A wind farm project is quite unique: when it starts nobody has any guarantees that the wind farm will be effectively built at the site identified, but, on the other hand, if the assessment and planning phases go through, it can give a regular and steady income for the stakeholders.

If this is true, how can a company think about the possibility of asking for a loan, given the fragile nature of the development first phase?

What about a financial structure in which the only security for a loan is the project itself? Such financial model does exist and it is called "Project Finance". In project finance, the owner of the project is not personally, or corporately, liable for the loan. In a project finance deal, no guarantee is given that the loan will be repaid; however, if the loan is not repaid, the investor can seize the project and run or sell it in order to extract cash. This kind of loan looks like a gigantic mortgage, since if the project owner doesn't repay the loan, the project itself can be repossessed and sold by the lender.

Obviously, this financial operation is not that easy as it may look. To give an idea of the complexity, we can think about a property mortgage and the detailed checks made by the lenders over the borrowers capabilities of repaying the loan. Considering that in that case at least the property is available as a guarantee for the loan, in the case of a project this might simply be on paper when the loan is paid out. Therefore, before investment, any project finance lender will want to know if there is any risk that repayment will not be made over the loan term.

The good news is that a project loan is backed by the cash flow of the project itself. The predictable nature of cash flows from a wind farm means they are highly suited to this type of investment mechanism and this fact can reassure the lenders. Also, since in recent years there has been a constant growth of wind farm developments across the world, financial institutions are getting familiar with wind farm project finance and they tend to be more confident on the profitability of such investments.

It's time to see how this can be realized in practice. In Figure 1 I have described a typical project finance scenario.

Figure 1 - A project finance scenario for Zero Emission Project

Let's assume that a fictional company, Zero Emission Project (ZEP) Ltd, decides to build a wind farm. ZEP forms a Special Purpose Vehicle (SPV) company called Zero Emission Wind Farm Ltd, which is an independent legal entity whose only target is to build, operate and maintain the wind farm. The SPV will shield ZEP Ltd and other project sponsors from the detrimental effects of a project failure. ZEP Ltd has very little money to invest in the project, so it needs to ask for equity funds from venture capitalists. They will take part as shareholders of Zero Emission Wind Farm Ltd.

Once around 25-30% of the project is funded by equity, Zero Emission Wind Farm Ltd will look for a loan investment from banks. One bank may act alone if the project is very small, but will usually arrange a lending syndicate – this means that a group of banks will join together to provide the finance, usually with one bank as the "lead arranger" of the deal. At this point, the lenders will carry out a "due diligence", which is a process to check that the project is well planned and that it can actually make the necessary repayments on time. There will be usually separate technical and legal due diligence carried out by third parties on behalf of the bank.

The banks' loan provides a guarantee to the subcontractors that Zero Emission Wind Farm Ltd can pay for their service. The subcontractors will be in charge of planning, developing and building the wind farm and the surrounding infrastructure, usually under the common direction of wind farm consultants. Zero Emission Wind Farm Ltd will also manage the facility: it is clear that the ultimate purpose of Zero Emission Wind Farm Ltd is in fact to protect the assets of Zero Emission Project Ltd: if anything happens at the wind farm and the loan can't be repaid, nobody can target ZEP Ltd's assets, since it neither owns nor operates the wind farm.

A Power Purchase Agreement (PPA) will be signed between Zero Emission Wind Farm Ltd and the electricity power supplier (In one of my previous articles I gave an overview of the mechanisms behind a PPA ). This will give the necessary guarantee that the loan will be repaid. In fact, the cash-flow of Zero Emission Wind Farm Ltd generated from the wholesale delivery of electricity will be used to repay the loan as well as to pay out dividends for Zero Emission Project Ltd and the other equity stakeholders.

What is impressive is the fact that in the last 20 years, no wind industry project has ever had to be repossessed, according to the EWEA. This means that the project finance model has well served the wind industry and this is giving confidence to banks, encouraging them to lend money to wind farm developers.