Risks and due diligence involved in an SPC green energy investment project

Updated: Dec 22, 2021



Due diligence


As wind energy reached a total of 51.8 billion euros in investment in the year 2019 (Wind Europe, 2020), due diligence becomes an important part of an investment evaluation. In the case of the investment summarised in this report, 2 years (2021-2023) were spent before the final commitment to the project funds was made and financial closure was concluded. The three main components of due diligence are technical, financial, and legal (Blaiklock, 2014).


Technical due diligence


For example, investors and lenders may seek third independent professional advice on technical matters of design and specifications of the proposed project and seek advice if the project is commercially viable based on the maturity of the technology applied.


Financial due diligence


Furthermore, due diligence may be required to double-check the integrity and projections undertaken in the cash flow model and sensitivity analysis by the financial advisors. This could be found necessary by the investors and lenders as the models could be used in a later stage for renegotiation of energy tariffs.


Legal due diligence


Lastly, legal advisors will have the responsibility to review documents and laws such as licensing and permits required, environmental liabilities, relevant statutory instruments required for the project, the enforceability of contracts, local laws, and more (Blaiklock, 2014).





Risks


Risk is uncertainty and various risks can be a risk to investors and may not be a risk to lenders and vice versa (Blaiklock, 2014). Risks and uncertainties become apparent by carrying out a sensitivity analysis but sometimes are also very difficult to predict based on the nature of the project. A list of possible overall and specific risks and risk mitigations possibly to be encountered in the project assessed in this report are listed in the table below.


Risks

Risk explanation

Risk mitigation

Planning risks

  • Ground conditions

  • Wind conditions

  • Wake loss conditions

  • Site acquisition

  • Extensive technical due diligence to lower probability of technical uncertainty (damage limitation)



Construction risks

  • Construction costs overruns

  • Performance of suppliers and contractors

  • Weather conditions

  • EPC has invested into the project and the construction is curried under a fixed price turnkey contract which ring-fence risks

  • Negotiate penalties and incentive clauses in the construction contract (e.g., NEC4 contracts)

  • Negotiate underperformance penalties in contracts (however in this case a risk premium could be present when contractors submit tenders to cover their risk of completion on time)

  • Choose contractors with technical experience to undertake the project

Operational risks

  • Revenue predictions decrease

  • Operational cost increase

  • Low performance of WTGs

  • Electricity prices rise

  • Weather conditions

  • Supply chain delays on parts

  • Intensive due diligence on construction site constraints and technology performance

  • Introduce retention amounts to be paid after a period of project completion for maintenance issues due to low construction quality

  • Predictable energy demand such as agreeing with an industrial factory to supply constant energy on a constant agreed tariff

  • Availability payment (not applicable)

  • Spear parts of WTGs to be kept on site in case of supply chain issues

  • Agree on WTGs supplier warrantee for the next 5 – 10 years of operations and negotiate low service fees contract for period after warrantee

Currency risks

  • ​Hard currency convertibility and transfer (Euros to Krone)

  • Construction cost and O&M costs local currency expenditure

  • Sufficient revenues must be converted into the foreign-currency amounts required by lenders and investors

  • Offshore reserve accounts

  • Cross currency swap

Economic risks

  • Fluctuation of energy demand and electricity price

  • Market competition with other power sources

  • Negotiate a competitive PPA tariff

  • Due diligence on future market trends on energy price

  • Renewable energy market is in demand hence competition with other non-green sources is low

You may also find useful:

  • How to Determine the Financial Strength of Contractors ?

Financial risks

  • Production risk due to wind variability

  • Increase of interest rates which impact cash flow

  • Ability to service debt

  • Implementation of back-up, reserve capacity and power storage into the project costs will lower the risk of wind variability

  • Interest rate swaps

  • Carry sensitivity tests on cash flow performance if interest rate increase with indicators of DSCR and ICR evaluated for bankability

  • Escrow and reserve accounts, minimum requirement of DSCR,

  • Dividend payment constraints

Political and legal risks

  • ​Duties and customs on construction material affect the quality of project construction

  • Common contractual documents (e.g., NEC4 or JCT for construction)

  • Mitigations of political risks are very low as they cannot be controlled

Environmental and social risks

  • Noise pollution to nearby communities

  • Carbon emissions of construction and operations activities (

  • Address of environmental and social risks and mitigation measures in predevelopment stage before financial close (follow Equator Principles and UN sustainable development goals)



References


Blaiklock, M., 2014. Infrastructure Finance Handbook : Principles, Practice and Experience. London: Euromoney Books


Deloitte, 2014. Establishing the investment case of Wind power , Copenhagen: Deloitte.