBRS will review required approvals and the IE s assessment. The EPC contractor s ability to complete the project on-time and on-budget is assessed. If the EPC contractor is not publicly rated, DBRS will conduct an internal assessment of its credit quality. The rating may then be notched up for potential performance security. CONSTRUCTION PERIOD CONTRACTOR CREDIT ENHANCEMENT Credit and performance enhancements can be used to provide uplift to a construction phase rating. These may include (1) letters of credit (LCs) from a suitably rated issuer, (2) performance bonds, (3) warranties of performance after commissioning, and (4) parent guarantees. DBRS notes that LCs are the most direct support for the contractor and supplier credit profile during the construction phase. LCs issued by an acceptable financial institution can lift the construction phase rating. For example, LCs of 5% to 10% of the EPC contract value can lift the rating by one to two notches, respectively. In addition, an EPC contract generally provides for liquidated damages (LDs) in the case of delay in the construction schedule. For wind projects, LDs are typically between 10% and 20% of the contract value and should cover potential costs of delay or performance shortfalls, including debt service to bondholders and penalties owed by the project to the PPA counterparty. Performance bonds commit a surety to complete construction if the contractor defaults on its EPC obligations. An LC is viewed by DBRS as superior to a performance bond, assuming an equivalent credit rating, since the performance bond relies on the surety s process of assessing claims and selecting among numerous options for addressing a default, rather than providing cash on demand. Given the likelihood that sector participants may be relatively small and likely non-investment grade, DBRS typically considers third-party credit enhancements, such as performance bonds and LCs, superior to LD obligations of the contractor, unless such LD obligations are supported by an LC issued by a suitably rated issuer. 9

10 Third-party guarantees, insurance or equipment warranties may be positive for credit quality but require assessment of the credit quality and operational performance of the entities underwriting the risk. These forms of support benefit the project rating only if the entities credit quality is superior to the risks assumed under the related warranty or insurance instrument. Parent guarantees for affiliate contractor entities are a customary requirement. To be viewed as effective by DBRS, the guarantee should be irrevocable and not require exhaustion of recourse against the subsidiary. Trapping mechanisms that withhold progress payments to a contractor until delays or overruns are resolved may form part of the financing structure. Contractors can also be subject to a periodic test for value of work performed (as the modular nature of the construction task is convenient for checking progress against specific completion milestones) and not be allowed to front run drawdowns. DBRS notes that trapping mechanisms do not represent surplus funding for the project, and so while such mechanisms can help to focus the EPC contractor on the timely completion of the project, no rating uplift is given. INDEPENDENT ENGINEER S REPORT CONSTRUCTION PERIOD DBRS carefully assesses the IE s report and reviews its findings to inform construction risk analysis. As is the case for traditional project financings, an IE is generally engaged to verify key technical and financial assumptions. The IE report should include the following key items in its scope of engagement: Turbine supplier and contractor capability. Construction design, budget and schedule. Technology risk. Ability of the construction plan to meet output specifications and commissioning tests. Equipment warranties and minimum performance thresholds. Contractor and turbine supplier replacement cost. Risks of sourcing labour and materials. The impact of local content rules and any constraints that these may pose for the project. Site preparation, condition and access, regulatory requirements, environmental compliance and satisfaction of all permitting requirements. 10

11 Operating Period Risk The primary risks for the operating period are the accuracy of the wind resource forecast and the performance of turbines in accordance with the specified turbine power curve. O&M costs are typically between 15% and 20% of revenue, consist of low-to-moderate complexity monitoring, repair and equipment maintenance tasks, and are considered by DBRS to be a relatively low risk. Performance monitoring of operational wind farms is usually done remotely. Risks assumed under the PPA and the credit quality of the PPA counterparty are typically investment grade but are carefully assessed. Long-term PPAs with investment grade counterparties that fully contract the project s capacity under a defined price schedule (and inflation adjustment) are consistent with an investment grade rating. To assess the wind resource and power production forecasts, DBRS analyzes site selection, the measurement plan (for collecting site data and correlating with relevant nearby historical datasets), conversion of the wind resource data to a power production forecast, adjustments for uncertainty and power loss, and equipment types and reliability. These elements are generally included in the IE s scope. FUNDAMENTALS