 In this module, we are going to talk about financing of energy projects. Previously, we have been looking at energy economics and in energy economics, we looked at how we can look at an upfront C0, which is an initial investment and then we were getting returns A1, A2, An. So, this was typically for a project where we are looking at a tenure of the project of N years, we had an upfront investment and we compared the benefits with the cost and we looked at different ways of doing this, the net present value benefit cost ratio, internal rate of return, the life cycle costing, annualized life cycle costing. At that time, we did not bother about where we are getting this initial investment from the C0 and that is what we will be talking about in this module. How do we finance or get the investment required to actually implement or initiate a large energy project? So, let us start with seeing that in that session, we talked about building a solar thermal power plant and in a solar thermal power plant, you will have the solar field that means you will have, for instance, you have parabolic concentrators where you have the solar insulation coming in that is concentrating the energy to a working fluid. Normally that is a heat transfer oil, that heat transfer oil is then heated to a high temperature in some of these cases, it may be 394 degree centigrade that heat transfer oil then is used to generate steam in a heat exchanger, that heat is steam then is used to drive a turbine and generate power that shaft power that is connected to a generator and you get electric generator, you have electricity which then is transmitted to the grid. So, in all of these components, if you look at the components, if you want to estimate the different cost components of this, we have different components, the solar field, the turbine and the solar insulation. So, we need to estimate based on the, so we start by looking at for a given location, we will know what is the solar insulation from that insulation for a particular output, we can estimate what will be the solar field area based on that you have the solar field cost, the land area the land cost and the heat transfer fluid and its cost. So, with all of this we get also the power plant, the power turbine and the generator and the heat exchangers and then you get the power block and the capital cost. And from all this capital cost then we can analyze it based on life discount rate and we can calculate the replacement cost the capacity factor. This is in terms of the overall cost analysis. When we want to look at now the cost, the total capital cost that can happen in terms of we may use our own finance, our own equity or the company itself puts in the money or we can take a loan and we can finance it and we have to for the loan, we will have to repay the loan and then we can see for the equity what is the rate of return on the equity. And so typically when we look at this, we are trying to see whether or not the company should invest and of course in that there are choices in terms of where will the funds come from. And typically we are looking at funding coming from equity or debt that means your own money or you are borrowing the money from somewhere. So let us look now at a little bit of the basics of financing. When we talk about a project, a project is a well defined entity. For instance, we talk about a wind based turbine, wind turbine, wind field, solar power generator, a particular heat exchanger and these are all specific projects. If you look at let us say you are building a road that is a fixed project for a particular goal with a particular time period and then you can look at the investment. So in each of these projects, there will be a profile of risks and returns. That means there are some uncertainties or risks involved, especially if we are talking about new technologies and then based on the risks, based on making the investment, you will get returns based on the benefits that you get from the project. So the whole issue when we talk about financing is to estimate what kind of risks and what are the tradeoffs between the risks and the returns. So in general, there might be a credit risk. That means the project whoever is sponsoring the project, how credit worthy is that individual or company and what is the guarantee that they will actually return the money and once they get the revenue. So there is a credit risk and there are commercial risks. So in the case of commercial risks, there could be a risk related to the technology. If you are trying out a new technology for the first time, it may be you have estimated how it will perform but actual performance may not be the same. So it may be a proven technology or not. In some cases, there may be a risk in terms of resources. For instance, many of the new plants which were installed in the case of wind, the wind speeds were much lower than what was expected and so the capacity factors or the amount of generation that were being obtained were relatively less and with the result then the revenues were less. Similar kinds of problems have happened with solar insulation. Sometimes there have been sites where the solar insulation data has not been mapped over a long period and after we installed, we expected a certain, we installed it based on certain design values of solar radiation incident and actual solar radiation was lower with the result that the output was lower than expected and there could be environmental risks. For instance, if we think in terms of a large hydro project or let us say a large nuclear project, for instance there is this project which was the VBRs with Russian technology in Kudankulam and the problem in that has been, there have been strong local opposition with the result that there have been delays and this again associates with it a certain amount of risks. There had the extreme end, the project, the environmental impacts and the opposition to the project, the actual environmental impacts or the perceived environmental impact may result in the project actually getting stalled. It