Università Commerciale Luigi Bocconi

Corso di laurea CLEAM 2010

Financing innovation: a study on

project financing issues in the wind
power sector

Lavoro finale di Marco Cavalli

Matricola 1246883

Giugno 2010

1
Acknowledgment
2
A large part of the information and data utilized in the preparation of this work have been
gathered through meetings, interview and “Q&A sessions” with some ‘key players’ in the
field of project development, manufacturing, consulting and financing of renewable power
project (wind farm in particular).

I am extremely grateful to all the persons who have been available to help me in this effort:

 Mr. William J. Heller – Managing Director – Falck Renewables Plc – London

 Mr. Francesco Novelli – Principal - Grimaldi e Associati Law Firm – Rome
 Mr. Gianni Gori – Head of Structured Finance – MPS Financial Services –
Florence
 Mr. Thomas Barkman – South Europe Commercial Manager – Nordex GmbH –
Bremen
 Mrs. Nadia Prando – Manager of Project Financing – Falck Renewables Italia –
Milan
 Mr. Christof Stork – General Manager – Garrad Hassan Consulting – Bristol-Forlì
 Mr. Maurizio Longini – Head of Structured Finance - Banca Infrastrutture
Innovazione e Sviluppo S.p.A. – Milan

Without their contribution this work would not have been possible.

I heartily thank them all.

Marco

3
4
 INDEX

Introduction and Executive Summary

1. Brief overview of the industry’s historical path and sector’s characteristics

1.1 Wind power industry in a nutshell

1.2 Wind power usage
1.3 Wind power resisting the financial crisis

2. The market and the key players

2.1 The Wind Market in 2009

2.2 The top players

3. The wind turbine industry: peculiarities, trends, areas of technical innovation

3.1 Quick presentation of the technology’s characteristics

3.2 Areas of Technical Innovation in the Wind Energy Sector, and relevant risks

4. Financing innovation in the Wind Power Sector: risk evaluation, allocation

and mitigation, roles of the key players

4.1 Project Financing in the Wind Power Sector

4.1.1 Introduction
4.1.2 The attitude of Lenders towards P.F. in a phase of “credit crunch”

4.2 Presenting a wind farm project to the Lenders

4.3 The role of the different players in the identification and allocation of the
technological innovation risks

4.3.1 The Sponsor

4.3.2 The turbine Manufacturer
4.3.3 The lenders
4.3.4 The Legal Consultants
4.3.5 The Technical Advisors, and the Certifications

4.4 A typical contractual framework for the supply, erection and operation of
innovative wind turbine model

4.4.1 Introduction
4.4.2 Warranties and Bonds
4.4.3 The ‘Type Certificate’
5
 4.4.4 Schedule of Payments
4.4.5 Protection against “Serial Defects”
4.4.6 Manufacturer’s Liabilities
4.4.7 “Full Service” clause in the Operation Contract
4.4.8 Availability guarantee
4.5 Main financial mitigants to control innovation risks

5. References

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Executive Summary and Conclusions

Wind turbines are a mature technology, and wind farms installation is rapidly growing
across Europe, US and Asia (China and India in particular), as shown in Chapter 1.

Today wind plant’s output is second only to hydroelectric power as renewable source for
the production of electric energy for national electrical networks; this underlines the
relevance and topicality of the subject discussed in this work.

Moreover, by 2012, the wind industry is expected to offer 1 million jobs, making it one of
the fastest growing industrial sector in the World and an exciting place to find a job in the
near future.

Wind power is a truly “clean/green source of energy”. In fact, in 2009 the energy produced
by European wind farms avoided 106 million tonnes of CO2 emissions, equivalent to
taking 25% of cars out of the EU roads. Green energies are, with very few exceptions, very
well accepted by the public opinion and strongly supported by the institutions, by means
of economic and fiscal incentives aimed to encourage the diffusion of wind based power
projects (topic further discussed in Chapter 1).

Technological innovation is a key factor for manufacturers of wind turbines to gain market
share, and investors are keen in adopting ‘state of the art’ turbines with higher efficiencies,
lower operating costs, high availability factors, good performances also in low-wind
applications as covered in Chapter 2 and 3.

However, wind farms are a capital intensive business, and – with the only exception of
very small size installations – the investors must rely on the availability of banks to provide
financial means to implement the projects, usually through ‘non-recourse project financing’
schemes.

In this kind of transactions, the risk evaluation and allocation (outside the lender’s
boundary) is a key factor, and the technological innovation risk (together with the
permitting risk) is the major concern for banks.

7
The role of the different players (sponsor/owner of the wind farm, supplier of the wind
turbines, technical consultant, legal consultant, lenders), is discussed in this paper, on the
basis of interviews and Q&A sessions with some key players of the industry and banks
sectors.

Not surprisingly, the main candidate to bear the innovation risk is the manufacturer of the
wind turbines: suitable contractual provisions are in general required by lenders in order to
obtain from the supplier of the innovative equipment an adequate ‘security and
guarantees’ package. Main option to control and made risk acceptable for lenders are:
extended warranty period, suitable bond package, type certification, appropriate schedule
of payments, specific protection against serial defects, operation and maintenance
contracts with the supplier of the innovative equipment, including availability guarantee,
higher liability limits with suitable availability guarantee.

Also the terms of the financing contract (and in particular the debt/equity ratio –D/E -, and
the debt service cover ratio – DSCR -) may be affected by the technical innovation, as
further discussed – with reference to a ‘case history’ of a wind project utilizing a new
concept of wind turbine, without a sufficient ‘track record’ – in Chapter 4.

8
9
1 Brief overview of the industry’s historical path and sector’s
characteristics

1.1 Wind power history in a nutshell

Wind power is today second only to hydroelectric power as renewable source for the
production of electric energy for national electrical networks. It all begun in Denmark, at
the beginning of 20th century, when the first experimental wind electrical generators (with a
power of a few kW) were installed on towers some 25m tall, with four bladed rotors 1.

The first utility grid-connected wind turbine operated in the UK and was built by John
Brown & Company in 1954 in the Orkney Islands. It had a 18 meter diameter, three-bladed
rotor and a rated output of 100 kW.

The first model of ‘modern’ wind turbine (three-bladed, horizontal-axis, upwind, stall-
regulated turbine similar to those now used for commercial wind farms) was put in
operation in Denmark in 1957, with a rotor diameter of 24m, and was decommissioned 10
years later. From then on, Danish wind industry focused on progressive incremental
improvements in capacity and efficiency of wind turbines, and begun the serial production
of turbines based on the ‘Danish Model’: horizontal axis wind turbines (HAWT), with a
main rotor shaft and generator located on a ‘nacelle’ on top of a tower 2. Usually, the
nacelle also houses a gearbox, which turns the slow rotation of the blades into a quicker
rotation that is more suitable to drive the electrical generator. The turbine must always be
pointed into the wind, by means of a wind sensor coupled with a servo motor 3.

From the mid 1970's - following the first oil crisis - through the mid 1980's, also the United
States Government worked with industry to advance the technology and enable large wind
turbines to become commercially available.

