How to effectively finance your greenfield infrastructure project
Authors: Robin Norrbäck, Timo Kurki
Estimated reading time: 5 minutes
Lenders typically regard established technologies, like those utilized in wind farms, as more reliable compared to cutting-edge innovations in the circular economy. However, well-structured offtake agreements can mitigate the risks associated with these novel technologies. In all cases, a realistic bank model is essential for optimizing debt terms.
Financing an infrastructure project typically requires both debt and equity, with the ratio between the two depending on several factors. To optimize returns, it is generally advisable to maximize debt while ensuring that the financing terms remain attractive. Equity and debt financing have different characteristics, as do projects, which can vary significantly by industry, technology, and ownership structure.
Over the past two decades, our team has facilitated various large-scale financing arrangements for greenfield projects and M&A transactions, arranging billions of euros in debt financing. Below, we share key insights from successful debt transactions, with a focus on large-scale financing.
Mitigating risk with well-structured agreements
The key to securing competitive and lucrative debt terms lies in proper risk allocation. For greenfield infrastructure investments, this can be achieved through well-structured agreements established at the outset of the debt procurement process. Typically, offtake agreements serve this purpose. These agreements are used to hedge the price and/or quantity of an input or output of the project in question.
For example, a waste incinerator requires waste as a fuel input while selling heat and electricity as outputs. Both the price and quantity of waste, heat, and electricity can be hedged in advance through offtake agreements with various counterparties. While achieving this can be challenging, successfully doing so will appeal to lenders and result in more favorable financing terms. The point is that such agreements enhance the predictability of cash flows, reducing volatility and facilitating lenders’ credit assessments.
The key to securing competitive and lucrative debt terms lies in proper risk allocation.
Considering the sponsor’s perspective
In project-financed (i.e., non-recourse) transactions, the amount of debt – leverage or gearing – depends on forecasted cash flows. Therefore, it is essential to consider if the available offtake terms are feasible from an equity investor’s perspective. First and foremost, it is crucial to remember that every case is unique, and finding the optimal funding structure always requires a careful balancing act.
From a lender’s perspective, established technologies, such as those used in wind farms, are generally viewed as more reliable than entirely new innovations within the circular economy. Nonetheless, regardless of the technology employed, having well-structured offtake agreements can mitigate project risks, assuming the counterparties possess strong creditworthiness.
Importance of staying realistic
All business plans and financial models rely on assumptions, which are typically drawn from either third-party market forecasts or historical data such as past sales, costs, and industry benchmarks. Due to the inherent uncertainty of the future, risk-averse financiers, such as banks, often focus on how projects will perform under pessimistic scenarios. This is especially true for novel technologies.
However, financiers also prioritize conservative assumptions for established technologies with proven track records to mitigate risk and ensure financial viability in potentially unfavorable conditions. For instance, when assessing the profitability of a wind farm investment and sizing the appropriate amount of debt financing, banks commonly require careful revenue projections that include low-wind scenarios to inform their financial calculations.
Nevertheless, conservatism is not to be mixed with the worst-case scenarios. Conservative or pessimistic assumptions can represent probable outcomes, while worst-case scenarios are typically unlikely to occur.
Value of comprehensive market understanding
To remain realistic regarding the success of the project and secure funding from external sources, it is crucial to have a thorough understanding of customer demand and market conditions in the foreseeable future. This includes comprehension of the prevailing market conditions and the level of competition, whether the product is being sold in markets that are emerging or already saturated. Additionally, macroeconomic factors such as tightening regulations and the financial market environment must be considered.
Unrealistic assumptions and expectations can not only deter banks from providing debt financing but may also damage the project developer’s reputation by suggesting incompetence. A truthful and pragmatic approach helps clarify the assumptions used in the business and financial model, showing whether the project can sell its products, generate profit, and repay or refinance the debt as forecasted.
Unrealistic assumptions and expectations can not only deter banks from providing debt financing but may also damage the project developer’s reputation by suggesting incompetence.
Unlocking success: cautions and opportunities
While offtake agreements can be beneficial, there have been instances where they have led to significant challenges, highlighting the necessity of thoroughly understanding the associated processes. Furthermore, if Operations and Maintenance (O&M) agreements or other outsourcing arrangements are required, it is vital to ensure that these are either finalized or nearing completion when securing debt financing.
Ultimately, a realistic bank model not only facilitates the optimization of debt terms but also enhances the risk-return profile for equity investors. Therefore, careful assessment of all critical factors is vital for ensuring bankability of the project with best possible terms.
Key points to consider
When assisting our clients with their greenfield investments, we typically follow this high-level procedure:
It is important to consider steps 1 and 2 before progressing to step 3. A clear understanding of how contracts operate under various conditions and how these outcomes can impact funding is crucial.
Robin Norrback
M.Sc. (Tech) in Industrial Engineering and Management
Robin has over six years of experience in investment banking and strategy work within the Nordic energy sector. He is currently an Associate Director at Elron, a member of Elomatic. Robin’s focus areas include M&A, financing, and project development of renewable energy projects.
robin.norrback@elron.fi
Timo Kurki
M.Sc. in Economics and Business Administration
Timo has over four years of experience in the energy sector and currently works as an Analyst at Elron, a member of Elomatic. He has worked in financial consulting and investment banking within the energy market, focusing primarily on valuations and financing related to renewable energy projects, district heating, and electricity transmission.
timo.kurki@elron.fi
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