Pinning down indexed revenue for project finance

In Europe, inflationary pressures are being strongly felt across wind project finance markets since last year’s war-driven spike in oil and power prices. 

Increasingly, offtake revenue is indexed as standard in various countries. This has been positive for investors in the current market for operating projects where the debt cost was fixed. However, investors in Europe say that opex costs that are linked to inflation are slightly impacting operational wind projects. Increasingly, project sponsors and investors are becoming nervous when it comes to indexation of turbine supply contracts, in which suppliers seek to pass indexation into not only the initial turbine supply agreement but also into opex costs that continue after projects start financial flows.

Investors and advisors in Europe observe that timing is of growing importance in turbine supply deals as suppliers only fix prices for a certain period. There is more pressure on sponsors and legal advisors to lock down financing fast, particularly closing interest rates before the other financial flows. Construction contracts are yet to be indexed, to the relief of banks and legal advisors, but they already “bake in” the indexation from agreed supply deals. 

In addition, sponsors now face issues with baseload PPA contracts in an environment where they have very high prices for their intermittent assets, so pay-as-produced PPAs are rising in popularity. Sponsors have not ceased to do baseload contracts, but, having been caught off guard by inflation and the price of meeting baseload obligations, they are now looking very carefully at the proportion of baseload agreed on projects. Law firms in Europe observe that some sponsors and have successfully renegotiated baseload output reduction and PPA prices for PPAs taken out right before the war in Ukraine.

Certain law firms in Europe are seeing “dynamic” changes of structure for PPAs, with increasing indexation usually and a cap at 2 or 3 per cent. Sponsors are more often than not requesting indexation of PPA offtake prices, which is important as they can try to use this to deal with inflation of supply and construction costs. 

Indexation triggers an increase in PPA prices if inflation goes beyond a certain point. Alternatively, prior to that point the PPA may increase the price a certain percentage every year, an idea which used to be in vogue in the US. 

Another US contractual import seen by observers seen in the past six months is the arrangement whereby a generator agrees and lower strike price for a corporate and the corporate doesn't take all the upside, instead agreeing to take a certain percentage of the upside in order to get a lower fixed price. This has the advantage of satisfying the corporate’s need for price predictability.

Other structures may link to power prices, either in virtual or physical PPAs, with market following at a discount and a floor, and one-sided CFDs. A final PPA development seen amid the increased demand for PPAs driven by rising European power prices is that sponsors of some of the best PPA projects have run a request for proposal process which will seek bids from corporate offtakers, rather than the other way around