OF THE WIND RESOURCE Wind turbines use the kinetic energy of the wind to generate electricity. Wind is created by atmospheric pressure differences that cause air to move from zones of high pressure to zones of low pressure. Such pressure differences are created by temperature differentials on the earth s surface. As the surface of the earth rises in temperature, the air mass above it rises and pressure falls. Wind results when air moves to fill the zone of low pressure. Temperature differences between ground surface, the ocean surface and surfaces at different elevations also cause pressure gradients. Topography and surface roughness matter to wind volume, and long flat expanses are conducive to wind speeds. Wind speed is important in quantifying and characterizing the ability to convert wind energy into power. Wind project development is typically undertaken at sites with a mean wind speed of 6.5 metres per second (m/s) (about 14.5 miles per hour or 23.4 kilometres per hour) or better. However, measurement of wind speed is not sufficient by itself. The wind resource is also described by wind direction, changes in wind speed and direction, wind shear as well as atmospheric density, each at different times in the day for different durations and at each turbine location in a wind project. Wind resource data are analyzed in the following stages: Project siting. Location of measurement towers or masts. Determining the number of anemometers (wind measurement instrument), wind vanes and other sensors. Types of sensors and their vertical locations and orientations on measurement masts. Data collection and monitoring. Validation and verification of anomalous data values. Extrapolation of actual measured data to wind turbine generator hub height. Adjusting actual data against long-term historical datasets. Wind flow modelling, including consideration of the effects of existing and planned developments (e.g., other wind power projects, land use changes, etc.) in the site area. 11

12 SITE SELECTION The site selection process is crucial and often begins with consultation of a wind map that identifies the average wind speed for a particular height at a given location. During the preliminary site selection process there is a review of site access, the permitting process and other local regulations to ensure that no material impediments may be introduced into the construction process or grid interconnections. The regional track record and degree of local support for wind projects should be taken into consideration, including the following key items: (1) Permitting. (2) Approval of individual tower locations. (3) Requirement for separate agreements with landowners (typically, an agreement to lease the land during the data collection, monitoring and development phase, with an option to lease the land afterwards if the project proceeds). (4) Land use and other environmental rules. (5) Local rules that may require prohibitive distances from residences. (6) Potential for multiple local jurisdictions that may complicate the licensing and approvals requirements. Other considerations for site selection include geotechnical factors, market conditions and pricing, distance from transportation and grid infrastructure and the relevant government policies and regulatory framework. Once a potential site has been selected, wind data gathering begins. MEASUREMENT PLAN A detailed measurement plan 5 is a key success factor for correctly characterizing the wind resource and is assessed by DBRS, the resource consultant and IE as a first step in analysis of the ProjectCo s power forecast. The critical data for measurement of wind resource are wind speed, direction and temperature. The industry standard is the recording of an average wind speed, direction and temperature at ten-minute intervals based on one- to two-second samplings. A data logger records the data, time-stamps it and includes interval minimum and maximum values and standard deviation. One to three years of tenminute or hourly data is the typical measurement campaign. DBRS notes that a minimum of three years is preferred. Anemometers and wind vanes are key to measurement of wind speed and direction. While anemometer performance has improved, they can be a source of error. Manufacturers publish error estimates for each anemometer type, although the manufacturer s published error estimate is generated in controlled conditions and may be affected by non-typical operating environments. The scopes of engagement for the resource consultant and IE typically include assessment of measurement error, including anemometer error. The measurement plan should have a quality assurance and control plan including an O&M plan for each monitoring station, procedures for equipment calibration and audit trail. Data recovery is the percentage of total available measurement time that data is captured and reported, and during the measurement campaign, it should be > 90%, minimizing extended data gaps. In addition, there should be protocols for data scrubbing or validation, transmission from the logger, storage of measurement data, analysis and internal audits. Quality control should be designed to detect and eliminate data anomalies recorded during the logging process, sensor and data transmission failures A detailed, more technical description of wind measurement, data quality control and forecasting is included as Appendix A.

