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 to be held in order to assess the viability of a project, enabling clients to make a fully informed decision before investing any money (5).

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. The clarification of this method through this article can strongly benefit investors and lenders in need of bridging their financial gaps between them but also the managers, by securing their strategical planning, minimizing the risks and handling successfully their portfolio (9). This is all for investors and managers that

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 defense is used to prove the integrity of their position. Also 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 this particular project be done and the profitability of it calculated with realistic uncertainty. To scale it down, this technic has been sufficiently determined as a combination of risk assessment, character and performance checks involving the third parties related to the project and feasibility studies (5). That way it is possible to achieve lower interest rates and better insurance conditions for a project.

Background Financing 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 bank which requires a detailed due diligence from the investor’s side who develops and contributes with own equity which determines the liability of the company.

The financing form is determined 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 who have established a supporting background for “green technologies” penetration (1).

The bank takes into account the expected cash flows generated annually and the risks of the project in order to determine 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 (1). Prevailing market price methodology is also applied to verify the prices of the equipment provided by manufacturers or retailers (5). A very used method from banks nowadays is to gather multiple balance sheet projects in a single portfolio and arrange a loan that will cover it entirely due to the emerging number of involved companies in the sector (2).

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. Contracts - Legal A very important notice is whether or not a wind farm asset is being developed, operated and managed inside legal limitations. The tailor-made due diligence team that is going to focus on the project is summoned to review all the relevant contracts to ensure there are no technical risks and everything is under compliance. Among others that should be reviewed are the turbine certifications, the electrical design parameters, the grid compatibility, building permissions, remuneration and the power purchase agreements (4). The risks that are being taken into account during the due diligence procedure involve the following: Investment phase • engineering, procurement and construction contractor • Turbine supply agreement • Balance of Power contract (BoP) • Grid connection and usage agreement Operating • Power Purchase Agreement (PPA) • Land rights contracts • Operation & Maintenance Agreements • Insurance contracts Financing • Project finance loan agreement • Shareholder agreement • • manufacturer’s market share • how broadly is the specific technology used or proven? (1) Possible violations of legal aspects might be found • Legal risks: Contractor insolvency, breach of contract • Market and Political risks: Price and currency fluctuations, legal system change, civil commotion, war, terrorism • Probability of natural disasters in the area or extreme weather events. • Technical risks: Faulty design, materials, construction performance, labour conditions, health, safety in the workplace, land acquisition • Construction risks: Ground risk, interface risk, permit compliance, foundation and turbine installation (8). • Environmental risks: Biodiversity and conservation of it, pollution during construction, impact on landscape, effluent emissions, on-site contamination, hazardous materials • Economic risks: Cost of construction, supplies, maintenance. (5) Performance The main factor that is used to evaluate a potential wind energy project or an existing one is the meteorological conditions that take place in the specific are of interest. Strong and stable winds indicate an investment opportunity with safe financial figures like positive Net Present Value and Return of Investment higher than the interest rate. Those winds that define a site are extracted from a thorough Wind Resource Assessment using advanced numerical analysis tools which include linear or Computational Fluid Dynamics based software packs. The target is to determine the net yield of a wind farm, the probability of wind availability, the fluctuations in production and the loads that the turbines are expected to undergo (Wind Classification) (8). The initial phase is to define the measurement campaign as reliable, appropriate and standard complying. Next step is to assess those measurements taking into account the micro-meteorology of the site using the tool mentioned above and finally introduce safe uncertainties estimation and technical losses factors. It is of high importance to compare actual performance with the theoretical turbine efficiency since various power boost and optimization programs have been launched by the manufacturers in order to promise higher performance (8). IEC compliance and discrepancy investigation ought to be carried out to ensure the turbines are performing according to their standards because complex winds and harsh weather conditions (extreme heatness, below zero conditions, sand, sea salt, degradation) shorten the efficiency of the blades. Downscaling to key performance figures which are crucial in a due diligence report, the ‘exceedance cases’ of the Wind Resource Assessment play a major role in defining the willingness for bankability. Representing the minimum estimated production for 50% of the time (P50) and for 90% of the time (P90). Extra liquidity might occur in parallel with promising values of the ‘exceedance cases’ Cost overruns and delays more obvious here but also easily prevented. Since the turbine costs accounts for approximately the 75% of the project, suppliers and companies involved in the project as subcontractors or third parties are being brought to the due diligence spotlight, especially for offshore where the costs double and further assessment should be conducted. If the erecting of the wind turbines comes with committed services and offers from the supplier, comfort and security will have higher chances to appear since the supplier shares his knowledge of his product for the first years obtaining responsibilities in the project also in the operational phase (5). It is important for the lenders to check the creditworthiness of the participating supplies die to the fact that strong financial platforms mean lower potential warranty problems and honour availability guarantees. Experienced, well-established equipment providers who are directly related to good reputation and broad portfolio can contribute in bridging potential finance gaps with financial institutions and creditability agencies. The profitability and safety between short-term and long-term contractual agreements should be investigated

External Pol sit / credit With detailed mechanisms insurance, currency hedging, contingency funds, lines of credit and the guaranteed capital of the owner ought to be reviewed Environmental The Environmental Impact Assessment will need to be revisited due to the trendline of the few past years of banks adopting environmental and social policies. By following strictly the legislation, the environmental liability regime of the host country and the past actions of the project sponsors, additional unforeseen costs can be reduced that could occur due to lack of environmental compliance (5). 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 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 Lack of specific expertise for the performance of due diligence Perception barriers Information availability barriers Lack of governmental and other institutional support Increase in transaction costs for review procedures p.82

1) 2_Project-structure-and-financing-sources-for-wind-farms- 2) https://www.wind-energy-the-facts.org/index-45.html 3) https://en.wikipedia.org/wiki/Due_diligence 4) https://www.dewi.de/dewi_res/index.php?id=12 5) http://www.renewableenergyfocus.com/view/19361/spotlight-on-due-diligence-for-wind-power/ 6) http://lup.lub.lu.se/luur/download?func=downloadFile&recordOId=1324773&fileOId=1324774 7) https://www.dewi.de/dewi_res/index.php?id=12 8) https://www.k2management.com/services/due-diligence 9) https://www.ae911truth.org/project-due-diligence