Renewable Project Risk – An Introduction

Renewable Project Risk – An Introduction

Bjornar Eide

06/29/2010

Framing the Issue

• The political push for renewable RPS programs and projects have changed

the traditional way of thinking about physical and financial risks for energy

procurement functions and portfolio managers, but a subject that has

received little attention in the overall debate is how renewable energy

can/should be “integrated” in the traditional physical and financial risk

framework.

• By understanding these risks and choosing proper identification, monitoring

and management methods, communicating feasibility of projects and

expected price can be made easier.

OUTLINE

• This presentation will address / introduce how risk issues present themselves

throughout the life cycle of acquiring / building a renewable resource and what some

of the qualitative and quantitative implications are to traditional Risk Management

focusing on the following segments of the life cycle;

A. Establishing the need / investment opportunity

B. Financial pro-forma assessment / fuel comparisons

C. Pre-construction

D. Construction

E. Commercial operations

Establishing the need / Investment Opportunity

• Mandated RPS goals are still the primary reason for adding new renewable resources, however

investment opportunities may identify themselves dependent on various incentives and market

conditions. Regardless, importance should be placed on evaluating physical and financial

implications to communicate strategic implications to all stakeholders due to complexity of issues;

QUALITATIVE IDENTIFICATION

a) What is the primary reason for adding the resource (RPS Mandate / Commercial / Both?)

b) On what basis will these resources be compared physically and financially, stand alone or

integrated to an existing portfolio (incremental impact) ?

c) Is it expected that physical and financial contingencies need to be present for a sustained

period of time to communicate financial results/portfolio fit to seek optimal returns ?

d) What are the qualitative and quantitative processes in place to lower the strategic risk

implications for the organization throughout this process ?

e) Have NPV/IRR models been built to accommodate these non-typical issues (risk adders) ?

Quantitative Identification

• The quantitative assessment of the “need” or investment alternative can be broken down to

applying prevalent methods to the two following categories;

• Stand alone impact / Incremental Impact

o Evaluation of how the resource will impact the market, credit, and operational risk of the existing

dispatch portfolio /RTO as it pertains to ancillaries, capacity and energy using Monte Carlo methods,

non-linear methods to determine cost implications before and after adding the resource. Stand alone

assessment should follow a regression based methodology to assess how the bus price is impacted

by changing the underlying supply situation.

• Method for determining Title of Risk Structure / Organizational model choice

o How does the organization plan to control the revenue stream of the facility for lending, FIN46

consolidation purposes ?

o Is there a strategic understanding of what risks developers, equity, debt and PPA holders are faced

with ?

o Have probabilistic scenarios been built to determine impact to variable interest holders to determine

primary interest holders in the proposed setup?

INVESTMENT OPPORTUNITY/NEED – Non-traditional risk issues

Project

RPS Legislation

Stake Holders

Share holders

Debt Holders

Who bears the risk for assumptions behind

the need study / investment opportunity ?

Are there implications for parties, between

parties if investment contingencies change ?

How compatible is the overall delivered

price based on incremental portfolio

impact against other resource alternatives

and is this comparison sustainable over

time – can it be fixed ?

How does the financial stability of

developers and proposed organizational

structure impact likelihood of delivered

price and project feasibility ?

How is the organization insured against

these non-traditional risks that can surface

in the future dependent on legislation or

other structural issues ?

FINANCIAL PRO FORMA ASSESSMENT

Building the financial pro forma (Income and Balance Sheet statement) for the renewable asset is an

important process and introduces some new risk issues dependent on the organizational structure chosen to

finance the project. The most important issues are centered around the following;

QUALITATIVE DETERMINATION

i. What is the variability in the overall income and balance sheet for the planned / contracted asset ?

ii. Who holds the variability (Equity holders, PPA holders, 3rd party contractors, debt holders) ?

iii. What type of variability has been identified ? (market, credit, operational, volume, tax incentives, other)

iv. Who holds the majority of variable interest (FIN46) and what are the financial implications ?

QUANTITATIVE DETERMINATION

i. What is the basis for determining the various scenarios to identify variability ?

ii. Will Monte Carlo methods be used focusing on standard deviation input for identified variables ?

iii. Will deterministic probabilities be used to determine outcome for each scenario and deviance from

probability weighted scenarios (FIN46R method) ?

PRE - CONSTRUCTION

During the pre - construction period risks can be described as possible changes to project

assumptions. These variables can change feasibility and the delivered price of the project

dependent on contractual arrangements. It will become important to quantify these risks and

understand who has title to these risks in order to communicate possible effects to all stake

holders.

