Renewables financing poised to overcome interest rates, project delays in 2024

US renewable energy project financing will continue apace in 2024 as developers and banks adapt to higher costs, supply chain-related delays and evolving funding models.

A sectorwide sell-off spurred by rising interest rates and concerns about renewables' economic viability drove negative sentiment in 2023, while more expensive debt and tax equity shortfalls squeezed liquidity available to developers.

"It's just seen as short-term turbulence," Greg Hutton, Rabobank's head of project finance for the Americas, said in an interview. "If anything, it's brought up some big issues in the market that need to be solved — like very full transmission queue bottlenecks, supply coming from domestic markets to satisfy the domestic [content] tax credit — but I think there's a strong will and desire to work through these things."

Clean energy demand remains robust despite the sell-off, Hutton continued, pointing to a landmark package of energy transition laws in Michigan, requiring electric utilities to expand renewables and energy storage purchases toward meeting a 100% clean energy standard by 2040.

Power purchase agreement renegotiations

Projects in advanced stages have also had construction setbacks due to equipment bottlenecks, but flexible counterparties have helped soften the blow.

"We're seeing a lot of those [delayed projects] come to market," Hutton emphasized. "It's extremely busy right now" thanks to motivated buyers willing to pay slightly higher power purchase agreement (PPA) prices.

Mike Lorusso, who heads First Citizens Bancshares Inc.'s energy finance unit, agreed that deal volumes have remained robust in the face of higher rates due to successful PPA renegotiations.

"[Buyers] are going to be paying a higher price no matter who they're working with, so they seem to be receptive within some reason," Lorusso said in an interview.

The bank was a lead arranger on about 20 of the approximately 25 renewables debt transactions it helped put together in 2023, many for battery storage, totaling "easily a couple of billion" dollars in financing. First Citizens anticipates a similar deal flow next year, according to Lorusso.

First Citizens also benefited from a regional banking crisis that took down Silicon Valley Bank, which it then acquired.

"There was a window of opportunity … that allowed deals to be directed towards us and some others like us that remain strong and active in the market," Lorusso said. "We got some additional business by picking up some of the fumbles that some of these other banks had, some of the deals they couldn't execute on."

Still, Fitch Ratings sees the increase in corporate PPAs fueling financing for projects as a potential negative, since they "typically have a shorter tenure, which would potentially expose projects with longer-term debt to merchant tail price risk," the credit rating agency said in a Dec. 5 report.

New tools

One significant change to the renewables financing landscape in 2023 came from a provision of the Inflation Reduction Act that allows developers to convert unused tax credits into cash payments themselves by transferring, or selling, the credits to unaffiliated corporate entities instead of monetizing them via tax equity partnerships.

That market has gained traction faster than most expected, according to Keith Martin, a renewable energy tax expert and co-head of projects at Norton Rose Fulbright.

"We've closed 10 tax credit sales this year and we have 20 in documentation," Martin said in an interview, noting that there will also be more "hybrid transactions" in 2024 where tax equity is in place to monetize depreciation that transferability cannot capture and the partnership sells the credits to a buyer.

The IRA also included an advanced manufacturing production tax credit that has already spawned a massive effort to reestablish domestic clean energy supply chains in the US. Climate investment firm Hannon Armstrong Sustainable Infrastructure Capital Inc. sees opportunities to participate in that growth.

"We're not typically a financier of manufacturing plants, but now with the demand side for the products that are going to come out of these facilities, I think there will be new business models to help finance them knowing that they've got their product sold for five years forward, for example," Executive Vice President and Chief Client Officer Susan Nickey said in an interview.

Hannon Armstrong is not interested in becoming an equity investor in these plants, but taking on a role in the capital stack that could help launch a factory would "almost be like doing an offtake agreement for a wind project," Nickey continued.

Banks subsequently broadened their offerings beyond developers and owners to include the entire renewables value chain in response to the IRA, Rabobank's Hutton said.

Delays have also led to new kinds of loans for clean energy projects to account for development pipeline buildups.

"You're starting to see innovations like construction revolvers for utility-scale projects," Hutton explained. "Whereas before they would've maybe done one or two one-off construction-to-term-loan financings, they're trying to build a machine to finance multiple projects in a given year."

Nascent technologies struggle

Tax credits for nascent industries like hydrogen production and carbon capture and sequestration have not yet translated into the burst of financing activity that is benefiting more established parts of the renewables sector.

"Credit profiles for these new technology-based projects will remain constrained by the uncertainties for their operating performance and revenue frameworks, which rely heavily on sales into merchant markets for the end products, such as ammonia, hydrogen and renewable biofuels," the Fitch report cautioned.

The levelized cost of green hydrogen in the US, for example, has increased from $4/kg when the IRA was passed to about $7/kg, Morgan Stanley analysts noted Dec. 6. That does not include the maximum $3/kg tax credit, but developers are concerned that the stringent additionality and time-matching guidance issued by the Treasury at the end of December will jeopardize commercial viability.

Keith Martin, a renewable energy tax expert and co-head of projects at Norton Rose Fulbright, said in an email that the proposed rules would make securing offtake contracts even harder. "Developers will have a hard time persuading banks to lend until they can demonstrate an ability to comply with hourly matching," Martin predicted.

Morgan Stanley noted that Plug Power Inc.'s first green hydrogen plant in Georgia has also faced both delays and "a near-doubling of capex." That plant was scheduled to begin operations by the end of 2023, but in November the company's stock price plummeted after Plug Power issued a going concern warning that it could run out of liquidity during the next 12 months.

"The market's not going to fund their operating losses like it was willing to, say, 24 months ago," Morningstar analyst Brett Castelli said about earlier-stage developers like Plug Power struggling to turn profits.

US carbon capture and sequestration developers face similar financing shortfalls even though the IRA raised the tax credit to $60 per metric ton from $35/t for carbon dioxide used in enhanced oil recovery or other industrial operations and to $85/t from $50/t for permanently stored CO₂.

"For these larger proposed projects in renewable energy, energy storage, hydrogen, and [carbon capture, utilization and storage], cash flow potential and the cash flow generated by comparable assets will be critical," S&P Global Commodity Insights climate and clean tech executive director Peter Gardett and director Conway Irwin wrote Nov. 1.

"In many cases, those projects have attracted equity financing without yet securing matching debt financing," Gardett and Irwin continued. "The willingness of equity investors to give up modeled returns as more potential cash flow is reallocated to debt providers has been a point of contention in project finance negotiations."