This effort was led by NASA at the Lewis Research Center in Cleveland, Ohio and was an
extraordinarily successful government research and development activity. With funding
from the National Science Foundation and later the United States Department of Energy

1
History of Wind Energy in Encyclopedia of Energy Vol. 6, page 426
2
Paul Gipe Wind Energy Comes of Age, John Wiley and Sons, 1995, Chapter 3
3
www.windpower.org/en/tour/wtrb/comp “Wind Turbine Components”
10
(DOE), a total of 13 experimental wind turbines were put into operation including four
major wind turbine designs. This research and development program pioneered many of
the multi-megawatt turbine technologies in use today, including: steel tube towers,
variable-speed generators, composite blade materials, pitch control (i.e, the ability of the
blades to automatically adjust their pitch in relation to wind speed), as well as
aerodynamic, structural, and acoustic engineering design capabilities 3.

The large wind turbines developed under this government supported effort set several
world records for diameter and power output. In 1987, the largest single wind turbine with
a rotor diameter of nearly 100 meters and a rated power of 3.2 MW was put in operation
(though as a prototype), demonstrating an availability of 95 percent, an unparalleled level
for a new first-unit wind turbine.

The large scale, serial production of wind turbines began in early 80’s, by Danish
manufacturers Kuriant, Vestas, Nordtank, and Bonus. These early turbines were small by
today's standards, with capacities of 20–30 kW each. Since then, they have increased
greatly in nominal capacity (the power than can be produced by each turbine, measured in
kW or thousand of kW, i.e. MW), dimensions, and the so called “power curve” (which is the
characteristic of a wind turbine to generate electric energy when hit by wind of a given
speed).

And, not surprisingly, wind power accounts today for nearly one-fifth of electricity
generated in Denmark, the highest percentage of any country.

1.2 Wind power usage

There are now many thousands of wind turbines operating, with a total nameplate capacity
(at the end of 2009) of 159,000 MW (with an increase of 38,000 MW on previous year) of
which wind power in Europe accounts for 48%. World wind generation capacity more than
quadrupled between 2000 and 2006, doubling about every three years. A large part
(>80%) of wind power installations are in the US and Europe. In 2009, the growth rate of
installed capacity showed a rate of 32%, the highest since 2001, continuing the trend that
wind capacity doubles every three years.

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 By end of 2010, the World
4
Wind Energy Association
expects more than 200 GW
of capacity to be installed
worldwide, with an
impressive yearly
generating capacity of 340
TWh (equivalent to the total
electricity demand of Italy,
or to 2% of global electricity
Figure 1.1 - World Installed Capacity (MW) - Source: World Wind Energy Association
consumption of the World).

The wind sector in 2009 had a turnover of 50 billion, employed 550’000 persons
worldwide. In the year 2012, the wind industry is expected for the first time to offer 1
million jobs, making it one of the fastest growing industrial sector in the World.

Also in 2009, China continued its role as the locomotive of the international wind industry
and added an outstanding 13’800 MW in one year, making it the biggest market for new
turbines, and more than doubling the installations for the fourth year in a row.

The USA maintained its number one position in terms of total installed capacity, but thanks
to its impressive growth China became number two in total capacity, only slightly ahead of
Germany, both of them with around 26’000 MW of wind capacity installed.

Thanks to the leading role of China, Asia accounted for the largest share of new
installations in 2009 (40,4 %), followed by North America (28,4 %) and Europe fell back to
the third place (27,3 %).

The role of wind power in China in the recent years is impressive: a Chinese
renewable energy law was adopted in November 2004 (following the World Wind Energy
Conference organized in China) and the Government originally set a generating target of
30,000 MW by 2020 from renewable energy sources, but the installed capacity already
reached 22,500 MW at the end of 2009 and could easily surpass 30,000 MW as early as

4
http://www.wwindea.org

12
end of 2010 ! Indigenous wind power could generate up to 253,000 MW.5 By 2008, wind
power was growing faster in China than the government had planned, and indeed faster in
percentage terms than in any other large country, having more than doubled each year
since 2005. Policymakers doubled their wind power prediction for 2010, after the wind
industry reached the original goal of 5 GW three years ahead of schedule. Current trends
suggest an actual installed capacity near 20 GW by 2010, with China shortly thereafter
pursuing the United States for the world wind power lead. 6

India ranks 5th in the world with a total wind power capacity of 10,925  MW in 2009, or 3%
of all electricity produced in India 7. The World Wind Energy Conference in New Delhi in
November 2006 has given additional impetus to the Indian wind industry. Muppandal
village in Tamil Nadu state, India, has several wind turbine farms in its vicinity, and is one
of the major wind energy harnessing centers in India led by majors like Suzlon, Vestas,
Micon among others 8.

1.3 Wind power resisting the financial crisis

The global financial and economic crisis, all in all, had no significant negative impact on
the general development of the wind sector worldwide. Many governments sent clear
signals that they want to accelerate wind deployment in their countries and indicated that
investment in wind and other renewable technologies is seen as the answer to the
financial as well as to the still ongoing energy crisis.

Hence, politically stable and in many cases improved frameworks lead to more investment
in wind utilization around the globe. Two milestones in this context were the first feed-in
law in North America, adopted in Ontario, in the aftermath of the WWEC2008, and the
introduction of the first feed-in tariff in Africa by the National Energy Regulator of South
Africa. Similar incentive schemes (in the form of all-included, fixed feed in tariffs, or as
incentives payable on top of the regular electric energy market tariffs) are already applied
in different Countries, in particular in Europe.

Within this political environment the finance sector has started to understand that wind
technology is in principle a low-risk investment not only for the investors themselves,
5
Lema, Adrian and Kristian Ruby, ”Between fragmented authoritarianism and policy coordination: Creating a Chinese market for wind
energy”
6
Watts, Jonathan (2008-07-25). "Energy in China: 'We call it the Three Gorges of the sky. The dam there taps water, we tap wind'"
7
World Wind Energy Association Statistics, 2009
8
Watts, Himangshu (November 11, 2003). "Clean Energy Brings Windfall to Indian Village"
13
but also for lending institutions, given that right policies are in place. In addition to such
direct microeconomic benefits for wind investors, wind turbines stabilize the overall energy
prices and hence reduce general economic risks in a country, while reducing the
dependency on (in most cases imported) fossil and nuclear resources. Interesting
prospects for financing wind and other renewable technologies came up in the context of
the UN climate change discussions: The International Renewable Energy Alliance
proposed at the COP15 in Copenhagen a Global Fund for Renewable Energy
Investment, including a Global Feed-in Tariff programme. This proposal would enable
mainly developing countries to invest on a large scale in renewable energy and has
already attracted major interest amongst governments and international organizations.
Adopted in the frame of the United Nations Framework Convention on Climate Change
UNFCCC, it would pave the way for an accelerated huge and worldwide boom of
renewable energy deployment 9.

9
http://unfccc.int/2860.php

14
15
 2 The Market and the key players

2.1 The wind market in 2009

In the year 2009, altogether 82 countries

Figure 2.1 – Top 10 Countries Total Capacities (MW) – Source: World
Wind Energy Association Report 2009
used wind energy on a commercial basis,
out of which 49 countries increased their
installed capacity. China and the USA
established themselves as the by far
largest markets for new wind capacity,
together accounting for 61,9 % of the
additional capacity, a share which was
substantially bigger than in the previous

year (53,7 %)10.

Nine further countries could be seen as major

markets in 2009, with turbine sales in a range
between 0,5 and 2,5 Gigawatt: Spain, Germany,
India, France, Italy, the United Kingdom,
Canada, Portugal, and Sweden.