13 The adjustment of site data against long-term historical data is a check on forecast accuracy. Inter-year variability of wind resource is also reviewed. The length of the historical reference period and homogeneity and quality of data over that reference period are assessed. While there may be 50 years of wind data from nearby sources, only the most recent ten or 15 years may be sufficiently uniform without discontinuities caused by changes in collection procedures. The actual measured site data are correlated with the long-term dataset. CONVERSION OF WIND RESOURCE FORECAST TO POWER FORECAST Proven wind flow modeling techniques are used to extrapolate wind measurement data at each proposed turbine location. Error estimates introduced by wind flow modeling should be identified by the resource consultant. Approved software is used to test various turbine configurations to optimize power output. The software uses numerical wind flow model results as an input and applies estimates of wake interference and shear. An overall error estimate for the wind resource forecasting should be calculated. For example, anemometer measurements have an estimated uncertainty, assuming good data quality, of 1.5% to 2.5%. With redundancy of measurement (two anemometers per mast), this falls to between 1.1% and 1.8%. 6 The wind resource forecast forms the basis for the power production forecast. A starting point for estimating the power output of a wind farm is the manufacturer s turbine power curve. The turbine power curve is a function relating power output to wind speed. The shape and location of the curve is defined by (1) the starting speed (also called the cut-in speed), which is about 3 m/s to 4 m/s and is the speed that first causes the turbine to turn; (2) an operating range, which is represented by a rising positive slope as output rises with increased speeds; (3) a maximum output at a maximum-rated speed (typically 13 m/s to 15 m/s) where the turbine reaches its rated capacity; and (4) a cut-out speed, where wind speed is too high for safe turbine operation. TECHNOLOGY RISK While wind turbine technology is relatively mature based on a number of model generations and increasing size and efficiency, with consolidation of market share by top manufacturers, it is expected to remain a competitive sector with evolving technology. As such, DBRS pays considerable attention to the technology utilized, including loss and availability assumptions, which are based on the track record of the equipment and the supplier, the specific model type and expected performance of the maintenance program. (Availability is the ratio of hours of normal turbine operation to hours of eligible operating wind conditions.) European system availability is estimated at 97%. North America system availability for new projects is about the same, although it can be several percentage points lower for older wind projects. DBRS notes that the IE s opinion of the reasonableness of the maintenance program is particularly important in this regard. Insurance should be verified as consistent with market standards, reviewed by an insurance consultant and evidenced by the provision of annual insurance certificates. Turbine performance adjustments for field conditions can be between 2% and 3%, icing between 0.5% and 1.0%, and blade degradation between 0.5% and 1.0%. These are annual levelized adjustments and not cumulative reductions in production that grow over time. The resource consultant s projection includes estimates of all sources of power loss as part of the overall forecast that forms a project base case. As part of its assessment, DBRS reviews the reasonableness of loss assumptions as these can potentially be a material source of error in the power production forecast. As such, projects already in operation and with a meaningful period of production data ( 1 year) may be viewed somewhat more favourably by DBRS as actual data should validate loss assumptions and reduce uncertainty estimates. Investment grade projects are expected to utilize well-established technology with a track record of stable performance. New technology would require a warranty significantly exceeding the standard two-year coverage and even then would not likely support an investment grade rating. 6. Wind Resource Assessment: A Practical Guide to Developing a Wind Project, First Edition. Michael C. Brower, et al John Wiley & Sons Inc. 13

14 OPERATION AND MAINTENANCE The O&M functions of a wind project are often performed by an affiliate of the equity sponsor but can also be provided by a third-party operator. In each case, DBRS assesses the degree to which the O&M contract incentivizes operator performance through rewards and penalties, although there is a fundamental alignment of operator interest with its parent equity sponsor in the case of an affiliate. In addition, this affiliate approach, or owner-operator strategy, is a common practice for some of the most active market participants with the largest portfolios of operating assets. The owner-operator strategy benefits from centralized monitoring of wind project performance and economies of scale and expertise achieved by using the same operator entity for entire wind portfolios. Whether or not the operator is an affiliate of the equity sponsor, DBRS will carefully assess the track record of the operator and its financial and technical capability to perform and review the IE s analysis of same. In