may go to the courts and the courts may go against it so there could be various issues and that is another risk which the company or the project developer has to take. There could be a problem in terms of revenues. For instance, in order to mitigate this risk, the government in the Indian context created the national solar mission and in the solar mission, it was decided that for all the new solar projects, there would be a separate entity called which would be a joint venture set up jointly by the NTPC which would guarantee that the project always got a fixed amount of revenue and this was the NBBN which was buying the electricity from the new solar projects and it was sheltering it from the discombs. However, finally, the NBBN has to have the discombs of the distribution companies taking the solar electricity and one of the risks is that if for instance, the demand, we have created excess capacity and then there is not sufficient demand, then it is possible that there may not be companies who are interested in purchasing that electricity at that price. So, even though there is a guaranteed price, there might be a problem in terms of revenue. The operational maintenance requirements, in case there are issues related to O&M and there are additional operation maintenance costs, if there are shutdowns or there are problems with some of these O&M operation and maintenance problems, this can also be another source of risk. In terms of the returns, the project costs, there could be cost overruns, there could be project delays and we can look at how much costs are put and how much we have to actually pay out and how much we are getting in and then what is the mode of financing, there is a financing risk and what is the cost of capital. So, this is essentially overall picture of some of the kind of risks and returns. So, when we are talking of financing, we are differentiating between if we look at this C0, C0 will be equal to the sum of the equity plus debt, equity and debt. So, the fraction of debt is the D by C0 and depending on now normally whenever one thinks in terms of taking a loan, there will always be a certain minimum amount of equity or your own contribution that you need to pay. So, the debt by definition would be the acquisition of funds by borrowing and this could be either corporate or project loans or it could be a leasing arrangement and equity is your own, is the promoter's own contribution and it could also be done in terms of selling some of the shares for raising the capital, so that you give someone a share of the company. In addition to that, we could also have financing in the form of grants and guarantees and this is specially true for relatively clean energy technologies. In the case of something that the government would like to do a new technologies, you may actually get a certain amount of your initial investment actually paid for in the form of a grant which does not need to be repaid. In the case of debt, this is something which will result in some repayment in the future. So, essentially what will happen is that if you look at the initial thing is we saw we had C0 and we had all of these, that is your AK, A1, A2, general AK, AN and this is C0. Now, if instead of putting the entire amount C0 here, we put only a fraction of this which is the equity which is nothing but 1 minus the fraction debt into C0 and this remaining amount is the amount which is being put by the company giving the loan and that is the debt. This is being invested and so actually we are only putting this equity as a result of this equity we have to repay the loan, loan repayment each year till the duration of the loan. So, whatever is the term of the loan NL, we have the loan repayment. So, the question then becomes that in each year what we will have is we will have now the benefit stream will become A1 minus LR or AK minus LR and the question is should we take the loan to what extent should we take the loan. In some cases we may not have the option because we may not have enough money to pay C0 and so this is the kind of issue which is there. How much should I take in terms of debt and how much should be equity and of course in most of these cases what happens is that there is a leverage ratio but there is a minimum amount of your own contribution. So, typically we will do some examples we will see whether you have debt to equity let us say 70, 30 or 50, 50 and we will see the effect and of course this will depend on for the loan there will be an interest rate and then we will convert that loan into equivalent annual payments and you can see in many of the cases even when you buy some if you are buying a car or you are buying a high-end phone you can buy it out outright or you can also pay it in installment. So, we will see how to make that calculation of this payment in installments. So, typically what happens is for large well-defined projects we can have a way in which we can talk in terms of project financing and see where the money is going to come from in general we can decide whether to choose between debt or equity and then we can see a way in which we calculate and find out which ratio of debt equity is good for us for a particular project. So, let us look at a little bit of background and history and before we do this typically what will happen is that in general there will be a risk return profile. So, typically for any project we get some returns and then there are certain risks and typically there will be this is the acceptable for this is the acceptable risk for a given return. And if your risk is less than that then we will invest and if it is more do not invest. So, this is the risk return profile and this will be the characteristic of a particular individual or a company which is making these investments and then we will try and see what kind of risk. Of course, explicitly when we want to think in terms of risk and risk quantification it is a little tricky and then there are uncertainties in all of this. So, let us again we have talked a little bit about the risk but let us list out