As a consequence of this sharp growth in 2009,

Figure 2.2 – Country share of new capacity 2009 – Source:
the World Wind Energy Association Report 2009

Country Share of total installed capacity at

the end of 2009 showed 17 countries with
more than 1’000 Megawatt installed,
compared with 11 at the end of 2005.

Worldwide, 35 countries had wind farms with

a capacity of 100 Megawatt or more

10
World Wind Energy Association,“World Wind Energy Report 2009”, March 2010
16

Figure 2.3 – Country share of total capacity 2009 – Source:

World Wind Energy Association Report 2009
 installed, compared with 32 countries in the previous year and 24 countries just four years
ago, showing that more and more Countries enter the wind power market with significant
investment on medium- and large-scale wind farms. In some Counries, wind energy has
become one of the largest electricity sources, the highest shares being Denmark (20%),
Portugal (15%), Spain (14%), Germany (9%); the present installed capacity in Europe
would produce, in a normal wind year, 4.8% of the EU’s electricity demand 11.

In 2009 (a “slightly above average”

windy year), the energy produced by
European wind farms avoided 106
million tonnes of CO2 emissions,
equivalent to taking 25% of cars out
of the EU roads !

Figure 2.4 – World Market Growth Rates 2004-2009 – Source: BTM Consult 12
The table on the left shows the
ApS - Denmark
wind market growth rates over a
period of 5 years (2004-2009), both
in terms of new power installed, and of cumulative power growth. The average expansion
of the market (more than 36% increase on average over the previous year) characterizes
the wind energy sector as one of the most fast and steadily growing market.

2.2 The Top Players

In terms of manufacturer’s market share,

in 2009 the top ten suppliers accounted for
more than 81% of the market share. Vestas
(www.vestas.com) of Denmak managed to
cling onto its position as the world’s number
one manufacturer. One very interesting
feature of 2009 has been the growing role of
chinese manufacturers: Vestas’ market
share has fallen from 19.8% in 2008 to
Figure 2.5 – Top 10 Suppliers In 2009 – Source: BTM Consult ApS
11
EWEA – The European Wind Energy Association – Fact Sheet 2010
12
BTM Consult ApS - Denmark
17
12.5%, and second placed GE Wind (www.gewind.com) has fallen from 18.6 to 12.4,
while at the same time three Chinese manufacturers (Sinovel, www.sinovel.com,
GoldWind www.goldwind.cn, and DongFang www.dongfang.com.cn) now feature in the
top 10.

The other major manufacturers are Enercon (www.enercon.de) from Germany, the
Spanish company Gamesa (www.gamesacorp.com/en ), Suzlon (www.suzlon.com )
based in India (which recently bought the control of the German manufacturer Repower,
www.repower.de ), and Siemens (www.energy.siemens.com ).

A quick overview of these major players is given below.

Vestas Wind Systems

Vestas was founded in 1898 in Denmark as a manufacturing company of steel windows for
industrial buildings.

In the early 1970s, during the second oil crisis, Vestas began to examine the potential of
the wind turbine as an alternative source of clean energy, and in 1979 Vestas delivered
the first wind turbines. The industry experienced a genuine boom at the start of the 1980s,
but in 1986 Vestas was forced to suspend payments because the market in the United
States was destroyed due to the expiration of a special tax legislation that provided
advantageous conditions for the establishment of wind turbines. A large sections of Vestas
were sold off and a new company called Vestas Wind Systems A/S was founded at the
end of the year to concentrate exclusively on wind energy.

After the merging with another Danish wind turbine manufacturer, NEG Micon A/S, Vestas
acquired a growing role in the wind manufacturing sector, becoming leader of the market
in the 2000s.

Today Vestas is present in 65 Countries in 5 continents, with an installed portfolio of more

than 40000 wind turbines. Vesta’s R&D centre is the largest in the world, with the
capability of real-time monitoring of all the portfolio of operating wind farms.

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Enercon

German giant Enercon was founded in 1984. Since then a small

team of engineers has developed its first E-15/16 wind turbine with a rated power of 55kW.
The changeover to gearless technology was made in 1992 with the first Enercon E-
40/500kW.

This technology, with its innovative drive system and few rotating components, enables
the direct connection of the rotating blades with the generator, without a gearbox. The
advantages are a lighter, simplest construction, less components, lower friction, reduced
mechanical stress and operating and maintenance costs. The ‘no-gear-box’ construction is
a true peculiarity of Enercon, as is the ‘vertical integration’ of this Company, which
develops and manufactures all the components of its turbines (including, of course, the
‘purpose designed’ gearless-generator), while almost all the competitors utilize industrial
components manufactured by third parties.

Today there are more than 13,000 Enercon machines installed worldwide in over 30
countries, with a combined capacity of more than 15GW.

Gamesa

Gamesa Corporación Tecnológica was established in 1976,

developing new technologies for application in emerging sectors with a promising future
such as robotics, microelectronics, environment, composite materials, etc.. Its corporate
headquarters are located in the Autonomous Community of the Basque Country (Spain).

The wind turbine manufacturing unit was set up in 1994, while promotion, construction and
sale of wind farms was started in 1996. In 1997, Gamesa began a process of
concentration on activities considered as strategic, culminating in 2006-2008 in withdrawal
from aeronautics and solar sectors, and focusing on wind energy, where Gamesa is active
not only as a manufacturer, but also as a developer/investor/owner of wind farms. 

The company has been listed on the Stock Exchange of Madrid since October 31, 2000
and has been included in the top Ibex-35 index since April 24, 2001.

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GE Energy

GE is one of the world's leading wind turbine suppliers and

boasts more than 13,500 wind turbine installations worldwide with more than 218 million
operating hours and 127,000GW/h of energy.

With wind manufacturing and assembly facilities in Germany, Spain, China, Canada and
the US, GE's product portfolio includes wind turbines with rated capacities ranging from
1.5 to 3.5MW and support services ranging from development assistance to operation and
maintenance.

The top selling GE wind turbine is the GE 1.5 MW model, originally developed by General
Electric in cooperation with the United States Department of Energy - DOE.

Three models in the series (the 1.5se, 1.5sle, and 1.5xle) had been developed and are
commercially available. Their rotors ranged in diameter from 70.5 m to 82.5 meters,
accommodating variable wind speeds, and making it one of the most popular turbine
model, in particular in the US (more than 10,000 installations in the US, or 50% of the
national commercial wind energy fleet.

GE's offshore wind business recently acquired Norwegian company ScanWind to increase
its product offering even further to serve the expanding offshore wind turbine segment.

Repower

Repower was founded in Germany in 1994, when the first in-

house developed 500 kW turbine was presented to the
market, later developed into a 600 kW (0.6 MW) turbine. Four years later the series
production of the BWU 1000/57 model begun, the first turbine in the “One MW” class.

The increase of unit power continued with the MD77 model, a 1.5 MW turbine with 77 m
rotor, designed to ‘capture wind’ also in low-wind sites, which become the most popular
model of Repower.

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Today the product ranges include turbines from 1.5 up to 5MW . The latter turbine – one of
the largest turbine’s in the world, with a rotor diameter of 126m – has been designed
primarily for offshore wind farms and the company is currently installing three of its new 6
MW 6M turbines onshore in Germany.

