Using REC

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Using RECs, and Depreciation in Financing Wind
Trintek Energy Consulting, Inc.

Creating Competitive Advantage Thru Intelligent
Development
Native Renewables Energy Summit November
15-17, 2005
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Discussion Outline

• PART 1
• RECs-Renewable Energy Certificates
• REC Markets
• REC Prices
• REC Ownership, Tracking, Certification, and
  Contracting
• Issues and Solutions for RECs In Project
  Financing
• Comparison of Revenues and D/E Ratio with and
• without RECs
• PART 2
• Depreciation
• Eligibility for Accelerated Depreciation on
  Tribal Reservations
• IRS 168(j) Depreciation Lives on Reservations
• Qualified Indian Reservation Property
• Qualified Infrastructure Property-Off Reservation
• CreatingValue in Allocation of Depreciation
• Creating Value in Using Accelerated Depreciation

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PART 1 - RECs-Renewable Energy Certificates

• 1 REC 1 MWh of electricity production from a
  renewable resource
• In a REC, the renewable attributes are unbundled
  from
• commodity energy
• Projects can generate two revenue streams
• -one for commodity, one for RECs
• -Has implications for financing
• The market is still illiquid, but emerging
• -A recent DOE report says the REC market is
  145 MM/yr.
• -DOE Forecasts that it will get to 900 MM/yr.
  By 2010

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The Markets in which RECs Trade

• There is not one single unified U.S. market for
  RECs
• - instead, there are a variety of fragmented
  State and regional markets
• - Prices from market to market may vary
  considerably
• Mandatory Compliance vs. Voluntary Markets
• - Some RPS States include mandates to
  purchasers of power
• - Purchaser must either purchase RECs,
  purchase renewable power,
• generate renewable energy, or pay penalties
• -The price of a REC in theory should approach
  compliance penalties
• -Penalty ranges are 10-50/MWh varying by
  state and market
• - Thirteen states have or are phasing in REC
  trading as a feature of
• their State RPS
• - Voluntary markets also exist in which
  purchasers desire to encourage
• development of clean renewable energy
  sources through their purchases

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RPS States As of 10/2005
From CRS
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REC Prices-Voluntary Markets

• Higher Prices in MidAtlantic-Northeast than in
  Central and Western
• States
• Reasons
• Lower Wind Class resources in MidAtlantic-Northeas
  t
• Higher consumer demand for renewables with tight
  supply
• -Growing number of State RPS policies in the
  region.
• In general, REC prices are a function of
  individual markets,
• applicable law, supply, and demand

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REC Ownership, Tracking, Certification, and
Contracting

• Rules for earning RECs, transfer, certification,
  and distribution vary
• from state to state and are state specific or
  regional in nature
• - Rules include tracking systems and expiration
  dates
• - Banking of RECs Usually allowed 2-3 years
  out
• - Certification systems such as Green-e can
  also apply
• REC Ownership
• -Per FERC, RECs belong to generator unless
  conveyed in PPA or
• unless specified otherwise by the applicable
  State
• -Ultimately, State law governs who owns RECs
• PPA Structuring
• -Change of law risk in PPA
• -Purchasers want firm RECs with LDs for non
  delivery other
• than for Force Majuere
• Mitigate risks via portfolio of RECs/projects,
  alternate back-up supply of RECs,
• Cap LDs

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Miscellaneous Financing and Structuring
Considerations

• Carve out REC revenue from collateral in Security
  Agreements
• Royalty and Lease agreements-carve out RECs from
  Revenue

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Issues for RECs In Project Financing

• Projects are financed over 10 to 20 years
• Due to the nature of the emerging market for
  RECs, and regulatory uncertainty, the Term for
  REC contracts is usually no longer than 5 years,
  and usually 1-2 years
• Exceptions are States where as part of the State
  RPS, long term contracts are required
• -New York 10 years
• -Colorado 20 years
• -California 10 years

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Financing Issues and Solutions RECs (Continued)

• For large projects -REC marketers are generally
  too small and have insufficient credit to provide
  the necessary security for guaranteeing or
  backstopping long term REC purchase agreements
• In some markets, large creditworthy end-users,
  such as universities or government agencies have
  committed to make long-term commitments (i.e., 10
  years or more) to purchase stand-alone RECs or
  RECs bundled with energy.
• The same large entities may enter into a REC
  contract for differences would provide price
  stability to the buyer and revenue security to
  the seller

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Financing Issues and Solutions RECs (Continued)

• State renewable energy funds could offer a price
  floor for RECs to ensure minimum REC revenue, as
  one component of a risk management strategy
• Example
• -The Massachusetts Renewable Energy Trust
  offering to purchaseor purchase options to
  buyRECs for a period of up to 10 years
• These funds are limited, however, in the number
  of projects they can support
• States could require long-term contracts for
  bundled energy or stand-alone RECs as a means of
  satisfying an RPS

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Financing Issues and Solutions RECs (Continued)

• Forward Selling of RECs
• -RECs that will be generated over the lifetime
  of a new or planned
• renewable energy project can be sold in advance
  to consumers
• before the project is constructed
• -The present value of the future revenue stream
  can be used to
• finance the project directly
• Example
• Vermont-based NativeEnergys customers purchase
  RECs that will
• be generated during the expected operating life
  of renewable energy
• projects.

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Financing Issues and Solutions RECs Continued

• With its Windbuilders product, NativeEnergy
  helped support the development of the 750-kW
  Rosebud Sioux wind turbine in South Dakota by
  selling the RECs that will be generated during
  the 25-year expected life of the turbine.
• NativeEnergy discounts the RECs price to account
  for the time value of money and the avoided risk
  of the project not being able to sell all of the
  future RECs.
• Because NativeEnergy markets RECs from
  prospective projects
• the company guarantees that it will support an
  alternate project or purchase RECs from other
  new renewable facilities, in the event that the
  initial project is not completed.