all the risks which are there. So, we talked about credit risk in terms of credit worthiness, construction and development risk again and sometimes when you are going ahead with the construction and development especially let us say we are talking of a metro. There are certain areas where you need to get right of way or you need to get the land being cleared and you need to and if that there is opposition and you do not get that you may need to rework your plans and so that is a construction and development risk. Operating commercial risks we saw that in terms of resources, we saw that in terms of technology, we saw that in terms of O&M, in terms of environment. Political risk now this is you will see that often that a particular government opts for a project and if that is a high profile project which has had opposition if the government changes the new government can always reassess the project and so there is a risk in terms of that. Normally governments try to have continuity so that you try to honor commitments which are done but sometimes there are issues for instance in Andhra Pradesh when a new government took over and Telangana when the new government took over they actually said that we will relook at all the power purchase agreements which were signed with renewable companies. Now these power purchase agreements were signed for a period of 25 years and now the developer or the company which is owning this has the issue of renegotiating the prices and this has become a big issue especially in the case of solar photovoltaics where the prices have really come down drastically. When we started off the initial feed-in tariffs, we had electricity at 11 rupees per kilowatt hour. Now we are signing agreements at 2 rupees 50 paisa per kilowatt hour. Naturally, many of the distribution companies want to relook at the agreements which were signed earlier but please remember these agreements were done in a regime where renewables was considered to be more risky. There was a technology risk, there was a market risk and there was a legal process by which the developer and the distribution company signed an agreement at a particular price. There could be financial risks and the risks could be in terms of some of the companies which are financing having problems and some of the companies which were participating in the project, having a lot of outstanding funds and there may be risks in terms of payments especially this is true for many of the distribution companies which have large accumulated losses in the order of lakhs of crores and that means that for instance every unit of electricity which is sold to a distribution company, we actually do something like 80 paisa per kilowatt hour or 90 paisa per kilowatt hour. So, in such a case when such a company agrees to comes up with a PPA, it is possible that the payments are delayed or the payments do not happen in the way which was contracted to be. There could be regulatory or legal risk because the regulatory regime might change, the legal frameworks may change. Environmental risks we already saw this, there could be also certain things for instance if we created a bus fleet in a city which was running on diesel and we created a diesel infrastructure to cater to this bus fleet and because of the environmental emissions if it was decided to ban all diesel vehicles in that particular city and we went it to CNG, then there would be an environmental risks for the diesel supply chain. First measure is also known as an act of God, it is something on which we have no control. For instance, you have suddenly a flood or a tsunami and some kind of an extreme weather event which causes severe disruptions and that results in the, it affects the viability of many of the projects. This is not something one can anticipate by its very definition, but this is something that constitutes a significant risk and of course, you can buy insurance to sort of cover for that risk. There are two types of different finances and if you look at it, we have a corporate finance which is financing a company, a company or which is a multi-purpose organization, has many different products can get into different lines of business. On the other hand, there is a project, the project is a single-purpose entity. It has a final goal, it has a specified timeline and that goal is to make a particular project with a particular output. In the case of financing, there should be a permanent and an indefinite time horizon for the equity which is made put. In the case of project finance, is a finite project timeline and often it matches the life of the project and may also so that you are getting the returns during the life of the project. The different policies in terms of reinvestment and dividends and the corporate management makes the decisions and it can make that decision. It is autonomous from the investors and creditors. Of course, investors and creditors are informed. In the case of project finance, it does a fixed policy, immediate payout and no reinvestments allowed. The capital investment decisions in corporate finance is opaque to creditors, but in the case of project finance, it is supposed to be transparent to the creditors. The financial structures have a common form in the case of corporate finance and in the project finance, it is very tailor made, dependent on the structure of the type of project which is being built. The transaction costs for corporate finance are relatively low due to competition from the providers and for routinized mechanisms, short turnaround times. Project finance requires high cost due to documentation and longer gestational periods. Size of financing for corporate finance could be flexible, but in project finance, typically we need a critical mass to cover the high transaction costs so that usually they are in large chunks. That is why you have these large solar parks, you have installations in the case of solar which are like 648 megawatts, one of the largest installations in the world in Tamil Nadu. And so that means that you have a large amount of financing