REpower has offices in Germany along with subsidiaries and associated companies in
France, Spain, the UK, Greece, Australia, China, Portugal, Italy. In 2007 a majority share
of the Company has been acquired by Suzlon, the leader an Indian wind turbine
manufacturer.

Suzlon

Conceived in 1995 in India with just 20 people, Suzlon is now a

leading wind power company with over 14,000 people in 21 countries, and operations
across the Americas, Asia, Australia and Europe.

The Company’s portfolio of models includes wind turbines from 600 kW (0.6MW) to 2.1
MW, and the supply chain is fully integrated with manufacturing facilities in three
continents. In 2007, also thanks to the acquisition of Repower, Suzlon expanded its
operations in Europe, and presently has R&D capabilities in Belgium, Denmark, Germany,
India and The Netherlands

Market leader in Asia, Suzlon market share (Combined with Repower) rose to 9.8%
thereby making Suzlon 3rd largest wind turbine manufacturing company in the world

Sinovel Wind Corporation

Sinovel is among the world’s top-ten largest turbine manufacturers

and is taking advantage of the massive growth in its home market of China.

The leading manufacturer of large-scale wind turbines in China, it was the first company to
introduce 1.5MW and 3MW machines into the country. Sinovel has produced more than
1,500 units of its 1.5MW machine and has a production capacity of more than 1,000 units
a year.

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3 The wind turbine technology: peculiarities, trends and attitude
towards innovation

3.1 Quick presentation of the technology’s characteristics

Wind turbines, including the costs associated with blades, towers, transportation and
installation, constitute the largest cost component of a wind farm, usually accounting for
around 75% of the capital cost.

Basically, a wind turbine is composed by the following components :

a) a steel tower, housing the electrical components like the power transformer, the
control and safety systems, as well as the
elevator or stairs for accessing the top of
the tower.

b) a nacelle, including the electrical

generator, a gearbox (which transforms
the slow rotation of the shaft to the speed
requested for the generator to produce
electric energy), the yaw and pitch
Figure 3.1 – A Wind Turbine – Source: US DOE
systems (required to rotate the turbine to
follow the direction of wind, and to adjust
the pitch of the blades in accordance of wind speed).

c) the rotor hub, that holds the blades in position on the ‘nose’ of the nacelle.

d) the rotor blades, varying in length up to more than 60 m each, are manufactured in
specially designed moulds from composite materials, usually a combination of glass
fiber and epoxy resin.

3.2 Areas of Technical Innovation in the Wind Energy Sector, and relevant risks

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Wind Turbines industry today can be considered a mature technology, after a very
significant growth in terms of installed capacity in Europe, in USA and Asia (amazing
growth in China over the past 4 years), as discussed in Chapter 2.

This technology is, however, still characterized by a fast evolution and, due particularly to
the very high capital cost structure of the wind industry, technical innovation is of critical
importance, because very slight improvements in wind energy capture and plant
availability can provide huge returns.

Technical innovations have focused in the recent past to three main areas:

a) Capturing more energy out of the wind resource, by installing turbines with
larger blades, fine-tuned blades design, more efficient generator/gear boxes:
the ‘hub height’ (i.e. the length to the tower on top of which the ‘nacelle’
containing the electric
generator is installed) reaches
now 100 m (in comparison
with 40-50m of just a few
years ago). The length of the
blades has also grown
significantly: the rotor
diameter was in average of
15m in 1980, 40m in 1990,
110m in 2000 and 150m and
more in 2010 (the comparison
with the dimensions of a
‘Jumbo Jet’ is amazing…).
This increase of the overall dimensions is instrumental to the objective of
‘capturing’ more wind, and therefore producing electric energy also with lower
wind speeds. While this trend Figure 3.2 – Size Evolution Of Wind Turbines – Source:

will allow the installation of

wind parks also in location which were not economically attractive until a few
years ago, the increase of overall dimension may pose issues in terms of
structural strengths, use of more sophisticated materials, more complex
transportation and installation processes.

23
 b) Increasing unit power, which passed from a few hundred kW in the early ’90 to
several hundred kW in the early 2000’s (for several years, the ‘standard’
capacity has been the very common 850 kW size), to a few thousand kW (i.e.,
MW) today. The main manufacturers are now offering as standard turbines
having unit power of 2-2.3-2.5 MW, and newest machines are already offered
with a nominal capacity of 3 MW for on-shore applications. Off-shore wind
turbines with unit capacity of 5 MW and more are offered by some
Manufacturers, although this cannot be considered a ‘mature’ and ‘commercially
available’ technology yet, due to the rather limited track record of these turbines
and the limited number of units actually installed. Higher unit power means a
lower number of bigger turbines to ‘capture’ the same quantity of wind,
optimizing use of land and reducing overall infrastructure costs.

c) Obtaining better availability, by ensuring that turbines are operating when the
wind is blowing the most. The availability factor of modern wind turbines (i.e. the
percentage of time when the turbine is
‘available’ to produce electric energy)
exceeds today easily 97% (guaranteed
value of most manufacturers), with a
sharp increase with respect to just a few
years ago, when values just above 90%
where standard.

In addition to these three ‘main goals’, as with other

manufacturing industries improving operation
costs is important as well; clearly, since the ‘wind
resource’ is free, optimizing the maintenance
procedures (and therefore lowering the operating
costs) has a direct, important effect on the
revenues, and consequently on the project cash
flow, as well as in reducing and potentially closing

24

Figure 3.3. – The Construction Of A Wind Turbine

– Source: Internet
the ‘gap’ between the generation costs of wind energy with respect to conventional fossil
fueled power plants.

One area of innovation which is unique to wind energy is the need to reduce noise
produced by the wind turbines: as more wind farms are built, they get closer to housing
and noise rules often become a limiting factor. Having a ‘low noise’ turbine in the portfolio
may be an excellent chance for a manufacturer to beat competition, and gain market
share.

Another area of potential innovation is the Distributed Control System (DCS), which
governs the operation of each wind turbine, and of the wind park as a whole. The DCS
technology enjoyed significant technologic innovation over the past 5 years, with important
positive feedback on plant efficiency and availability. Also in this field there are
perspectives of further development with the implementation of more sophisticated
software/hardware systems: however, since the risk associated with this kind of
technological innovation is rather low (it is always possible to quickly ‘switch’ from a new,
but unreliable SW/HW system to an older, more stable system), this is not usually
considered as a ‘critical’ aspect by Lenders. This aspect will not, therefore, be further
discussed in this paper.

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4 Financing innovation in the Wind Power Sector: risk
evaluation, allocation and mitigation, roles of the key players

4.1 Project Financing in the Wind Power Sector

4.1.1 Introduction

Project Financing (P.F.) is the key tool to provide financing means to the development,
construction and operation of wind farms. By means of P.F., new wind farms can be
financed on the basis of the projected cash flows of the project rather than the balance
sheets of the project sponsors. Usually, a wind farm project financing structure involves
one (rarely more) equity investor (the Sponsor or Owner), as well as a syndicate of
banks providing the financial means to the operation.

The loans are usually “non recourse” loans (or ‘limited recourse’ loans, in case of
riskier or more expensive projects, requiring surety from Sponsors), which are secured by
the project assets and paid entirely from project cash flow generated during the operation
of the wind park through the sale of the produced electric energy (plus ‘green certificates’
as applicable in some Countries, like Italy and UK), rather than from the general assets or
creditworthiness of the project Sponsors.