QUALITATIVE IDENTIFICATION

a) Amendments to financing contingencies (project financing, tax credits, dates etc..)

b) Amendments to cost estimates built into the overall project

c) Amendments to tax legislation or/and use of PTC/ITC appetite, incentives

d) Amendments to credit terms, sellers expansion, extension options

QUANTITATIVE DETERMINATION

i. How do changes impact delivered price (short, medium and long term) ?

ii. Have variables subject to possible amendments been quantified from an upside and down

side risk perspective to communicate financial effect using prevalent methods ?

CONSTRUCTION

During the construction period focus is shifted towards identifying, monitoring and managing

operational risk associated with the construction phase that may make the project more or less costly.

QUALITATIVE DETERMINATION

i. What are the various milestones (segments) of the project ?

ii. What are the scheduled tasks within each segment that can be subject to issues leading to delay

or/and financial consequences for the overall project cost ?

iii. What is the probability and expected losses associated with identified operational risk within each

segment ?

QUANTITATIVE DETERMINATION

i. What historical experience data exist to draw distribution knowledge for operational risk for

identified tasks given project schedule ?

ii. Can Monte Carlo methods with known drifts be used to determine likely outcome for identified

variables ?

iii. Have contractual and/or OTC methods been used to mitigate identified operational risk ?

COMMERCIAL OPERATION

During commercial operation the renewable attributes delivered from the facility will be

dependent on the actual capacity utilization of the facility and any variance to planned output

could lead to commercial risks.

QUALITATIVE DETERMINATION

i. What are the probable deviances from ancillary, capacity and energy, rec positions due to

unplanned outages or/and probable variances in production contingencies (wind, solar

capacity etc.) ?

ii. Are any incentives (Production tax credits, depreciation) dependent on actual output and

EBIT appetite ?

QUANTITATIVE DETERMINATION

i. Analytical, historical and Monte Carlo Value at Risk can be quantified by understanding the

volumetric standard deviation of production patterns.

ii. To quantify volumetric risk and outage probability Monte Carlo methods can be used.

Summary of major risks throughout the life cycle

These risks will present themselves differently

dependent on complexity of the project and

chosen organizational structure

Risks Quantified VaR - 95% NPV Impact

a) The Business Case NO NO $0.0 M $0.0 M

b) Financial Pro forma YES NO $0.0 M $0.0 M

c) Pre - Construction YES YES $2.0 M $0.5 M

d) Construction YES YES $2.0 M $0.5 M

e) Commercial Operation YES YES $0.5 M $0.0 M

Communicating possible impact Summarizing and quantification of the individual components of the lifecycle can be done in a tabular format identifying possible impact for each of the life cycle segments to create an overall commercial understanding of the project

a) Risk to the business Case can only be quantified if a comparable benchmark has been established in the form of a floating or fixed formula comparing the investment to an alternative investment. (renewable, conventional resource)

b) Risk to the financial pro forma can be quantified on behalf of the equity holder, PPA holder or/and debt holder dependent on how the facility has been organized.

c) Pre - Construction risk can be quantified as the expected variability to contractual contingencies (market variables) d) Construction risk can be quantified using Monte Carlo method for identified tasks subject to variability. e) Commercial operation risk can be quantified as the market risk and other assumptions subject to variability through

Monte Carlo Methods.

BIBLIOGRAPHY

• Bjornar Eide was the Director of Risk Management for Sempra Energy Utilities from September

2005 to January 2010. Bjornar oversaw the risk governance structure for San Diego Gas & Electric

and Southern California Gas Company. He was a member of the Risk Management Committee for

each of the utilities, which is responsible for managing each of the utility’s exposure to market,

credit, liquidity and operational risk. Bjornar has over 15 years of experience from energy markets,

serving in a variety of capacities in an international environment. Prior to joining Sempra Energy

Utilities, he worked as an independent strategic risk consultant for a variety of clients in Europe

and the US focusing on strategic risk management related issues and the design of risk assessment

capability. As a Director of Risk Management for NRG (from 2000 –2002) he built up the risk

management department and during his four year tenure with Statoil A/S as a portfolio manager,

he actively managed positions that involved petroleum products, crude, natural gas & electricity

including the build-up of the power marketing department. Eide holds an MBA in Finance from

San Francisco State University and a BA in Business Administration from California Lutheran

University.