The Project Financing Outlook for Global Energy Projects

March 04, 2024

Both the US and global energy storage markets have experienced rapid growth over the last year and are expected to continue expanding. An estimated 650 gigawatts (GW) (or 1,877 gigawatt-hours) of new energy storage capacity is expected to be added globally from 2023 to 2030, which would result in the size of global energy storage capacity increasing by 15 times compared with the end of 2021.[1] The US storage market had a record-setting third quarter of 2023, adding 2,354 megawatts (MW) (or 7,322 megawatt-hours (MW) of installed capacity to the grid.[2] It is anticipated that the US storage market will install an estimated 63 GW between 2023 and 2027.[3]

The rapid growth in the energy storage market is similarly driving demand for project financing. Like any other project-financed asset class, lenders will analyze both the amount and probability of receiving cash flows generated by energy storage. Energy storage resources present a distinct set of challenges given their unique nature: unlike conventional or renewable generation, energy storage resources must be charged with electric power, which will sometimes (but not always) be provided by the off-taker. 

In addition, energy storage resources are limited in their ability to dispatch by the number of MW that can be used to charge the project (which amount may vary depending on the state of charge of the project) as well as the total number of MWh that can be stored. Energy storage resources are typically capable of providing capacity and other ancillary services, thus making them stronger candidates for multiple revenue streams than traditional generation. Each of these revenue streams will be subject to lender analysis. Moreover, there are certain additional considerations when structuring a project finance transaction for an energy storage project.

Technology Risks

Lithium-ion batteries remain the most widespread technology used in energy storage systems, but energy storage systems also use hydrogen, compressed air, and other battery technologies. Moreover, the energy storage industry continues to explore new technologies that can provide longer-duration storage to satisfy different market needs. Project finance lenders view all of these newer technologies as having increased risk due to a lack of historical data. As a result, a primary focus for lenders in their due diligence of an energy storage project will be on evolving technology risks.

Much of the lenders’ diligence on technology risks will be covered by a report from an independent engineer. The independent engineer will examine the project’s ability to satisfy the commissioning testing requirements and minimum performance requirements under the applicable offtake agreements. Further, for energy storage projects using lithium-ion batteries, lenders will expect a robust review from the independent engineer on capacity degradation and safety issues tied to overheating. Project companies can mitigate degradation concerns by securing performance guarantees, equipment warranties, and/or an operations and maintenance (O&M) agreement to ensure that equipment will be replaced or otherwise maintained at a minimum capacity.

In particular, performance guarantees and equipment warranties mitigate technology risks by shifting these risks away from the project company to the technology vendors. Performance guarantees and equipment warranties provide assurances to the lenders that the applicable equipment will perform at the projected levels set forth in the lenders’ financial models.

Lenders will also assess the value of any performance guarantees and equipment warranties based on a few different factors. First, any performance guarantees and equipment warranties should be assigned to the project company on or prior to the operation of the project so that the project company is able to directly enforce these performance guarantees and equipment warranties.

Second, any performance guarantees and equipment warranties should be given by creditworthy counterparties. Given the ever-changing landscape of energy storage technologies, some of the equipment providers and service providers are new entrants and may not have strong financials, which may limit the benefit of any such performance guarantees and equipment warranties. If an equipment provider or service provider has a weaker balance sheet, this weakness can be offset by securing letters of credit from the provider or a guaranty from a parent entity with a significant balance sheet.

Construction Risks

It is fairly common to see multiple equipment supply, construction, and installation contracts rather than one turnkey engineering, procurement, and construction (EPC) contract for energy storage projects. Lenders tend to prefer fixed-price turnkey EPC contracts so that there is a single contractor, which shifts some of the construction risk from the project company to the EPC contractor. An energy storage project with a split EPC structure will require additional diligence by the lenders to address any additional risk exposure. In particular, lenders will want to review the applicable contracts to ensure that they work together correctly from a timing and technical perspective. 

