IPP leveraged financing: Unfair advantage

IPPs normally employ project financing - in which the loans for a project are secured primarily by the assets of the project (and not by the assets of the parent or owner of the project). To support project financing, the IPP developer puts together a package that includes a site, a signed electric contract, a steam contract (if the plant is to be a qualifying facility (QF) under PURPA), a construction contract, and all the necessary environmental permits. The developer then usually attempts to borrow as much of the project's capital costs as possible - ergo the term highly leveraged financing. This is because debt is cheaper than equity (equity is a riskier investment and requires a return significantly higher than debt), and cheaper still when is preferential tax treatment is considered. For this reason, equity is typically used by IPPs only to take risks that lenders are unwilling to assume, and to assure lenders that the developer will not walk away if a project becomes, less profitable. In contrast, a utility finances construction - and all its other capital requirements - by issuing debt or selling equity from the parent company. Its capital needs are typically financed by issuingmore » equity and debt, secured by the assets on the balance sheet, in roughly a 50:50 ratio. The cost of debt depends on the utility's bond rating - with the more risky utilities rated lower and, therefore, paying more for debt. If borrowing new capital would cause the utility to exceed its allowed debt-to-equity ratio, the utility will have to sell equity to raise part of its capital requirements. In the case of utility financing, the debt is secured by all the utility's assets - not just those of the particular construction project needing the investment.« less