Due Diligence on Wind Farm Assets

Abstract

The purpose of this article is to assess the importance and the procedure of applying due diligence as a measure to evaluate financially, technically and legally a wind farm asset. When an investor is interested in acquiring a certain asset or obtaining a loan for development of a project, he needs to be aware of the risks, costs and benefits that might be laying under a hypothetically healthy investment. This is the reason why, especially when the funds are sourced from a bank or a financial institution, due diligence might be held from an independent third party with the scope of providing subjective judgement. Or even as an equity holder or project owner, a thorough mitigation of all the risks involved is suggested in order to assess the viability of a project, enabling clients to make a fully informed decision before investing any money .

Many consultancy companies that take action in the development, construction and operations phase of wind farm assets provide this kind of service as well and usually are assigned to deliver the due diligence report. When it is being held in the preconstruction phase, it helps determine and ensure the timeframes of the project. The more aspects this process covers, the more secure can the finance and loan conditions be considered since the quality and amount of information processed is enhanced leading to wise decision making. It is considered a good business practice with the data acquired contributing to a secure and safe lifecycle.

Due diligence is instantly related to project management since it establishes the foundations for a safe and efficient development, operation, management and strategy from the side of the investors. Every project needs a coordinated effort by a team of engineers to apply their experience and knowledge on assessing it and evaluating it. Emphasis is given in addressing all the key figures and risks when applying a due diligence practice. The clarification of this method through this article can strongly benefit investors and lenders in need of bridging their financial but also the managers, by securing their strategical planning, minimizing the risks and handling successfully their portfolio (2).

Why Due Diligence?

It is a legal and business term meaning “reasonable investigation” and is defined by the constitution. When brokers or consultants are accused of inadequate disclosure to investors of material information that define a project when it comes to selling equities, due diligence defence is used to prove the integrity of their position. In addition, this method is used to compare different projects mostly regarding costs and schedules, so the budget will not irrationally be over exceeded.

When it comes to wind farm assets, specific aspects raise awareness which include possible overestimation of production, unreal performance, deficient maintenance, unclear operational agreements, missing log files, misused equipment, lower operational costs or legal obstacles (3). Environmental standards should be met, social impact of the problem taken into account, thorough investigation of the affected stakeholders of a particular project be done and the profitability of it calculated with realistic uncertainty.

To scale it down, this method has been sufficiently determined as a combination of risk assessment, character and performance checks involving the third parties related to the project along with feasibility studies . That way it is possible to achieve lower interest rates and better insurance conditions for a project.

Financial Assessment

Renewables are playing a bigger role year by year in the markets and cause increased capital accumulation in their whole supply chain along with all the services that surround the facilities. Capital intensive investments might lead developers to not being able to finance a project through their capital reserves, causing them to turn to other financing options. Many types exist like Corporate Finance and Capital Market Finance but the most usual is the Project Finance scheme provided by banks that require a detailed due diligence from the investor’s side, developing and contributing with his own equity which determines the liability of the company. Similar to any other business sector, renewable energy facilities might change ownership during their lifecycle or might need to be certified that they follow the standards.

The financing form is chosen according to the maturity of the financial sector, the energy market and the project developer’s experience. Afterwards the loan is paid back by the generated, stable and forecastable cash flows, coming ideally from a reliable public support scheme or a long-term power purchasing agreement. That is why, renewable energy facilities are being developed mostly in countries with stable political situation which have established a supporting background for “green technologies” penetration (4).

The bank takes into account the expected cash flows generated annually and the risks of the project in order to approach the reliability and projectability of the future cash flows. Those financial risks during the planning phase are identified in the wind resource availability, the situation of the insurance services in the country, the feed-in tariff and the electricity spot price. The feasibility study takes place with the scope of investigating on an annual base the cash available for debt service, the equity cash flow and the key financial project ratios (4).

Prevailing market price methodology is also applied to verify the prices of the equipment provided by manufacturers or retailers . Including a strategy for decommissioning after the lifecycle of the plant, contributes positively to reducing the risks of local opposition.

It is becoming more and more important when developing a project or obtaining the ownership of one, to apply environmental risk management. Some key aspects will be addressed underneath following the procedure of risk identification, assessment and finally treatment:

• Impacts on asset values: Cleaner materials and energy efficient practices lead to increased value of investment. The opposite happens due to contamination or environmental obsolescence of equipment.

• Inability of borrowers to repay loans: Increased taxation and limitations to emissions or cleanup procedures might lead to fines and penalties if not followed according to the standards.

• Lender or investor liability: Environmental violations trigger the authorities to investigate on the causer. This is not something in favor of the investor or lender so the limits should be clarified especially when it come to obtaining a wind farm asset.

• Reputation impacts: Poor environmental performance might affect the public image, market position and future business of the possible lender or investor (6).

Stakeholders Approach

An impartial overview of the stakeholders involved in the project should be done since a wind energy facility affects many different groups of people. The highest risk spotted here would be the existence of strong opposition local groups, environmental organizations or local authorities who would protest against the construction of a wind farm in their area. These are facts that should be acknowledged by the investor or lender since these groups could delay a lot the project or demand high compensations. Relevant risk treatment and mitigation measures should be designed. In case a project is already operating but changes ownership, the scenario of expanding the capacity of the wind farm or switching to repowering after its lifecycle ends, could crash into many barriers by the above stakeholders.

Barriers in Due Diligence

Like in every procedure, some obstacles can define them and set the alarm for future improvement. Regarding due diligence, there has been spotted lack of specific technical expertise for the performance since it sometimes requires proper training and only big corporations might be in position of accepting this task. Perception barriers due to insufficient level of knowledge from wind farm investors who can be detected in non-corporate frames and develop collaborative small-scale distributed projects. Information availability is uncertain as well while all documentation might be hard to obtain. Lack of governmental and other institutional support might not motivate potential developers or lenders to undergo this procedure with integrity, especially in developing countries. Being a capital-intensive type of investment, a renewable energy investor might judge transaction costs as being too high for review procedures (10).