certain cases, turbine suppliers may provide long-term service contracts and these are viewed favourably by DBRS. Mechanical systems generally degrade from ordinary wear and tear, require regular servicing, and have finite lives ending in equipment replacement. Wind turbines have asset lives of up to 25 years and, except for periodic replacement of turbine blades and occasional replacement of other components, generally achieve stable performance of their respective power curves over the asset life. Operating period budgets usually include routine maintenance costs and estimates for unplanned maintenance for overhaul or replacement of equipment. The longer the particular equipment s performance history, the more observations the dataset is likely to contain. Two periods are typically the most critical: the teething period at the beginning of the operating period and the potential for equipment underperformance or failure near the end of the asset life. Maintenance reserves based on look-back and look-forward tests increase confidence that performance will be optimized. There are a number of sources of typical operating and routine maintenance costs, including the International Energy Agency, the European Wind Energy Association and the National Renewable Energy Laboratory. Estimated costs vary between USD 10/MWh and USD 15/MWh or approximately 10% to 20% of project revenue, depending on installed capacity and the PPA tariff. As such, a project will generally show limited sensitivity to moderate deviation in maintenance needs. Guidelines for major maintenance are prescribed by the manufacturer, checked by the IE and included in the base case budget. Turbine and balance-of-system maintenance are not based on a schedule of checks triggered by specific total hours of operation, but instead depend on anticipating and responding to underperformance or failure of equipment components. INDEPENDENT ENGINEER S REPORT OPERATING PERIOD In addition to providing expert analysis and conclusions for project construction, the IE and resource consultant reports are important inputs to considering the risk for both construction and operating periods. The IE and resource consultant usually generate separate reports, and the IE may also review the wind resource forecast and power production forecast of the resource consultant and its report. The IE report should include the following key items in its scope of engagement: Audit of all material components of site wind data measurement and quality, including Number, location/altitude, calibration and mix of anemometers and sensors. Quality assurance program (or compliance with the program, if the project is not greenfield). Measurement system reliability (data recovery percentage). Security, storage and validation and verification of data. Plan to revise the production forecast after a year of operation as the project may now use actual operating data instead of simulated figures. Greenfield projects may have higher forecast errors than operating assets with several years of performance data. Review of the O&M budget for any location, capacity factor and equipment details that may affect the O&M cost assumption. 14

15 Review of proposed major maintenance (in addition to routine maintenance costs) and the frequency and costs of overhaul and replacement. IE conclusions, which should include overall error estimates related to the forecast wind distribution and power production. RESOURCE CONSULTANT REPORT The resource consultant report should include the following key items in its scope of engagement: Confirmation of wind maps used in site selection and the quality of the methodology and data collection for the wind maps. Assessment of data review for anomalies, turbulence and adjustments made for differences between anemometer altitude and planned turbine altitudes. Audit of permanent record of key instrument settings, as well as logger instrument and converted data. Record of site visits confirming sensor configurations, in particular where the resource consultant was not responsible for managing the data collection campaign. Track record of vendors used in installation, maintenance, data validation and reporting. Comparison of site data years with long-term weather cycles, which are assessed to ensure that a sample period is not occurring at a peak or a trough, or a period that is otherwise anomalous. Analysis of correlation with nearby sites and broader regional data. If correlations are low, then longer data samples may be required at the site. Assessment of quality and continuity of data sets used for long-term correlation calculations. Review of accuracy of wake interference modeling, topography effects and adjustments to site data for wind shear. 15

