FEATURE / Renewable Energy
The fact that no one had anticipated this inflationary environment is now resulting in considerable pain in the renewables market which no stakeholder should ignore .” plants has been decreasing , in some aspects dramatically . Over the last decade the price of polysilicon , one of the major input materials for the manufacture of photovoltaic modules used in solar plants , has plummeted . Coupled with mass scaling of solar module manufacture , particularly in China , the overall cost of photovoltaic modules has dependably been trending downwards for over ten years . This means that in the red-hot , super competitive , Middle Eastern renewables market , developers frequently bid on projects on the assumption that not only current supply of photovoltaic modules would predictably be at prices secured at bid stage , but potentially decrease further as the relevant bid process was implemented and the procurer drew towards making a winning bidder announcement . In fact , it is the market ’ s worst kept secret that some developers would plan to aggregate all of their won projects under a single supply arrangement , which would decrease input costs even further through additional economies of scale and negotiating power with suppliers . With modelled equity returns on most Middle Eastern renewables deals sitting at single digits , an improvement to that return by a single percentage point during construction was not something to be ignored by the developers .
Interestingly , once procurers caught on to the fact that winning developers might improve on their returns by delaying the purchase of supplies , such as the photovoltaic modules , or aggregating all supplies across several projects , rigorous
claw-back provisions began to appear in the power purchase agreements . Essentially , the offtaker of power suddenly had the right to audit the accounts of the project company so as to determine whether the shareholders were benefitting from improved returns which exceeded those originally presented in the financial model at financial closing . To the extent that such returns did in fact exceed the previously projected returns , the project company and its shareholders were compelled to share in the spoils with the offtaker at a range of 50 per cent to 100 per cent of the excess profits . This obviously presented a myriad of additional issues , including the fact that the project company was effectively precluded from building up cash reserves , albeit at a level above those originally modelled , which might not have been immediately disbursed as dividend and could have been kept in reserve for the “ rainy day ” ( literally ). Worst still , to the extent that the offtaker audit discovered that equity returns had exceeded modelled returns for a number of years , the project company potentially faced the equivalent of back-pay liability in relation to cash which had already been disbursed to shareholders as dividend . This had conceptually put in jeopardy not only the project company ’ s cash flow as it now had to fork out cash which it didn ’ t have , but the project financing on which the project was built , as the resultant back-pay liability could affect the debt service cover ratio , potentially triggering a default under the financing .
However , that complication seems but a distant memory in today ’ s market . Meeting projected equity returns is no longer a foregone conclusion . Instead , it has turned into a goal which , if inflation continues unabated , many developers might struggle to realise .
Fortunately for developers , most utility scale renewables in the Middle East are procured on limited / non-recourse basis , which therefore includes a set of bankability rules that lend considerable amount of scrutiny to risk allocation and project implementation . This is in spite of what we have observed - more relaxed adherence by developers and lenders alike to well established risk allocation principles - mostly under the justification of “ market evolution ” and being “ commercial ”. Two particular project finance principles that most developers and lenders retained
18 ISSUE 114 • JULY - AUGUST 2022