In general, a Special Purpose Vehicle – SPV (or ‘Project Company) is created for each
project, thereby shielding other assets owned by the Sponsor from the detrimental effects
of a project failure, and at the same time protecting the Lenders from problems or issues
involving the Sponsor and not related to actual wind project performances (the SPV has no
assets other than the project).

Thanks to a suitable ‘security package’, the lenders are given a lien on the projects
assets (physical assets like the wind turbines and other relevant wind farm infrastructures,
or contractual assets, like the supply and erection contracts or the ‘power purchase/supply’
contracts), and are able to assume control of a project if the project company has
difficulties complying with the loan terms (the suppliers are usually required to
acknowledge this right, by executing a specific “Direct Agreement” with lenders).

26
Capital contribution by the owner of the SPV are in general necessary to ensure that the
project is financially sound, and to prove to the lenders the ‘commitment’ of the
sponsor/owner of the project.

4.1.2 The attitude of Lenders towards P.F. in a phase of “credit crunch”

The 2008 crisis had a dramatic impact on credit to industry: the so called ‘credit crunch’
had important consequences on both the availability of loans for new industrial
transactions, and on the lending conditions requested to the borrowers.

While this scenario has been valid in the latest years in general terms, the financing of
renewable energy projects through the instrument of ‘project financing’ has been less
penalized: several major lending institutions have diverted towards P.F. more founds than
in the ‘pre-crisis’ times. In fact, P.F. has been much less affected by the crisis than
‘standard’ corporate financing, and has been preferred also to other financing opportunities
for lenders, like acquisition financing. The reason behind this is the specific peculiarity of
P.F., which is to base the capability to repay the loan not on the financial strength of the
borrower (nor on the highly risky ‘multiples’ of the acquisition finance….), but on the actual
performances of the project.

What is important to lenders in a P.F. transaction is the project itself, and not the Sponsor
promoting it: even a Sponsor having contingent balance sheet difficulties due to the recent
financial crisis may – in principle – promote a project and find lenders willing to finance it,
regardless to the possible (and hopefully temporary) financial difficulties of the Sponsor
itself. From the other side, the Sponsor may find through P.F. the means to implement its
project, without burden on its corporate balance sheet.

One immediate effect of the financial crisis has been the increase of the overall costs of
the transaction, either in terms of higher spread, or more conservative project ratios
(DSCR, debt/equity): this situation contributed to ‘discourage’ the “purely financial
sponsors” (characterized by a more speculative approach) with respect to the “industrial
sponsors” (those having a real industrial role, track record and background in the specific
sector).

Lending to renewable energy projects (namely in the wind and solar sectors) is particularly
attractive for lenders, for two main reasons:
27
 (i) the incentive mechanism (‘green certificates’, or incentivized ‘feed in’ tariffs)
applicable in several Countries, has a positive effect on the cash flow, and on
project’s security;

(ii) the legislative framework (in almost all developed Countries) gives to
renewable energies a ‘priority’ in the production of energy with respect to
fossil fuel power plants: renewable power plants are allowed to deliver to the
electrical network all the electrical energy that they can produce, regardless
the actual energy request of the electrical system, leaving to the conventional
power plants the ‘modulation’ role.

As a consequence, the sector of the renewable energies is much more appealing to banks
than other more traditional areas, like the infrastructural one, characterized by a
significantly lengthy and complex permitting process, higher investment levels, less secure
returns.

4.2 Presenting a wind farm project to the Lenders

Risk identification, allocation and mitigation are key components of all P.F., and wind
projects are not exceptions. A wind farm project may be subject to a number of technical,
environmental, economic risks, and in addition to specific risks like those associated with
the wind resource availability and uncertainty.

To cope with these risks, before approaching the perspective lenders, the project
Sponsor(s) take a number of actions, namely:

a) Complete the permitting process, and secure all required rights on the parcel of
lands where the wind farm will be built, in order to avoid (or significantly limit) the
perception of permitting risks of the Lenders

b) Carry out a comprehensive wind resource assessment, by installing one or more

anemometer (‘met masts’) to measure wind speed and direction. Such wind
measurement campaign must be carried out over a period of at least 12 months,
but a longer campaign (two-three years) can significantly reduce the risk associated
by lenders to the wind resource availability, and make bankability easier and,
therefore, less expensive.

28
 c) Approach turbine manufacturers, to verify the
suitability of the wind turbines to the wind
characteristics (not only wind speed, but
especially wind turbulence which may affect
turbine performances and operating life), and
obtain (if possible) the declaration of ‘purpose
suitability’ (“fitness for purpose”) of that specific
wind turbine model/class.

d) Approach a reputable, specialized company or

consultant to carry out a comprehensive ‘Energy
Production Estimation Report’. The main result
of this Report is an estimation of the ‘Equivalent
Hours’ of the wind farm and the expected yearly
energy production (MWh per year), which
Figure 4.1 – A Wind Turbine – Source: Internet constitute one of the main input to the ‘business
plan’ of the project.

e) Prepare a comprehensive ‘PIM – Project Information Memorandum”. This

document includes the main information, data and results of the studies carried out,
as well as (in general) a section on ‘risks allocation and mitigation’, in a way that
should allow lenders to provide an offer to finance the deal.

All the above steps are performed by the Sponsors (or its consultants), and are a condition
for the Banks to consider lending to a new wind farm project.

4.3 The role of the different players in the identification and allocation of the
technological innovation risks

4.3.1 The Sponsor

The Sponsor may have an important, but ‘indirect’ role in the mitigation of the risk
associated with technological innovation. While Sponsors always seek to maximize bank
debt on projects, they may accept to add more equity, and borrow less debt, in relation
with a higher technological risk perceived by Lenders.

29
However, while the Sponsors are generally willing to accept to take responsibility (and
therefore accept to bear the cost) of risks related to the permitting process, or to wind
characteristics uncertainty, they are in general reluctant to provide such liabilities to
Lenders in relation to risks which are beyond their control, like technological hazard.

A preliminary phase during which the SPV/Sponsor play a decisive role in mitigating the
technological risk of innovation is the selection and appointment of their contractual
counterparties. In particular, the manufacturers’ credit worthiness and technical expertise
are crucial for the purpose of a positive evaluation of a project, in terms of bankability, by
the relevant financial institutions.

In project financing transactions the

Lenders must ensure that the
assumption by the Sponsor/Borrower of
a high technological risk is
counterbalanced by the relevant
Manufacturer’s technical, economic and
financial standing. Such characteristics
put the contractor in condition (at least in
theory) to duly and promptly respond to
requests for technical intervention and/or
relief from damages in case of
malfunctioning or not fully performing equipments and facilities.

4.3.2 The turbine Manufacturer

Not surprisingly, wind turbine Manufacturers are the lead candidates to sustain the risk
associated with technological innovation: suppliers and contractors are well aware that the
introduction in the market of new products with particularly innovative technical elements
would be hardly accepted by investors and financial institutions unless a relevant portion of
the associated technological risk is borne by such suppliers and contractors.

Companies without a sound track record, or willing to launch a new model of wind turbine,
will be required to provide a significant package of securities and guarantees to Sponsor
30
and Lenders. This is one of the main reasons why there are only around 10 major
manufacturers of wind turbines in the world. All but one of those large Companies
(Enercon, www.enercon.de is the exception: they develop all of their technology) buy
technology from smaller suppliers, and incorporate the benefits into their overall product.