16 Sponsorship, Legal, Financial and Other Considerations SPONSORSHIP An established, reputable equity sponsor with previous experience as a wind project investor will bring expertise to new projects and is more likely to closely monitor construction progress, provide guidance to the project s management and contribute a sense of urgency to early detection and timely resolution of problems. Project credit quality is supported by a sponsor with a proven track record, a significant volume of wind project completion and/or a portfolio of owned/managed wind assets, and experience throughout the wind power value chain (including turbine vendors, developers, financial equity and EPC market participants). Sponsors that have worked closely with a number of suppliers and contractors and have consistently completed wind projects on time and on budget will be viewed favourably. A single controlling sponsor with a reputational or strategic stake in a project is also a rating strength and is usually superior to multiple sponsor partners with limited and/or passive investment strategies. Somewhat less satisfactory are investment grade companies with a track record in the power sector but limited experience with wind asset development and ownership. DBRS expects a sponsor to be qualified to manage the construction, operation and maintenance of a utility-scale wind project. When a sponsor is not qualified or sufficiently experienced (particularly in the context of an owner-operator model) the project may not be rateable. DBRS notes that the project s rating does not incorporate any expectation of sponsor financial support in excess of contractually obligated amounts. LEGAL AND REGULATORY Special Purpose Vehicles Unlike a traditional securitization transaction where self-liquidating financial receivables are securitized in a true sale to a bankruptcy-remote SPV, obtaining complete isolation from the bankruptcy estate of a parent company is more difficult for SPVs created for project finance assets. These operating asset SPVs typically engage in a wider, although still limited, range of activities, creating the potential for broader credit risks or business liabilities compared with the typical passive securitization trust. Project finance transactions, however, are usually only structured to achieve ratings in the BBB/A range, unlike structured finance ratings, where AAA ratings are commonplace. In evaluating the merits of an SPV structure for project finance in the BBB/A range, DBRS will typically expect to see the separateness covenants and other transaction features noted below maintained through the life of the transaction. Separate legal identity organized for the sole purpose of carrying out the relevant business with restrictions on (1) changes in the business activity of the SPV; (2) commingling of assets with the parent or any other person; (3) disposition of assets; (4) additional assets; (5) additional liabilities; (6) the granting of additional security; and (7) amalgamating, merging or joining with another entity or otherwise reorganizing. Bank accounts, financial statements and books, and records separate from the parent or any other person. Covenant of the SPV to hold itself out as a separate person from the parent or any other person and to conduct business in its own name. Covenant of the SPV to maintain an arm s-length relationship with its parent or any other person. Covenant of the SPV to pay its own expenses and liabilities out of its own funds. Restrictions on guarantees to and from the parent or any affiliate. Organizational documents that include separateness covenants as well as a covenant to maintain the SPV structural features throughout the term of the transaction. 16

17 Creditor Cure of Contract Defaults and Security Provisions Project financing relies on contracts with the SPV. Lenders should be informed of any default by the SPV under its contract obligations and should have the ability to cure SPV defaults. Security provisions are an essential feature of a project financing arrangement. Generally, bondholders will have a first-priority, perfected senior security interest mortgage, hypothec and/or other appropriate security over the assets of the SPV, including any cash flows and contractual rights of the SPV. In a default by the SPV, bondholders should be able to obtain control of the SPV s assets and should also have the right to take over any contractual rights and obligations of the SPV, including the assignment of cash flows. Dispute Resolution Most projects have a prescribed process for settling commercial disputes between ProjectCo and the revenue counterparty or between ProjectCo and its contractors. When evaluating a dispute resolution process, DBRS looks for an efficient, timely and transparent framework that limits the automatic requirement of legal recourse and supports continued construction or operation while a dispute is ongoing. Legal Opinions DBRS will typically expect to see opinions covering, among other things, (1) the creation and legal existence of the SPV; (2) the power, authority and capacity of the SPV to enter into various binding project agreements; and (3) the validity, perfection and enforceability of the security granted to the security holders. DBRS may also require a non-consolidation opinion. DBRS expects to be named as an addressee on all such legal opinions that may be required by DBRS. Insurance In general, DBRS evaluates the amount of insurance coverage compared with (1) the force majeure provisions of the key contracts, (2) the replacement cost of the project and (3) the extent of potential business interruption. Bondholders should be an additional insured party and be able to choose whether the notes are paid out or the plant/asset is rebuilt or replaced. If insurance premiums are not paid by the SPV, bondholders should be notified and no changes to the insurance coverage should be made without the consent of bondholders. Insurance coverage must be from an institution with a reasonable credit rating compared with the project debt rating and may be evaluated by an independent insurance consultant for bondholders. The SPV