The Hidden Risks in Offsite Project Development: Should Buyers Be Concerned?
By Gavin Ahern
Once large energy buyers make the organizational decision to procure renewable energy (RE), they embark on a long journey that - although full of excitement - can be a lot of hard work. Given all of the work and stakeholders involved, it’s natural for buyers to focus predominantly on the economic proposition and sustainability claims, leaving the nuts and bolts of project development risks to the RE project developer. When contracting for RE via a Power Purchase Agreement, these risks, however, are ultimately the buyer’s if they prevent a project from ever reaching operations. Examples include the failure to acquire permits, interconnection delays and cost overruns, and difficulty raising financing.
Large energy buyers must be keenly aware of project development risks to increase their chances for success. In the United States, this includes understanding time and location specific risks across grid operators that administer and monitor electricity generation and transmission for various regions. This includes being aware of MISO, the Midcontinent Independent System Operator (the grid region that spans several states in the Midwest and Southern U.S. from Louisiana to Minnesota), experiencing interconnection delays and cost overruns, or ERCOT, the Electric Reliability Council of Texas (the grid region covering most of the state) undergoing basis risk issues (both discussed later in this piece). Project development risks cannot be eliminated. However, buyers can mitigate them by having a robust due diligence process and engaging experts as needed.
What Are Project Development Risks?
With procurement of RE heavily focused on building new projects, project development risks, particularly pre-construction development risks, are risks that pose a challenge to a project reaching commercial operations. These pre-construction development risks always exist for a RE project, but they reduce as a project reaches more advanced stages and approaches commercial operations. Although it is the project developer who is best suited to mitigate or avoid these pre-construction risks, large energy buyers should be motivated to understand these risks and, in most cases, steer clear of high-risk projects.
If a buyer signs a RE contract but the project never reaches operations, the buyer may contractually receive financial damages but will not receive monthly settlements or renewable energy credits (RECs) as desired. As a result, to reach its sustainability goals, the buyer would have to start the process all over again and potentially contract for a new, less attractive project.
Major pre-construction development risks can include failures or delays in:
Description of Risk
Examples of Major Considerations
Developer fails to acquire site needed for the project and the grid tie-in
Project does not receive approval or must pay higher costs to connect to the grid
Key studies indicate fatal flaws of the site
Developer fails to acquire necessary permits for the site
Project fails to obtain community support needed for key permits and incentives
Project fails to obtain upfront financing for construction
Project Equipment Procurement
Developer fails to procure equipment on time to meet the commercial operation date and receive tax credits
Engineering, Procurement, and Construction
Issues prevent third party construction of project
What Current Market-Specific Project Development Risks Should Buyers Be Aware of in the United States?
MISO Interconnection Delays and Cost Overruns
The process to receive an interconnection agreement in MISO is nearly a year and a half, but in some recent examples, the process has fallen behind this timeline by over a year. There’s currently ~70,000 MW of active RE in the MISO interconnection queue, but given significantly increasing upgrade costs and cost allocations, recent cycles have led to as much as 60%+ of projects dropping out of the queue. Buyers looking at MISO (and an increasingly growing list of additional ISOs) need to be wary that early-stage projects are susceptible to schedule delays and cost overruns. In order to raise concerns with developers or solution providers, buyers need to understand:
- The interconnection position and risk of the project of interest
- How certain the project’s cost estimates are for network upgrades and who takes the risk if those estimates are incorrect
- How the project interconnection position syncs up with other key RE project deadlines (e.g., tax credit deadlines)
ERCOT Basis Risk
Recently in ERCOT, a newly implemented grid stability focused market-based mechanism (i.e., the West Texas Export Generic Transmission Constraint) negatively impacted certain western Texas RE projects and effectively lowered the project node prices received. Even if buyers already contracted for a hub-settled RE project in western ERCOT, many of these projects will now have difficulties raising financing. What can buyers do? Some implications include:
- Potentially avoiding impacted projects in western Texas altogether but at least paying particularly close attention to these projects’ specifics, even if the settlement hub is outside of the region given the risk to the overall project
- Understanding the project’s current construction financing plans and progress, particularly with tax equity investors
- Outside of this specific issue, assessing the basis risk of the project (the difference between the settlement hub and project node prices) and addressing it in the RE contract. Basis risk will ultimately impact the project’s ‘financeability’
How Can Buyers Avoid or Mitigate Project Development Risks?
As mentioned previously, it is critical that buyers understand and evaluate RE project-specific development risks to increase their probability for success. How can buyers best mitigate these risks for their organization?
- Become more familiar and conversant in project development risks (including time and location-specific ones like the examples included above)
- Create a framework for evaluating and prioritizing development risks (if you do not know where to start, CustomerFirst Renewables can help)
- During a buyer’s competitive process, ask questions on each RE project (using both written questions and interviews)
- Request project documentation for review (incl. results of studies, proof of agreements, etc.)
- Get second opinions on project selection decisions as needed
With all of this in mind and to wrap up, what potential implications of mitigating project development risk may exist for buyers?
- The need to engage with experts or advisors well versed in RE project development risks
- Potential prioritization of later stage development projects in buyers’ selection processes
- Potential selection of more experienced and/or better capitalized project developers who can either better mitigate against or weather the storm through the relevant development risks
Interested in learning more about these these risks and preventative measures? CFR would be happy to connect you with one of our subject-matter experts. Contact us at firstname.lastname@example.org to schedule a time to discuss your organization.
This was the topic of a REBA Market Opportunity Monday session on May 3, 2021 where CFR facilitated a discussion regarding offsite renewable energy (RE) project development risks and how these risks can extend beyond project developers to buyers. If you're interested in reviewing the recording go HERE.