Those big Manufacturers/assembly Companies are large enough to satisfy the banks with
suitable corporate guarantees, which are very often necessary to secure financing in
presence of technological innovation, and may be available – to promote a new
technology, gain Sponsor’s and Lender’s confidence and therefore, in perspective,
increase market share – to accept a stringent contractual structure (as further discussed in
chapter 4.4).

As an alternative, Manufacturers may try to gain a ‘track record’ for a new model of wind
turbine by selling at least a first set of machines to costumers financing their project on the
balance sheet, so avoiding the complexity and the heavy liability/guarantees needs of a
typical Project Financing scheme. However, given the high capital cost structure of wind
industry, this should definitely be considered the exception to the rule.

In fact, in project financing transactions, risks such as:

 construction costs higher than expected (so called “cost overrun”);

 completion after the expected date (so called “delayed completion”);

 realization of a plant with performances significantly lower than those declared

and/or guaranteed (so called “performance deficiency”);

 decreased reliability and availability of equipment and machineries,

cannot be left (or, at least, not only) upon the project company and, indirectly, its financing
institutions, and the Manufacturer/Supplier is the best nominee to take care of these risks
and relevant costs (alternatively the sponsors may be required to cover such unexpected
costs by injecting equity into the project company through capital increases, shareholders
loans, etc. upon occurrence of the above negative events connected with innovative
technological elements of the project; such circumstance is – however – less common
than the assumption of risks by the manufacturer).

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Needless to say that the more innovative is the technology adopted in the project, the
greater would be the associated risks and, consequently, the Lenders reluctance to
finance the relevant project, and their willingness to procure that such risks are duly
transferred upon the contractors: a modification of the turbine blades profile, or an
increase of their lengths in order to “capture more wind” is clearly a much more substantial
(and risky) innovation than, for example, an improvement of the turbine control system or
of the wind direction/speed measurement device.

On this basis, and for the purpose of these new products to acquire a minimum track
record in the market, some manufacturers have expressed their availability to accept a
certain numbers of contractual burdens, both during the construction and operation
phases, which may encourage investors to adopt new technology and lenders to finance
such technology.

The proposed allocation of the technological risk’s upon the constructor would then take
place by adopting a range of contractual precautionary measure, providing, inter alia:

a) an extended product’s warranty period;

b) full service O&M contract with a tenor longer than market standard for non-
innovative technology; and

c) a higher manufacturer’s liability in terms of liquidated damages for delayed

completion or failure to meet the agreed standards of performances and/or
availability.

These aspects will be further discussed on paragraph 4.4, making reference to a specific
case.

4.3.3 The lenders

A very large share of project financing transactions in the private sector closed or in
development in 2009-2010, in Italy and in most of Europe, are relevant to renewable
energy projects. Banks active in this field are members of a ‘small club’ (less than 10 lead
banks active in the whole Europe, and probably not more than 5 or 6 in Italy), and are
32
therefore extremely more selective today than just two or three years ago. This is
particularly true today and in Italy, after the financial crisis of 2008, with the ‘consolidation’
of the lenders and the decision of some of the major foreign banks active in financing of
renewable energies to leave the Italian market.

In principle, financing institutions are generally reluctant to finance initiatives with

particularly innovative technical elements.

As a matter of fact, from a Lender standpoint the neutralization or at least mitigation to the
maximum possible extent of any risks that may adversely affect the borrower’s repayment
obligations constitutes its very major objective in project finance transactions.

However, the market knows of a certain number of projects based on innovative

technology, especially taking into account the indisputable benefits in terms of efficiency
and production that the industrial progress is providing to operators. The financing of
innovation by banks is much simplified when the technology supplier has an established
and well recognized reputation in the market, as well as a solid technical and financial
structure allowing it to promptly and properly respond to any requests for:

 intervention/restoration/replacement of defective facilities or equipments;

 relief from damages arising out in connection with the supply of malfunctioning or
not fully performing facilities or equipments.

Furthermore, as anticipated above, in structuring a project financing transaction the

Lenders tend to allocate the technological risk to entities (other than the borrowing
company) willing to assume such risk in whole or in part, and to be granted with legal
instruments allowing full or partial repayment of the financing upon occurrence of
particularly detrimental events.

4.3.4 The Legal Consultants

The main role of the Lenders’ Legal Advisor in the context of a project financing
transaction is to identify, analyze and allocate all (or, at least, the most significant) risks
and critical issues which may be even potentially capable of adversely affecting a project’s
capability to generate sufficient cash flow for the full reimbursement of the financing

33
granted by the Lenders, and/or the Borrower’s (the Sponsor, or the SPV) ability to fulfill its
obligations under both the financial and project documents.

More specifically, the activity rendered by the Lenders’ Legal Advisor mainly consists of
providing the financial institutions with remedies and solutions aimed at “ring fencing” the
project from any potential critical issue that may negatively affect the banks’ interest in the
financing.

The above mentioned “ring fencing” principle generally applies throughout the whole
structuring phase of the financing, by affecting in particular the following activities of the
Banks Legal Counsel:

a) the legal due diligence exercise, during which the Lenders Legal Advisor outlines
the actual legal framework of the project (e.g. at a corporate, permitting and real
estate levels) by identifying any possible issue which may affect its bankability, on
the one hand, and suggests the relevant legal countermeasures deemed
appropriate for mitigating the relevant risks, on the other hand;

b) the drafting of the finance documents, which is generally carried out with the
support of other independent consultants (e.g. market and technical advisors, see
paragraph 4.3.5 below) with the purpose of allocating any risks arisen during the
due diligence process – as well as those that may subsequently arise during the
loan’s life – on entities other than the banks (e.g. sponsor, borrower’s
counterparties under project contracts, insurance companies, third party providers
of guarantees, etc.).

Through a careful analytic work, on the one side, and the structuring of an adequate
defensive perimeter of the project, on the other side, the Legal Counsel

 allows its Clients (the Lenders) to have full access to, and comprehensive
knowledge of, all risks they are assuming by granting the financing to the
prospective borrower, and

 provides them with the legal instruments to protect their respective interest in
the transaction should the abstract risks be converted into concrete
prejudicial or potentially prejudicial events or circumstances.

34
4.3.5 The Technical Advisors, and the Certifications

Wind turbines are a mature, but also relatively ‘young’ technology, characterized by a fast
technological evolution. This means that no turbine currently on the market has actually a
‘track record’ close to the expected life time of 20 years. Therefore, third party certification,
providing comfort in particular on performance, reliability and project revenues, is key for
investors and banks.

A fundamental role, in this respect, is played by the Technical Advisor of the Sponsor
and of the Lenders. Its role is to assess the likely energy production of the project (see
point 4.2 (b) above), the cost in terms of Capex and Opex and the project time schedule.
There are a number of issues that represent a risk for not meeting one or more of the
above aspects (i.e. higher project costs; lower energy production due to low wind or low
turbine performances, and consequently lower project revenues; higher operating costs,
badly affecting the project revenues as well; longer construction times involving higher
costs and delayed revenues, etc).

The Technical Consultant must be in a position to identify and (where reasonably possible)
mitigate such risks, providing
advice and support to the
Sponsor, during the project
development phase, and to
Lenders during the structuring
of Project Financing. One of
the most authoritative
Technical Consultants in the
wind industry sector is Garrad
Hassan
(www.garradhassan.com),
which has provided his consultancy services to most of the wind project transactions
closed in the recent years in Europe.

