Joint ABAACORE Renewable Energy Teleconference Series Renewable Energy

Joint ABA/ACORE Renewable Energy Teleconference Series Renewable Energy Finance: Hedging During Financial Markets in Turmoil Hedging of Risk and Enhancement of Credit Quality in Alternative Energy Transactions A Project Finance Banker’s Perspective John May Stern Brothers & Co. 8000 Maryland Ave. , Suite 800 St. Louis, MO 63105 (314) 743 -4026 (314) 727 -7313 Fax November 19, 2008

Alternative energy projects present a variety of risks that must be mitigated or hedged in order for project financing to proceed. With the contraction in credit markets has come a flight to credit quality. A project’s risks vary depending on its segment within the alternative energy space, but most projects share the following issues: l l l Credibility of revenue streams from the sale of the energy. Consistency and pricing of feedstock. Technology/EPC risk. Counterparty risk relating to off-take agreements, feedstock supply agreements, third parties providing outsourced services (e. g. , risk management). Non-recourse borrower credit risk.

Bankers continue to create innovative approaches to enhancing the credibility of revenue streams across all segments within the alternative energy space. In the current environment, lenders seek to avoid merchant risk. Hedging techniques which have been used with increasing frequency in the biofuels and renewable power sectors include: l l l Off-take agreements. Tolling Agreements. Energy/Power Hedges. Power Purchase Agreements and Leases. Pre-Payment Agreements. Transaction examples: the tolled corn ethanol plant; the waste coal to energy plant.

Feedstock supply is an underappreciated risk in biofuels, biomass, waste to energy and clean coal transactions. No single approach to feedstock agreements is universally applicable due to the variety of types of feedstock and local circumstances. Issues common to all sources: l Local supply. l Diversity of sources. l Ensuring consistency of feedstock. l Impact on feedstock as project scales up or expands. l Collection, logistics and transportation. l Pricing. l Cost of energy involved in growing or transporting energy. Transaction examples: the municipal waste to energy plant; the wood pellet manufacturing plant.

Technology risk is the primary risk associated with most projects in emerging segments such as cellulosic, biomass, waste to energy, solar. This is the first risk which lenders assess before looking at credit quality of the transaction. l l l l l Stages of technology correspond to stages of funding. Pilot or demonstration plant; proof of concept. Consistency in application of technology as project moves to commercial scale; structuring the financing to address scalability issues. Feasibility study and independent engineer report. Technology performance guarantees. EPC wrap. Contingent equity. Third party insurance. Standard approaches to construction risk. Transaction examples: Cellulosic ethanol plant; coal to liquids plant

Counterparty risk is receiving more attention as lenders move away from a merchant model to contracted cash flows and margin protection. l l l Financial strength of counterparties. Is an investment grade rating necessary? Guarantors. Sector expertise, operational resources and management track record. Impact of macro-economic and regulatory factors on counterparty performance. Transaction examples: biodiesel plant; corn ethanol technology

Lenders are increasingly seeking credit enhancement or partial recourse to hedge the risk inherent in non-recourse financing. l l Government loan guarantees. Corporate loan guarantees. Equity-funded credit enhancement techniques. Stakeholder credit enhancement. Transaction examples: clean coal project; biomass project