For example, a balance of plant (BoP) contractor must have the site ready (including complying with any technical specifications from the equipment provider) before the batteries will be delivered on-site. If the contracts do not align, then the risk of resulting delays will be borne by the project company and, therefore, the lenders. Moreover, the lenders will expect that project costs will be fixed at the time of closing of the project financing, and, if the construction costs are subject to change, the lenders will require that there are sufficient reserves for potential cost increases. The lenders will typically require a collateral assignment of any construction contracts in accordance with a customary collateral assignment agreement. 

Operating Risks

As a general matter, lenders will conduct diligence to understand the energy storage project’s operating limitations and O&M costs. Lenders will look for an O&M agreement for the project with an experienced operator that will ensure that the project will be operated within the project’s operating limitations. Any such agreement would typically be included in the collateral package pursuant to a customary collateral assignment agreement. To the extent that there are project degradation issues or other anticipated major maintenance costs such as the augmentation of battery systems, lenders may require the project company to establish O&M reserves to ensure sufficient funds will be on hand to cover these anticipated maintenance costs.

In addition, lenders will look for confirmation that the project company has sufficient rights to the system’s software and any other intellectual property rights, which is critical to the daily operations of the energy storage project. More specifically, the project company will need to evidence that the system’s software can be accessed by the project company if the operator is replaced or by the lenders if the lenders exercise remedies and take ownership of the project. This can be evidenced with transferable software licenses or technology escrow agreements.

Revenue Streams

As with all project finance transactions, project companies must show that the project can support a steady and reliable stream of cashflows. Traditionally, energy storage projects have had long-term offtake agreements, which can cover payments for delivered energy, capacity, or ancillary services, or a combination of the foregoing. These projects will have long-term predictable revenue streams. In addition, lenders may be willing to finance merchant cashflows, but with less leverage and subject to detailed market studies, cash sweeps, and other lender protections. 

Energy storage projects with contracted cashflows can employ several different revenue structures, including (1) offtake agreements for standalone storage projects, which typically provide either capacity-only payments or payments for capacity plus variable O&M costs, (2) offtake agreements for renewables-plus-storage projects, which typically provide payments for delivered energy or energy plus capacity, and (3) build transfer agreements, which typically provide payment for title to the energy storage project upon substantial completion and operation of the project (or after mechanical completion and prior to the project being placed in service for tax purposes if tax credits are involved).

Lenders may be willing to finance merchant cashflows for energy storage projects subject to less leverage and cash sweeps. For energy storage projects with merchant cashflows (whether in whole or in part), lenders will focus on understanding the markets, running model sensitivities, and preparing for all reasonably foreseeable scenarios that would affect cashflows.

In particular, the available revenue streams for merchant cashflows in the United States differ significantly based on the location of the energy storage projects and the applicable market forecasts. Recently, there have been a number of energy storage projects financed in Texas utilizing hedge agreements that provide some sort of a revenue floor, together with market reports about future power prices. 

Developers may seek a portfolio financing as an alternative to a single project financing. Portfolio financings can mitigate the risks associated with any single project since the lenders will not be wholly dependent on a single project. However, portfolio financings can also be challenging from a diligence and structuring point of view.

Underwriting Tax Equity Investments

Renewable energy projects in the United States (particularly wind and solar) are eligible for tax benefits, including the investment tax credit and the production tax credit. These tax credits have been financed in the nonrecourse project finance markets, often using construction bridge debt that is fully repaid once the tax equity investment is made after the project is placed in service (as defined by the Internal Revenue Service).

Historically, tax credits have been available only for energy storage systems that are paired with renewable energy generation projects. However, with the passage of the Inflation Reduction Act of 2022, tax credits are now available for standalone energy storage systems, and as such lenders are willing to provide bridge capital that is underwritten based on the receipt of proceeds from an anticipated tax equity investment, similar to traditional renewable energy projects. See The IRA at a Year and a Half: IRS Guidance and Impact on the Energy Storage Industry.

While lenders may need to undertake additional diligence before financing an energy storage project, the project finance market for energy storage has and is continuing to grow alongside the rapid transition to less carbon-intensive resources.

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[1] 2H 2023 Energy Storage Market Outlook, BloombergNEF (Oct. 2023).

[2] Wood Mackenzie Power & Renewables/American Clean Power Association, US Storage Energy Monitor, at 5 (Dec. 2023).

[3] Id.