Alternative Energy Investments

Alternative Energy Investments Roads? Where we re going we don t need roads American College of Investment Counsel Spring Forum May 1, 2015

Panelists Jerry Hanrahan Vice President - Team Leader, Power & Infrastructure, Bond & Corporate Finance Group, John Hancock Financial Services Anthony Goodman Counsel, Babson Capital Management LLC Eli Hinckley Partner, Sullivan & Worcester LLP Page 2 5/1/2015 Alternative Energy Investments

Why alternative energy? Active industry Many opportunities for infrastructure investments Factors driving investments expected to continue, at least in the near term Public policies favoring green energy Abundance of cheap domestic natural gas Page 3 5/1/2015 Alternative Energy Investments

Introduction Trends in investments in the energy sector Renewable energy Tax credits State incentives Recently built merchant gas-fired generation Page 4 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Three general areas of funding for alternative energy projects: Debt Equity (including tax equity) Government subsidies and other incentives Page 5 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity Debt Subsidies Collateral Agent/ Paying Agent Project Company Offtake Purchaser(s) Operator EPC Contractor Project Operating Expenses Reserve Accounts Project Sponsor Project Assets Key Contractual Relationship Collateral Cash Flow Page 6 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Key Elements of Project Finance Model Single-project special purpose entity Investment grade offtake purchaser(s) Secure cash flow long-term offtake contract(s) Lockbox for payments Waterfall payment structure Reserve accounts Lien on all project assets/all project equity Step-in cure rights for key contracts Page 7 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Collateral for Loans Lender must be able to step in and own/operate or sell project after a default lender is inchoate project owner Collateral includes all projects assets: Equipment and other tangible assets Real estate Contract and warranty rights Intellectual property Permits (if allowed) Lockbox accounts Collateral typically includes pledge of all project equity Page 8 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity and Tax Equity Pass-through Entity for Federal Income Tax Purposes Limited liability company Limited partnership Different Classes of Equity Interests Distribution Preferences IRR triggers Carried Interest for Developer Page 9 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity and Tax Equity Tax equity driven primarily by opportunity to realize federal income tax credits Production Tax Credits Investment Tax Credits Generally passive investors other than manager/gp Income tax credits only matter to investors with income to be taxed Impact of recession on tax equity Page 10 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity and Tax Equity Passthrough nature of Project Company permits equity investors to use tax credits 10-year term of PTC creates flip structures: Change in ownership percentages after flip IRS requirements for flip Recapture of ITC for certain transfers of interest in first five years after placed in service Page 11 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity and Tax Equity Notices of Defaults on Debt Standstill Period Potential Cure Rights Page 12 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Equity and Tax Equity Management Issues Minority voting and veto rights FIN 46 issues consolidation on balance sheet Voting deadlocks and buyout provisions Transfer Restrictions Prohibitions if impact on regulatory status Right of first offer/first refusal Federal Power Act Section 203 issues Page 13 5/1/2015 Alternative Energy Investments

Production Tax Credits 26 U.S.C. 45 - Per kwh tax credit for energy produced by certain technologies: Wind Biomass Poultry waste Basics of Investing in Alternative Energy Marine/Hydrokinetic Municipal solid waste Geothermal Solar Hydropower Refined coal Page 14 5/1/2015 Alternative Energy Investments

Basics of Investing in Alternative Energy Production Tax Credits Currently 2.3 /kwh (wind); $.011/kwh (other technologies) Adjusted annually for inflation 10-year period to realize credit from date placed in service Construction must have started by 12/31/13 Continuous construction requirement Page 15 5/1/2015 Alternative Energy Investments

26 U.S.C. 48 Basics of Investing in Alternative Energy Investment Tax Credits 30% of qualifying project costs for solar/fuel cells/small wind/ptc-eligible technologies 10% for geothermal/microturbines/chp Must choose between ITC and PTC Step down to 10% after 2016 Page 16 5/1/2015 Alternative Energy Investments

Do we need to renew/replace the ITC and PTC for Alternative Energy to be Viable? Securing financing large scale projects small scale projects Competition in market Advancement in technology Declining energy costs of renewables Other subsidies Future of Tax Credits Page 17 5/1/2015 Alternative Energy Investments

Investment Structures Real Estate Investment Trusts ( REITs ) Sub-category of a corporation Corporate purpose is to own real estate assets REITs do not pay corporate taxes Must distribute 90% of taxable income to investors REITs raise $$$ and use to purchase real estate assets REIT cannot sell inventory Energy sales are sales of inventory for these purposes Page 18 5/1/2015 Alternative Energy Investments

REITs and Renewables Renewable transactions as lease or loan Fixed yearly payment for right to occupy/operate renewable energy asset Definition of Real Property Each asset of a renewable project must be tested Analysis done on asset by asset basis Structuring Using a REIT as a Developer Investment Structures Using a REIT as Owner/Manager Page 19 5/1/2015 Alternative Energy Investments

Investment Structures YieldCos Entity that owns cash-generating (operating) infrastructure assets Offered in public markets Typically lower risk Tax benefits Page 20 5/1/2015 Alternative Energy Investments

Investment Structures Project Portfolios Small size of renewable projects can make financing uneconomic due to transaction costs Warehouse Standard terms with same lender(s) for multiple projects Portfolio Bundling of multiple projects in portfolio Loans through holding company structure Multiple borrowers or guaranty structure Permits spreading of risks Additional expense if projects not standardized Page 21 5/1/2015 Alternative Energy Investments

