A customer tells you he wants to put a commercial-size wind turbine on his land and would like your bank to finance a portion of the project. The customer explains that he wants to use the Vestas turbine because of its high efficiency rating and that with this turbine he could operate at approximately a 42% “capacity factor” based on the wind resource above his land. He tells you that he has a power purchase agreement with a local electric cooperative and that everything is ready except completion of the interconnection study by the MISO. Your interest is high because you have seen the large turbines on the horizon while traveling through southwestern Minnesota and were amazed by the size of the turbines and blades. However, before going forward with the wind energy project, your bank must consider several issues to properly underwrite and document the financing.
Before a bank can properly underwrite and document a wind project, it must understand:
- the costs and risk in developing a wind project,
- how much gross and net income the wind project can generate,
- the risk relating to operating a wind project, and
- how to properly record a security interest in the project and its revenue.
Examples of development and operating issues the bank should consider include:
- What is the “capacity factor” of the wind turbine (the relationship between the actual production and full capacity)?
- Does the developer have a power purchase agreement (an agreement to sell the wind energy)? Does the power purchase agreement contain a curtailment clause that allows the purchaser to elect not to purchase the delivered electricity?
- How much does the wind project cost to develop?
- What are the expected gross revenues of the wind turbine?
- What kind of operating expenses does a wind turbine incur?
- Is the wind project being developed with the assistance of an equity investor who invests in the project to make use of federal “production tax credits”? Will the project be in commercial operation before the expiration of the credit?
- What type of turbine will be used and what is its warranty?
- Does the project manager have experience in operating a wind project?
The bank also needs to document the loan and structure its collateral properly. The bank should consider the following collateral and documentation issues:
- Should the bank require a reserve for catastrophic events, e.g., a mal-functioning generator outside the warranty period that could cost hundreds of thousands of dollars to fix?
- Does the developer have proper access rights to the wind turbine location and do those rights extend to the bank?
- Who owns the wind turbine land? If the land is leased, who needs to consent to the bank’s leasehold mortgage?
- Does the bank have the ability to assume the power purchase agreement, the warranty agreement, and the management contract?
Each wind turbine project is different, and the bank should consider each unique circumstance to insure proper loan underwriting and documentation for a wind energy project.
Dan Yarano is co-chair of Fredrikson’s Energy Practice Group and represents banks and other financial institutions in connection with the financing and development of wind projects. Dan is a member of the board of the Wind Energy Council.