should be required to provide annual insurance certificates proving continuing adequacy of coverage and compliance with project terms. Insurance renewal risk is present in most projects, although in the normal course, insurance premiums are a small percentage of overall operating costs. Most projects have the ability to absorb a significant multiple of base case insurance premiums, and while shortages in global insurance capacity do occur, they are generally short-lived. Expert Reports In most project finance transactions, bondholders retain experts such as independent engineers, resource consultants, insurance consultants, environmental consultants and market consultants in order to aid in assessing the level of many of the types of risk mentioned above. Issues that require expert evaluation may include (1) environmental assessments of potential liability (such as pre-existing conditions and the risk of lender liability when enforcing security rights); (2) construction process, schedule, and costs; (3) O&M costs; (4) operating requirements of the off-take agreements; and (5) various other matters, including financial projections, asset quality and the condition of existing projects, adequacy of the insurance package and, for renewable generation, a resource study forecasting expected production levels. It is preferable that independent experts be engaged on behalf of investors, who are then entitled to rely on the reports to minimize any potential conflicts of interest. 17

18 Regulatory Matters The political commitment to renewable energy subsidies within the jurisdiction is assessed. Growth in wind assets has been most rapid where policy support ensures above-market feed-in-tariff prices. However, even in highly rated economies, some risk exists of future economic and political pressure for revision to subsidized power prices for renewable energy projects. DBRS reviews the history of the legal jurisdiction to assess the risk of renegotiation of high-tariff PPAs. Where there are cut-off dates for policy subsidies, DBRS evaluates the risk of failing to commission a project within a prescribed deadline. The PPA is carefully reviewed to assess the counterparty s obligation to pay and the project s obligation to perform. Power Purchase Agreement An investment grade PPA counterparty with a contracted tariff schedule sufficient to generate robust project debt service coverage ratios (DSCRs) is a significant rating strength. Where a PPA includes exposure to market prices, DBRS will apply sensitivity analysis to assess the ratings impact, although DBRS notes that even modest merchant exposure is likely to cause a ratings impact. PPAs are assessed for the reasonableness of availability thresholds or minimum output requirements, if any, and the term of the agreement should be at least one year greater than the project s debt maturity. The primary credit value of a PPA is the long-term price certainty provided to the project. Other contractual mechanisms can be used to achieve the same aim, such as a contract-for-differences or price hedging. DBRS may consider alternative revenue contracts as equivalent to a PPA in this regard, recognizing that other risks may be transferred to a counterparty under a PPA. For example, a PPA may allocate the transmission system interconnection risk or some force majeure events to the counterparty, whereas under a price hedging arrangement these risks would remain with ProjectCo. Where a project involves construction risk, the PPA should allow for a construction schedule overrun without immediately terminating. DBRS will consider the amount of time between the target completion/ generation date and the point at which the PPA counterparty may terminate the PPA. If this period is too short, the ProjectCo may not be able to replace either the EPC contractor, turbine supplier or other subcontractors in a timely enough fashion to avoid a default. Wind projects that involve the construction of new transmission may be exposed to risk of delays in interconnect approval and commissioning. Where new transmission is outside the project scope, the PPA should provide relief against grid connection delays. A DBRS rating is provisional until approvals have been met and is only finalized once all required authorizations have been granted. FINANCIAL RISK Wind projects are structured with many of the traditional project finance features. Analysis of financial risk includes assessment of certain metrics, scenario and break-even analysis, and key financial terms based on a conservative approach to the early-stage wind project market. DBRS considers project metrics and related scenario and break-even analysis in the context of all other critical rating factors. That is, the overall profile of debt service coverage is a guide and does not, strictly by itself, determine a specific rating. Metrics The primary metric for a BBB (low) rating is a minimum P90 DSCR of 1.35 times (x) for a greenfield project or 1.3x for an operating asset with one year s operations, and where the financial model has been validated with a true-up process, adjusting the production forecast for actual instead of simulated performance. These levels of coverage assume a 100% contracted single location project with no merchant risk. DBRS confirms a base case using peer group data to support a most likely set of financial and operating assumptions including resource volume, energy production and O&M costs. 18