35
When financing new wind turbine models, there will be not significant track record, and
therefore Lender’s comfort must be based on track record of similar models from the same
manufacturer, or more generally on the turbine manufacturer historical track record. Since
the Lenders are ‘conservative’ by nature, and are not technical expert, they usually rely on
Figure 4.3 – A Wind Power Plant – Source: Internet
their Technical Consultants to
approve new technologies. This role is therefore extremely critical: without a strong
recommendation from one of the top two or three Technical Consultants, Banks will very
hardly accept to loan to new technologies.

In particular, the assistance rendered by the Technical Advisor to the Lenders covers four
main phases:

 the technical due diligence exercise , when the Technical Advisor outlines the actual
technological framework of the project by identifying any technical issue which may
weaken its bankability, on the one hand, and verifying that the technical
assumptions comprised in the ‘business plan’ base case are consistent with the
actual layout of the project, on the other hand;

 the drafting of the finance documents by the Legal Advisor, where the Technical
Advisor supports the Lenders in addressing the technical issues;

 the construction of the plant, where its role is critical in the context of the approval of
(A) the works carried out by the relevant contractors; (B) any change to the
technical design of the works; and (C) the invoices issued by contractors;

 after the commencement of the commercial operation, during which the Technical
Advisor renders monitoring services.

Throughout a comprehensive and ongoing analysis of the technical elements of the

projects, especially those having specific innovative nature, the Technical Advisor allows
the Lenders to have knowledge of the technical risks which may affect the successful
completion and operation of such projects and supports the Legal Advisor – during the
drafting of the finance documents – in evaluating, excluding or mitigating such risks.

From a technical view point, in addition to the ‘thumb up’ of the Technical Consultant to a
turbine model enjoying an innovative technology, it is also very important the “Type

36
Certificate” issued by an international recognized classification body. Such entity (among
others, Det Norske Veritas, www.dnv.com) will review in detail the design and testing of
any new model, before releasing the relevant Type Certificate (i.e. a certificate of quality
and performance, which will be applicable to all wind turbines of the same model).

Besides technical innovation, it is worth to mention the role of the Tariffs Consultant,
which has an important responsibility in providing both Sponsors and Lenders with an
estimate of the tariff structure and – when applicable – renewable energy incentives (like
the ‘Green Certificates’ in Italy, or R.O.C. in UK) which will be applied during all the life of
the project (and in particular during the period of reimbursement of the loan to the banks).
The tariff survey and relevant projections provided by these Consultants (among others,
Poyry – www.poyry.com has a reputation in this specific field) are a strategic input data for
the ‘business plan’ of the project.

4.4 A typical contractual framework for the supply, erection and operation of
innovative wind turbine model

4.4.1 Introduction

As already pointed out, the Lenders have a very ‘conservative’ approach towards
innovation in a project financing transaction, and use to say that ‘the best mitigant to a
technologic innovation risk to refrain from financing the project’. This has always been the
case, but is particularly true under the present ‘credit crunch’ situation. On the other hand,
the P.F. market is today ‘short’: there are more projects on the market than lending
capabilities of the banks. There is therefore much less appetite from lenders to be involved
in more risky transactions, while they prefer to concentrate and use their resources on
more traditional, less complex and risky deals.

As discussed previously, neither the Sponsor, nor the Technical Consultants, can provide
sufficient contractual mitigants to the lenders, and inevitably the support to a new
technology must be provided by the Supplier, through a suitable set of contractual
obligations and liabilities provided to Sponsor and lenders. The Supplier will, in general,
accept such support to its new technology in order to gain the status of “bankability”, and
therefore increase its profits and market share.

37
These contractual provisions have a key role in reaching the ‘bankability’ for an innovative
project: financial mitigations are of course important as well, but are definitely of secondary
importance with respect to contractual aspects.

A ‘case history’ is discussed in this section, relevant to a ‘non-recourse project

financing’ of a wind farm based on a new model of wind turbine, incorporating
significant technical innovation (new blades dimension and design, higher unit power, new
cooling system, modified gear boxes, etc.), without a track record and not yet provided
with ‘Type Certificate’.

The turbine is supplied by a top rank European Manufacturer. The Lender’s Syndicate is
composed by five primary Banks, led by a major Italian Bank.

Details on Manufacturer, Lenders Syndicate and Sponsor cannot be disclosed at this

stage, but some of the fundamental contractual provisions of the ‘Turbines Supply’ and
‘Wind Park Operation’ contracts will be discussed, providing an overview of the innovation
risk allocation and mitigation strategies being applied in order to secure ‘non recourse’
project financing.

4.4.2 Warranties and Bonds

The Warranty Period is the period of time during which the manufacturer is committed to
repair, or replace at its own expenses, all defective equipment. The Warranty Period in the
wind industry is typically 24 months from the beginning of Commercial Operation of the
wind farm.

In this specific case, the Lenders have requested, and the Manufacturer has accepted, to
extend such Warranty Period to 60 months (5 years).

The manufacturer has also accepted to issue a set of bonds, as a guarantee to the SPV-
Sponsor-Lenders that the Manufacturer will adhere to the provisions of the terms of the
Supply and Operation contracts. The main guarantees are the performance bond
(guarantee that the turbine manufacturer/contractor will perform the work as specified by
the Owner) and the operation/maintenance bond (guarantee that the contractor will
provide wind park repair and upkeep, maintaining a minimum guaranteed plant availability,
for the duration of the operation contract).

38
In addition, the bonds are ‘first demand’: this is an additional protection for the SPV-
Sponsor-Lenders, since the guarantee is payable upon the beneficiary’s written first
demand, notwithstanding any defense of the manufacturer/contractor (in other worlds,
proof of default or underperformance of the manufacturer is not needed, and the bond can
be cashed by the beneficiary without discussions or delay).

The validity of these guarantees has been extended from the first payment made in favor
of the Manufacturer, up to the end of the Warranty Period of the wind park (5 years).

4.4.3 The ‘Type Certificate’

The wind turbine model is not yet provided with a complete set of ‘Type Certificates’,
ensuring its quality and performance as certified by an independent certification body. It
has been agreed to consider the issuance of the complete set of ‘certificates’ as a major
‘milestone’ of the project, with an associated important payment. This contract clause
confirms the importance attributed to the instrument of the ‘Type Certificate’, and the key
role played by the certification bodies for the commercialization of innovative models and
products.

4.4.4 Schedule of Payments

In general, the payment of the contractual price of a wind park is performed on a ‘step by
step’ fashion, with settlement of the price of each single turbine at successful completion of
operating test of that turbine. In this case, the Lenders have requested, and the
Manufacturer accepted, to perform a significant portion of the payment at the acceptance
of the overall wind park, after successful completion of a rigorous set of tests on the
performance of the whole facility.

4.4.5 Protection against “Serial Defects”

This aspect is extraordinarily important for innovative wind turbine models. In case the
same ‘defect’ is identified in a certain number of units (three or more, for example) during
the operation of the wind farm, then this defect is deemed to be a ‘serial defect’, and
corrective measures must be taken not only on the units already affected by the problem,
but on all the wind turbine supplied.

