The capital stack
Every project is paid for by a mix of money with different risks and returns, stacked by who is repaid first.
Lenders typically fund most of a power project, often 60 to 80 percent, because a long-term contract makes its income predictable. Equity takes the first loss, which is why lenders insist sponsors have real money at risk. Grants, where they exist, reduce how much has to be repaid at all.
Most large projects are held in a special purpose vehicle: a company created only to own that project. Lenders are repaid from its cash flows alone, without recourse to the sponsors’ other assets. That is the essence of project finance.
Contracts that repay the debt
A bank lends against future revenue, so the revenue contract is the heart of every deal.
- Power purchase agreement (PPA). A buyer, usually a utility or a bulk trader, agrees to buy the plant’s electricity at a set price for 15 to 25 years. Some PPAs pay for capacity made available as well as energy delivered.
- The buyer’s credit. A PPA is only as good as the buyer’s ability to pay. Where utilities are weak, lenders ask for government support, letters of credit or guarantees.
- Tariffs and connections. Mini-grids and solar home systems earn from many small customers under regulator-approved tariffs, so lenders look at collection rates and customer numbers instead.
- Construction and supply contracts. A fixed-price, date-certain engineering, procurement and construction (EPC) contract, and for gas plants a fuel supply agreement, close the other big gaps.
Managing risk
Each risk sits with the party best placed to manage it, and what remains is priced into the interest rate.
- Payment risk
- Partial risk guarantees from development banks such as the World Bank, and liquidity facilities that cover missed payments for a few months.
- Political risk
- Insurance against expropriation, breach of contract and currency inconvertibility, from MIGA and national export-credit and development agencies.
- Currency risk
- Local-currency loans and guarantees, such as those InfraCredit provides in Nigeria, or tariffs indexed to the dollar.
- Construction risk
- Fixed-price EPC contracts, performance bonds and contingency budgets.
- Resource risk
- Long measurement campaigns for sun and wind; for geothermal, drilling-risk facilities like those the World Bank has financed in Indonesia.
Blended and results-based finance
Blended finance uses public or concessional money to make a project attractive to private investors: a first-loss tranche, a cheaper loan or a guarantee that absorbs the risk commercial capital will not take. The Centre’s proposed Nigeria Energy Transition Fund is designed on this principle.
Results-based finance pays only for verified outcomes, typically a fixed grant for each household or business connected to a mini-grid or solar system. It has become the main public tool for off-grid electrification in Africa, including in Nigeria’s programmes run through the Rural Electrification Agency.
Six steps to financial close
Prove the project
A feasibility study shows the resource (sun, wind, water or gas), the site, the technology and the demand, and estimates cost and output. Lenders will test every assumption in it.
Secure the rights
Land, grid connection, environmental and social impact assessment, and the licences the regulator requires. In Nigeria, NERC licenses generation, and its mini-grid regulations set lighter permits for small systems.
Sign the revenue contract
A power purchase agreement, a concession or a tariff approved by the regulator, with a buyer creditworthy enough for lenders to rely on. This contract is what the debt is repaid from.
Build the financial model
Cash flows year by year, debt service, returns to equity and how they hold up when output, prices, interest or exchange rates move against the project.
Raise equity and debt
Sponsors commit equity; lenders run due diligence and negotiate terms. Guarantees, insurance or concessional money may be added to close a gap.
Reach financial close
All contracts are signed and the first money can be drawn. Construction starts; the debt is repaid from operating revenue over 10 to 20 years or more.
Questions
Does CEII lend money or give grants for energy projects?
No. Centre for Energy Investment and Innovation does not lend, grant or invest, and never charges fees to process funding applications. It designs funds and investment frameworks for governments and investors, and this site points to the institutions that do finance projects.
What makes an energy project bankable?
A reliable revenue contract with a creditworthy buyer, a proven resource and technology, the permits and land in place, an experienced sponsor with equity at risk, and risks such as currency and political risk either mitigated or priced in.
What is the difference between project finance and corporate finance?
In corporate finance a company borrows against its whole balance sheet. In project finance a single-purpose company owns the project and lenders are repaid only from that project’s cash flows, so the contracts behind those cash flows matter most.
Where can a small solar or mini-grid developer find finance?
Results-based grants paid per verified connection, concessional loans through national programmes (in Nigeria, through the Rural Electrification Agency), impact investors, and local-currency guarantees. See the directory of lenders on this site.
Why does currency matter so much?
Equipment and loans are often in dollars while customers pay in local currency. If the local currency falls, the same revenue repays less of the debt. Local-currency lending, guarantees and indexed tariffs reduce this risk.