Due Diligence of Energy Infrastructure Assets

During the  due diligence in the investment process, the investor confirms a project’s financials, contracts, customers, and all other pertinent information. The goal is for the investor to accurately establish the benefits, costs andrisks associated with the investments and to enter negotiations accordingly.

Source: Positive Energy Ltd. Asset Value & Risk vs lifecycle 
(assuming external market factors remain the same)

The seller, would usually aim to secure a successful transaction and close it at the highest price possible. Taking time to perform due diligence beforehand will help to provide a realistic valuation for the asset before you engaging investors. It will also help to provide accurate information for to potential buyers.

When an investor considers a potential investment, there are two considerations: whether the investment fits in well with the overall strategy, and invest at the fair price. This is where a rigorous due diligence process can help. Objective due diligence provides a factual, detailed assessment of important areas. Some third parties involved in the investment, such as insurers of the asset, would have additional requirements and checks.

For Renewable Energy projects, due diligence would in general include the following areas:

  • Anti-Money Laundering / Combating the Financing of Terrorism (AML/CFT) and anti-bribery and corruption (ABC) of the project and developer
  • Technical audit
  • Environmental and social impacts audit
  • Operation audit for live assets
  • Key contracts (PPA, EPC, site lease) audit
  • Off-taker creditworthiness
  • Land Easements and permits audit
  • Corporate and legal audit
  • Financial audit
  • Tax and Accounting audit

The data room associated with the Due Diligence of a renewable energy project can include more than 100 documents. Inside these documents, investors will find key information that will confirm/refute their financial analysis of the opportunity directly impacting the bankability andvaluation of a project.

The size and level of detail of a dataroom is not static; it depends on the complexity of the project and its maturity; earlier in the project less information is available than when the project is operational.

Source: Positive Energy Ltd. Project Lifecycle.

The Due Diligence process involved multiple parties. The Seller side and the Buyer side will have their own external auditors that will support them in the transaction. The Seller will have to manage several potential investors in parallel, while the investor will review several projects in parallel to identify the most interesting ones.

As Due Diligence can mobilize large number of resources, it is very important for both the Seller and the Buyer to engage in such activities only when the chance of a successful transaction is high. The pre-qualification work of theprojects and of the investorsplay an important role in reducing the overall cost of transactionby limiting the cost associated with unsuccessful transactions.

Challenges of investment in small to mid-size projects

The financing of small to mid-size Renewable Energy projects can be particularly challenging for the following reasons:

Field expertise: Investing in a renewable energy project for the first time is difficult and can be intimidating even for professional investors, when they are not used to such asset class and transaction. As a result, this market remains mainly served by a small number of specialised investors (energy and infrastructure) who have developed the knowledge and know-how associated with these projects. They generally focus on the larger renewable projects.

Deal origination: We estimate that by the year 2021 in Asia alone there will be more than 3500 small / mid-size renewable projects financed. This market is highly fragmented, and it can be difficult for investors to get a good overview of the opportunities available on the market. Doing 100 projects of 5MWp versus a single large asset of 500MWp requires a much larger pipeline in terms of number of projects. Assuming that 20% – aggressive assumption – of the projects screened by an investor get invested, it requires for an investor to screen 500 projects and execute a 100 of them to build 500MW of small to mid-size projects during a year. It is a massive deal origination and data processing effort.

Transaction costs & time

For smaller projects, the work that needs to be done in terms of screening, valuation, due diligence, negotiation… is not much smaller than for a larger project. For example the legal checks to be done for a huge 500 MW solar plant will be roughly the same as for a 5 MW project. This means relative to the transaction size, the time and money spend on the transaction represents a much larger percentage. This may ultimately make a project too small to finance. a largers cost.

  • Inefficiency of the process
  • Investor and project developer time allocation to capture, review, analyze, consolidate, and summarize the data. The investment decisions requires a lot of data, documentation and analysis. This work is mainly done using simple e-mail discussions or hardcopy paperwork.

Nature of developers

Small- to midsize renewable energy projects are commonly executed by local developers. Those might be technically capable but work often in more informal ways; they might lack the standards of documentation and procedures that larger companies have, and are not used to engage with large investors parties. The investors in turn have are used to work with a few major parties and have difficutlies assessing the quality or creditworthiness of local companies. This complicates the investment process.

Specific challenges related to Emerging Markets

Currency: For international investors, the exchange rate plays a key role in the economic assessment of the investment opportunities. With contracts for revenue mainly signed in local currency, investors are exposed to currency movements after the construction. The risk of local currency devaluation will also be looked at carefully. The simpler way to reduce the currency risk is to provide local financing.

Governance: Identifying the real beneficial owners of an entity is essential for ensuring Anti-Money Laundering Combating the Financing of Terrorism(AML/CFT) and anti-bribery and corruption (ABC) compliance, but this is a cumbersome activity. Business ownership information is fragmented, stored in different forms and locations, and often difficult to find. Each jurisdiction has its own method for defining and recording ownership and complex corporate structures, often deliberately making it difficult to identify the real owners.

Localization: Economic zones like the EU or the US provide a more relatively uniform playground for investors. Emerging markets tends to present many discrepancies. It can be difficult for international investors to apprehend the local context associated with an asset, this include topics like:

  • Local energy market requirements and local energy tariffs
  • Local grid infrastructure
  • Local environmental regulations
  • Local land regulations
  • Local tax and corporate laws

Language:In some countries, it is hard to find information in English. Quality translation work to and from the local language is then mandatory.

Equator Principles Financial Institutions (EPFIs) apply EPs to new projects (globally and across all industry sectors) financed by four financial products: Project Finance Advisory Services, Project Finance, Project-Related Corporate Loans, Bridge Loans.

It is primarily intended to provide a minimum standard for due diligence and monitoring to support responsible risk decision-makingandcompliance with the underlying IFC Performance Standards and World Bank Group EHS Guidelines.

To date, 94 international financial institutions in 37 countries have signed up to the Equator Principles.