Investment Structures Solar RECs and Solar Leases Solar/REC Leases Lease to own structure for solar system Capital Lease vs. Operating Lease Low up front costs Tax treatment of lease payments Shorter term than PPAs Environmental attributes typically owned by customer Page 22 5/1/2015 Alternative Energy Investments

Investment Structures Project Risk Factors Completion Risk: technology risk, contractor qualifications, construction contract terms Operation Risk: qualified operator, maintenance plan, technology Resource Risk: resource reliability, energy production forecast Offtake Risk: offtake sales arrangement, purchaser strength Regulatory risk: stability of any regulations forming basis for economics Page 23 5/1/2015 Alternative Energy Investments

Emerging Due Diligence Issues Utility Concerns with Long-Term PPAs Declining customer usage Distributed generation causing further erosion Long-term liabilities spread over declining base Out-of-region resource challenges Necessity of outside hedges Change in law risks Page 24 5/1/2015 Alternative Energy Investments

Emerging Due Diligence Issues Constitutional Framework Supremacy Clause U.S. Constitution, Article VI, Clause 2: This Constitution, and the laws of the United States which shall be made in pursuance thereof; and all treaties made, or which shall be made, under the authority of the United States, shall be the supreme law of the land; and the judges in every state shall be bound thereby, anything in the Constitution or laws of any State to the contrary notwithstanding. Preemption Legal doctrine developed by courts based on Supremacy Clause. Any state law that conflicts with a federal law is preempted and is void. Page 25 5/1/2015 Alternative Energy Investments

Emerging Due Diligence Issues Recent Constitutional Cases PPL EnergyPlus, LLC v. Nazarian, 753 F.3d 467 (4th Cir. 2014) ( Nazarian ) Program at issue solicited proposals for construction of new power plant, winner got a fixed 20 year Contract for Differences that state would compel Utilities to sign Generator was paid difference between wholesale price and the Contract for Differences Price Court found preemption existed because the compensation under the Contract for Differences superseded the price in the federally regulated wholesale market PPL EnergyPlus, LLC v. Solomon, 766 F.3d 241 (3rd Cir. 2014) ( Solomon ) New Jersey s Long Term Capacity Pilot Program Act ( LCAPP ) instructed the New Jersey BPU to offer Standard Offer Capacity Agreements for 15 year terms (similar structure as Contracts for Differences) Court found preemption existed because the LCAPP program superseded wholesale prices in PJM Allco Finance Limited v. Klee, No. 3:13cv1874, 2014 U.S. Dist. LEXIS 170674 (D. Conn. Dec. 10, 2014) ( Allco ) At issue is Section 6 of Connecticut Public Act 13-303 that gives the Commissioner of the Connecticut Department of Energy and Environmental Protection ( CT DEEP ), authority to solicit proposals for renewable power and compel utilities to enter into PPAs Court found no preemption because bidders came up with prices, not CT DEEP Page 26 5/1/2015 Alternative Energy Investments

Emerging Due Diligence Issues Allocating Change of Law Risks Incentive Structure Changes New incentives Repealing/changing existing incentives Who should bear the risk of a change in the law? Seller vs. Buyer Compliance representation as of date of agreement Cap cost of compliance Commercially reasonable efforts to comply Page 27 5/1/2015 Alternative Energy Investments

Emerging Investment Opportunities Emerging Technology: Offshore Wind Recent Offshore projects Deepwater Wind, Rhode Island Transmission assets purchased by utility in 2015 Wind farm to begin construction in 2015 Cape Wind, Massachusetts PPAs terminated in 2015 Construction stalled Fisherman s Energy, New Jersey NJPUC denial of approval in 2014 (appeals pending) Construction for underground transmission began 2015 Page 28 5/1/2015 Alternative Energy Investments

Emerging Investment Opportunities Emerging Technology: Energy Storage and Smart Grid Smart Grid or Grid Modernization Improve grid efficiency and reliability Better integration of renewable energy/storage tech. State approaches to implementation Privacy concerns Energy Storage Thermal storage Compressed air storage Energy storage services when utility rates are high Page 29 5/1/2015 Alternative Energy Investments

Emerging Investment Opportunities Evolving Capacity Markets Capacity payments compensate generators for being available Capacity Payments as revenue stream for generators Without capacity payments, units that operate only during peak demand times would require huge payments to recover their full costs during few hours of operation Capacity Markets Commitment to pay generators for capacity several years in advance Some generators can get a multi-year commitments enough to support financing? Penalties for failure to deliver power if/when called in peak demand periods Page 30 5/1/2015 Alternative Energy Investments

Financing Emerging Investment Opportunities Merchant Transmission Prior FERC limitations on allocation of transmission capacity other than through open season competitive process and impact on financing options Evolving FERC policy to permit early allocation of 100% of transmission line capacity through negotiation Increase in available funding for merchants from: Private equity, transmission developers, construction companies Merchant transmission rates Merchant provider must obtain negotiated rate authority Page 31 5/1/2015 Alternative Energy Investments

Questions? Paul Belval: pnbelval@daypitney.com Anthony Goodman: AGoodman@Babsoncapital.com Jerry Hanrahan: jhanrahan@jhancock.com Elias Hinckley: EHinckley@sandw.com Page 32 5/1/2015 Alternative Energy Investments