39
The acceptance of this obligation by the Manufacturer is very important, and represents a
key factor for the ‘bankability’ of a new model of turbine. From one side this protection
against ‘serial defects’ actually shields the Lenders and the SPV from design defects or
manufacturing problems; from the other side, the acceptance of this obligation by the
manufacturer is a prove of its ‘confidence’ on the new technology/innovation, and can be
extremely useful in gaining support for the new technology.

4.4.6 Manufacturer’s Liabilities

The level of liabilities that the manufacturer is willing to take is another key factor to
demonstrate its trust in the new model of turbine launched on the market. Also the ‘cap’ on
the liability of manufacturer is usually much higher in case of innovative technologies. In
general: the wind turbines Supply contract for a wind park includes penalties for (i)
completion time, and (ii) performance; both those liabilities have a cap (usually a
percentage of the contract value) that cannot be exceeded. In general, these liabilities are
capped respectively at 5% (completion time), 10% (performances), with a cumulative cap
at 10-15%. In case of innovative technologies, these values may grow significantly, up to
15%-15%-20% or even more. Again, this is considered an indication of the ‘confidence’ of
the manufacturer towards its ‘new’ technology. Clearly, in any case the manufacturer’s
liabilities (due to the unavoidable ‘cap’ on its contractual obligations, and to the exclusion
of any ‘consequential damages’) can only marginally cover the risk of economic losses due
to (unlikely, but still possible) ‘dramatic’ underperformance of a new model of wind turbine
(the actual damages that SPV and Lenders may suffer would in this case be massive, and
much higher than the ‘capped’ damages paid by the Contractor).

4.4.7 “Full Service” clause in the Operation Contract

The supplier of the wind turbines (in particular in the case of a innovative model) are
requested – at the end of the construction phase – to enter into an ‘operation contract’,
including all maintenance costs and a guarantee of ‘plant availability’. The clause of “full
service” includes “all” costs, both for planned and unplanned maintenance, as well as the
cost for replacement of all defective equipment (with the only exclusion of ‘force majeure’
events). This is – ‘de facto’ – an extension of the warranty period (which is, in the specific
case, of five years) for a fixed annual fee, and constitute a very significant protection for

40
the Sponsor/SPV/Lenders against the technological risk, and its possible consequences
on the cash flow.

Also the duration of the Operation Contract has been extended from the ‘market standard’
(two or five years) to twelve years, corresponding to the duration of the loan, as requested
by banks.

4.4.8 Availability guarantee

A guaranteed availability of the wind farm is a standard clause in all ‘Wind farm Operation’
contracts. In the case under discussion, however, in the light of the technical innovation of
the new turbine model, the manufacturer/Operator of the wind farm has accepted the
following specific conditions:

a) A duration of the availability guarantee (97% minimum on yearly basis) equivalent

to the duration of the Operation Contract (12 years).

b) A penalty for not reaching the guaranteed availability significantly higher than the
standard practice.

c) A ‘cap’ on the above liability equivalent to the amount of two years of operation fee
(this cap is normally one year of the operation fee)

The above availability guarantee package is extremely attractive from the Lender’s view
point, and the willingness of the Manufacturer to accept this scheme had an important role
in the decision of the syndicate of lenders to consider ‘bankable’ the innovative technology.

4.5 Main financial mitigants to control innovation risks

In addition to a suitable contractual framework, ensuring the commitment of the Supplier in

supporting its innovative technology, the banks may (and usually will) require the Sponsor
to accept “conservative” and prudent (from the lenders view point) lending terms, in
particular in relation to the Debt Service Coverage Ratio - DSCR, the Debt to Equity
Ratio – D/E and the Spread, as briefly discussed below.
41
The Debt Service Coverage Ratio (DSCR), is the ratio of cash available for debt
servicing to the sum of interest, principal and lease payments: a DSCR over 1 means that
(in theory, as calculated to bank standards and assumptions) the entity generates more
than sufficient cash flow to pay its debt obligations, while a DSCR below 1.0 indicates that
there is not enough cash flow to cover loan payments. This is the key benchmark used in
the measurement of the wind project ability to produce enough cash flow (through the sale
of electric energy and ‘green certificates’) to meet interest and principal payments on debt:
in order to consider a project ‘bankable’ and suitable for a P.F. transaction, the lenders
usually require that the project’s business plan shows a minimum DSCR (clearly, always
higher than 1) that makes the banks comfortable about the ability of the project itself to
produce the cash flow necessary to repay the loan. Breaching a DSCR covenant can, in
some circumstances, be an act of default under the contract (incidentally, the risky attitude
of “too aggressive” – or better reckless – banks to accept DCSR values close or even
lower to the 1 in the commercial real estate finance has been one of the main reasons for
the financial crisis of 2008-2010).

Under normal circumstances, with no permitting risk, a good and stable wind resource, a
trustworthy Sponsor and a reputable turbine manufacturer supplying a turbine model with
a proven ‘track record’, values of DSCR in the range of 1.22, 1.25 have been standard in
transactions closed in the recent years. However, in the presence of technological risk
related to innovative turbine model, the banks may require an increase of this ratio to 1.3
and even more. This is clearly an heavy condition for the sponsor, since a quite significant
amount of cash must be kept inside the SPV, as a guarantee for the banks, and cannot be
distributed to shareholders as dividend.

A possible compromise (which has been quite popular in recent transaction in the wind
sector) is to have a ‘variable DSCR’ over the operative life of the wind farm: higher (1.3 or
even more) in the first period (three to five years), when the risk associated with the
technological innovation is greater, and lower in the following years (1.2, or slightly less)
up to the full repayment of the loan.

The Debt-to-Equity Ratio (D/E) – also known as Gearing or Leverage - is the ratio
indicating the relative proportion of SPV shareholders' equity and debt used to finance a
project in a project financing framework.

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Before the recent financial crisis, typical D/E ratios for wind energy projects in the range of
85/15 were usual practice. More recently, transactions have been closed or are in final
stage of negotiation with ratios in the range of 80/20 down to 75/25; the latter in presence
of perceived higher risk, due to a overall project’s complexity and the utilization of turbines
with limited track record.

However, instead than increasing the gear it is often possible - and definitely preferable -
to negotiate with Lenders a commitment of the Sponsor to pay a “Contingent Equity” to
the SPV in case of cost overruns related to the innovative technology selected by the
Sponsors: it is clearly a form of “indirect guarantee” by the Sponsor in support of the
business of the SPV. Such ‘conditional cash injection’ into the SPV may be performed
through a SPV’s capital increase, or a shareholders loan. By taking the commitment of
such ‘conditioned’ guarantee, the Sponsor may succeed in controlling lender’s perception
of risk towards an innovative technology, avoiding – at the same time – a too low gearing
of the project (low D/E), or too much cash ‘trapped’ in the SPV (high DSCR).

On the contrary, an increase of the ‘spread’ (which reflects the additional net yield the
lenders wish to earn in relation to the yield on a “risk-free” benchmark security or
reference rate) is not usually considered a way to mitigate a risk; in fact, the spread is in
general seen as an indicator of the overall risk of the project as perceived by the bank (and
is therefore a ‘premium’ paid to accept such risk), and not – in general – a ‘tool’ to mitigate
it. In fact, an increase of the ‘spread’ does not mitigate the risk for the bank..…but may well
dampen the enthusiasm of the Sponsor in adopting a new technology which is perceived
as too risky!

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5 References

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