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Financing Issues and Solutions RECs Continued

• Note this kind of forward sale has only been
  done on a small
• scale to date because of the challenge of forward
  selling the entire output of a
• large project.
• Although this product can help develop some
  small renewable energy projects, it may be slow
  to generate financing for substantial expansions
  in large scale renewable projects.
• Perhaps large credit worthy state agencies,
  trusts, and other governmental
• authorities can also assist in achieving larger
  scale forward sales.

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Example of DSCR Calculation - BASE
CASE
For a 100 MW Project with 35 Capacity Factor
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Example of DSCR Calculation With REC of 10/MWh
For a 100 MW Project with 35 Capacity Factor
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Comparison of REC Enhancements To Base Case

• A REC price of 10/MWh or .01/KWh increases
• project revenue by 2.8 MM/yr. for a 100 MW
  project
• Available leverage or D/E ratio, holding DSCR
  constant goes up
• by 12 from D/E ratio of 63 to 75
• Project IRR also goes up
• Alternatively, with an extra REC revenue stream,
  the project may
• choose to hold revenue and returns and D/E ratio
  constant and
• bid more competitively on the PPA pricing

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Financing Conclusions For RECs

• It may eventually be possible to achieve higher
  D/E ratios if a REC revenue
  stream meets certain criteria
  
• Lenders should consider issuing a separate
  tranche of debt with higher margins and DSCRs,
  but allow RECs to add some leverage over a term
  matching the length of the REC purchase contract
• Lenders could allow funding of Debt service
  reserves with the REC revenue stream
• For RECs to be accepted as a financeable revenue
  stream
• -Lenders need a strong state and or regional
  legal and regulatory environment
• -REC purchasers and PPA counterparties must be
  creditworthy
• -Longer term REC contracts and purchases are
  needed,
• - More liquidity and bankable forward price
  curves need to develop
• For now, with state of markets, probably safer
  not to try to disaggregate attributes

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More Due Diligence is Always
Better Make sure your deal is a REC deal not a
Wreck deal
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PART 2 - Depreciation

• Industry MACRS tax depreciation norm is 200
  declining
• balance over 5 year depreciation life
• This is substantially shorter than the 15 to 20
  year depreciation
• lives of non-renewable power supply
  investments
• Faster depreciation results in tax benefits early
  in a project's life
• because a dollar is worth more today than later
  on
• Depreciation Can be allocated disproportionately
  to ownership
• The Internal Revenue Code of 1986 (as amended)
  now
• provides for additional accelerated depreciation
  of property
• placed on tribal reservations

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Eligibility for Accelerated Depreciation on
Tribal Reservations

• To be eligible, the property must
• Be used by the taxpayer predominantly in the
  active conduct of a trade
• or business within an Indian reservation on a
  regular basis
• Not be used or located outside the Indian
  reservation on a regular
• basis
• Not be used in conducting or housing class I, II
  or III gaming as defined in the Indian Regulatory
  Act
• Not be residential rental property
• Not be owned by a person who is required to use
  the "alternative
• depreciation system".

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IRS 168(j) Depreciation Lives on Reservations
Property Class Life Accelerated
Depreciation Life 5 years
3 years 7 years

4 years 10 years
6 years 15 years
9
years 20 years
12 years 39 years
22 years
(nonresidential real property)
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Qualified Indian Reservation Property

• The term qualified Indian reservation property
  means
• Property which is,
• used by the taxpayer predominantly in the active
  conduct of a trade or
• business within an Indian reservation,
• not used or located outside the Indian
  reservation on a regular basis,
• The above restriction shall not apply to
  qualified infrastructure property
• located outside of the Indian reservation
  if the purpose of such property
• is to connect with qualified
  infrastructure property located within
• the Indian reservation.
• not acquired (directly or indirectly) by the
  taxpayer from a person who is
• related to the taxpayer (within the
  meaning of section 456 (b)(3) (C ), and
• not property (or any portion thereof) placed in
  service for purposes of
• conducting or housing class I, II, or III
  gaming (as defined in section 4
• of the Indian Regulatory Act (25 U.S.C.
  2703)).
• The term qualified Indian reservation property
  does not include any
• property to which the alternative
  depreciation system applies

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Qualified Infrastructure Property-Off Reservation

• Qualified Infrastructure Property means
  qualified Indian reservation
• property which
• Benefits the tribal infrastructure,
• Is available to the general public, and
• Is placed in service in connection with the
  taxpayers active conduct
• of a trade or business within an Indian
  reservation.
•  Such term includes, but is not limited to,
  roads, power lines, water systems,
• railroad spurs, and communications facilities.

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CreatingValue in Allocation of Depreciation

• Can disproportionately allocate to an investor
  or partner who
• has the tax appetite to monetize the
  depreciation to offset their
• taxable income
• Upon audit, an investor must show there was
  economic justification
• for a disproportionate allocation of tax credits
  and be able to show
• differentiated risks
• The downside is to risk disallowance and
  unwinding of the structure
• entailing financial consequences to the investor
  and the project
• It may be best to get a letter opinion from the
  IRS

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Creating Value in Using Accelerated Depreciation

• The benefit of accelerating depreciation is the
  present value
• of the stream of avoided cash taxes when added
  taxable income
• is offset in years 1-3 versus over a 5 year
  period
• The effect of combining disproportionate
  allocation and accelerated
• depreciation can make a substantial value
  creation difference
• and result in higher returns for investors and
  partners who can
• monetize these benefits