which is required for this. Then the basis for the evaluation of the project of the finance for in the case of corporate finance, it depends on the overall financial health of the entity. The focus is on the balance sheet and the cash flows. In the case of project finance, it depends on the technical and economic feasibility of the project, focus only on the project and the project assets, the cash flows and the contractual arrangements for the particular project. And corporate finance relatively has lower costs of capital while project finance has higher costs of capital. And the corporate finance has a larger broader participation by an investor base and has deep secondary markets. Project finance typically a small group of funding agencies and there is a limited secondary market. So, you can see that there is a difference, distinct difference between corporate finance and project finance. There are many different financing instruments and this is from an IEA report on PV projects. And you can see that we can get funding for large solar photovoltaic projects or small rural electrification projects. And you can see that they can be from multilateral development banks like the World Bank, the IMF and the Asian Development Bank. Could be bilateral aid and that means Indo-Germany, Indo-US and this can involve loans and soft loans. It can also involve some grants. It can also involve technical assistance. And then we could look at many funds and foundations that are interested in the case of for sustainable energy, for low carbon, for climate. And again these are, they have loans, soft loans, they also have grants and they have some possibility to do also equity investments. Green investments would be typically equity investments. And then when we look at the national development funds, they could be again in the form of loans and guarantees and technical assistance. Commercial loans and investment will be typically market based loans. They can also be, we can also invest in equity. So, this gives you sort of an idea of the kind of financing modes. Historically, project finance has been around for quite some time for more than 700 years. The recorded historical case is the, in about 1300, 1299, the English Crown or the English Government and in this case it was the royalty which was ruling England. It financed in Devon a silver mine and this financing was done by an Italian bank, a Florentine bank, Fresco Baldi and they provided the funds to actually mine and start the silver mine and take extract the silver from it. Fresco Baldi was given a contract or a concession in which one year's lease and mining it was allowed on this Devon silver mines. So, the arrangement was that the bank, the Florentine bank Fresco Baldi provided the entire money for this development of the mine with the understanding that whatever they could extract in the first year belong to them and that was the full payment for the financing of the mine. So, this was the first example of project finance. In a similar fashion in England, in the 17th century, there used to be sailing ship voyages and it was financed on a voyage by voyage basis. So, in they would start with a voyage which was going to a particular targeted location and they would during the voyage, they would accumulate different kinds of goods and wealth from various countries and locations and whatever was got and traded whatever came back as cargo and ships, these were liquidated. So, it means they were sold and the money collected, the proceeds were split among the investors based on the agreed upon formula or the contract which was done when the ship was financed. So, that gets it gets the ship goes, it acquires goods and it buys things it gets from various places, it then sells these and then the proceeds are split amongst the investors. There have been many large projects, including the North Sea oil pipeline of the coast of the United Kingdom. These are large projects with large investments which involved a whole group of financiers coming together for financing this and then they got revenue which was staggered over time. So, in the public domain in the, there is a water and teaching note in on project financing and there is a paper by Weynand in the Harvard Business Review. So, this defines project finance as a financing of a major independent capital investment that the sponsoring company has segregated from its assets and its general purpose obligations. So, that means this is a project which is sheltered from the rest of the things and it is this represents a major independent investment and you can also look at the flows associated with that particular project and it is not connected with the rest of the. So, if you look at the funding sources and stages, we have depending on the level and the technological readiness level of a particular technology at the first point when we start at the early funding stage, you have what is the research stage, the R&D stage and this is typically this would be primarily funded by the government. Once you have the technology which is there and you do some basic experiments, you have shown something, it will now have a prototype or we have the know how and then it has to be developed into a technology and then this is where you have the possibility of venture capital coming in. Some companies may be started and you might get private equity which comes into this and you have the technology development. The next step is you have this technology, its demonstrator is developed and we need to think in terms of large scale manufacturing and scale up and that is the third stage. This typically will require public utility funding and may also have involved mergers and acquisition and then finally, once this is done, we would roll it out and create the assets, this would be asset finance and this could come from either credit or debt markets and it can also come from equity and mergers and acquisition. So, you can see different kinds of at different stages of the technology development, you have different possible funding sources.