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Thursday, 13th August 2020
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Financing opportunities for wind farm development not fully taken up Back  
Convinced that there is more scope for lending to wind energy developments, Niall King, sets out the characteristics of the elements of finance for alternative energy plants - equity, debt and tax based lending.
We are the best placed country in Europe to harness wind energy. At conferences which I have attended many seasoned wind farm operators in Sweden and Denmark have said they envy us. And yet we have failed to grasp this opportunity with both hands.

Why should this be so? We have wind in abundance. As an island nation we rely on imported fossil fuels. And yet wind energy offers wind farmers the chance to produce their own energy requirements and sell their surplus into the national grid.

As a financier of wind energy projects, we at Bank of Scotland in Ireland have watched with disappointment how relatively few wind farms have been actually completed to date in Ireland. This is because the development of wind farms is a long and arduous process. The hurdles to overcome include planning permission, national grid connection and environmental issues.

There is considerable opposition at the planning stage on environmental grounds. This is a pity because the alternative is to continue burning fossil fuels with the attendant pollution and green house effects which they cause. It also seems to make no difference with objectors that the Kyoto Agreement, as confirmed by EU regulations, stipulates that at least 10% of Ireland’s electricity output by the year 2010 must be generated from ‘renewable’ sources (i.e. wind, wave, hydro). If this target is not met, Ireland will be liable for significant fines.

Despite the opposition and the obstacles, however, the future is still promising. The Kyoto requirements, the recent deregulation of the Irish electricity market, the financial benefits from wind farms and the growing realisation that it is a clean energy source will, I believe, see considerable expansion of this sector over the next decade.

Equity of 20 per cent
When it comes to financing a wind farm, there are several sources of funding which come together to fund wind farm companies. These are equity, debt and tax based financing. Equity wind farms are effectively ‘project finance’ operations, and accordingly are frequently financed on a ‘stand alone’ basis i.e. without personal recourse to the promoters. For this to be achieved, the shareholders of the wind farm company would need to inject a minimum of 20% of the total development costs into the company by way of ordinary share capital.

The amount of equity required does however depend on a variety of factors including whether or not there is an ESB Power Purchase agreement (PPA), the selling price, the wind speeds, forecast output, cashflows and so on. Promoters can also borrow the equity itself in their personal names if they have independent security apart from the wind farm company.

Debt finance
The bulk of wind farm financing is usually provided by way of straightforward debt i.e. the operating company borrows up to 80% of the total development costs, usually by way of a fifteen-year term loan. The facility can be secured on the assets of the farm itself if the project is regarded as strong enough to support the required level of debt. However personal or corporate recourse may also be required. It is unusual to see wind farms with debt levels as high as 80% because of the availability of other forms of finance as well as grant aid.

Section 62 / 486 (b) finance
Section 62 of the Finance Act 1998 (Section 486b of the Taxes Consolidation Act 1997) provides for tax relief for corporates investing in qualifying wind energy projects. These incentives are similar in nature to those which apply for Business Expansion Scheme (B.E.S.) investment and Section 35 (film) investment.

This form of finance can be utilised in two ways:
• The bank itself can invest Section 62/486b equity directly in to the operating company.
• The promoters may control another independent company which can make theSection 62/486b investment itself, directly into the wind farm company.

The main advantage of this form is finance is naturally its tax break, which is usually shared between the investor and the wind farm (which may receive interest free finance for five years). On the down side corporate tax rates are falling and hence the value of the tax break is reducing. In addition the specifics of the investment are very complex, and must be structured carefully to ensure that the investment complies with Revenue practice.

A key point with this form of finance is that, unlike Section 35 and B.E.S., it is only available to corporate investors and hence the relief is only available at the corporate tax rate. As these rates fall towards 12.5% in 2004, the relief is becoming more and more marginal and it is unlikely that we will see Section 62/486b utilised much unless the Government amends the legislation to allow individuals invest.

Reducing risk
Risks to the operating company during the construction phase can be reduced by incorporating banking instruments, such as a letter of credit, into the overall financing package. For example, a letter of credit, which is a form of conditional bank guarantee, can be offered to the turbine manufacturer ensuring him that he will receive payment for goods ordered, assuming he delivers them in line with agreed contract terms. The operating company can take comfort from the fact that payment will only be made to the turbine manufacturer on receipt of specific documentation under the letter of credit (a certificate of taking over signed by project engineer for example). There is also a financial benefit for the operating company, as it will only require debt finance from the end of the letter of credit cycle i.e. from when the farm is ready to be commissioned.

Tax efficient structure
A large proportion of the expenditure on a wind farm is for plant and equipment, which qualifies for capital allowances. The allowances are available at 15% p.a. over the first six years, with 10% in year seven. If this plant and equipment is retained within the wind farm company, then the capital allowances can be set against its trading profits. This is naturally very welcome for cashflow purposes, particularly in the early years of a wind farm, when it is likely to have a substantial debt burden.

However, with the significant and growing divergence between corporate (currently 24% falling to 12.5% by 2003) and personal tax rates (44% top rate), it is beneficial to structure the ownership of the plant and equipment, so that it vests with a ‘partnership of individual investors’ who can utilise the capital allowances at their marginal tax rate.

As with Section 62 finance, this arrangement is mutually beneficial for both the partnership and the wind farm company as the deal is priced so as both parties share the benefits.

Outlook
The next decade is likely to see considerable harnessing of wind energy in Ireland, ranging from single turbine operations to the large scale 100 MW off-shore farms as proposed for the Kish sand bank. The Government can influence the speed and scale of this development and will probably have to introduce fresh incentives if Ireland is to meet its renewable energy targets by 2010. Expanding Section 62 /486b relief to individuals as well as making it more ‘user friendly’ would be welcome.

Furthermore, the electricity market was deregulated on February 19th last, allowing producers of ‘green’ energy to supply electricity to any customer they choose. This is a major advantage over the fossil fuel burning large-scale producers who initially have restricted access, only to the larger consumers. Renewable producers who do not have ESB PPA’s will now also have the option of either selling directly to end users or utilising the services of companies such as eirtricity who have announced they will purchase green energy from renewable sources for onward retailing.

In summary, Ireland’s wind energy market is currently going through a turbulent infancy. Hopefully, we can look forward to watching it grow and mature over the coming decade.

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