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  3. Project Finance as a Lever for Climate Transformation

What are the advantages of project financing?

Project financing is a financing approach for large-volume, long-term investment projects - for example in the areas of infrastructure, renewable energies (solar and wind parks), the construction of production facilities or comprehensive digitalization measures. In contrast to traditional corporate financing, borrowed capital (e.g. bank loans) is not raised and repaid via the parent company, but via a legally independent project company (see Section 290 (2) no. 4 HGB). This company is founded exclusively for the respective project and the repayment of the funds is made solely from the income, i.e. the future cash flows, of the project.

The project company is a variety of special purpose company (SPC). It coordinates all central contracts with suppliers, construction companies, customers and other project participants. Its equity is contributed by so-called sponsors, which typically include the project sponsors and institutional investors. The company raises debt capital on this basis. The amount of equity required depends on the expected income and the debt service coverage ratio (DSCR).

A DSCR of over 1 shows that a project can cover its current interest and repayment obligations from free cash flow - a basic requirement for successful project financing. It is therefore a forward-looking financing approach that focuses on the project's prospects for returns, growth and success. It also has several advantages over traditional corporate financing.

Cash flow-oriented lending

As described, repayment is made exclusively from the project's current income, e.g. feed-in tariffs for green electricity or usage fees for infrastructure. Surpluses are first used to stabilize the project, then to service interest and repayments and finally distributed to the sponsors. Lenders do not assess the sponsors' balance sheet, but only the economic viability of the project. This means that project financing is sometimes also possible in times of political and economic crisis or when the companies involved have balance sheet difficulties, making access to corporate financing more difficult.

Off balance sheet financing

As the financing is provided by an independent project company, the loans taken out do not appear on the sponsors' balance sheets. Their liability to the lenders is usually limited to the equity contributed and project-related assets (non-recourse financing). This protects the creditworthiness and equity ratio of the companies involved, particularly in the case of major projects. However, due to the limited collateral, the lenders often receive additional rights, such as co-determination rights in management, performance monitoring or rights to enter into contracts. Lenders primarily want to ensure that the project is completed as planned - and does not fail before the start of revenue (completion risk).

Risk diversification

The project structure enables a targeted distribution of tasks and risks among various players such as sponsors, lenders, operators and insurers. In addition, specialized insurance policies (e.g. export credit insurance) are often taken out. In the contractual agreements and guarantees, liability can be transferred to the various parties involved on a project-specific basis in order to create a balance between the sponsors and lenders. The long-term contracts, usually for at least 15 years, also secure financing over the entire life of the project. This is intended to guarantee sufficient funds for the development of the project, especially at the beginning. Nevertheless, as with any investment, a systematic risk remains.

Depending on the financing requirements, funds are often allocated via a consortium of banks under the management of a so-called arranger. Some banks offer their own platforms for these syndicated loans. Different sources of capital can also be combined within the framework of structured financing: In addition to the sponsors' equity and (syndicated) loans, project bonds can also be issued and development funds from development banks such as KfW or NRW.BANK can be integrated if the project is of a suitable size. This not only creates broad risk diversification across stakeholders, but also across financing instruments.

How do climate protection projects benefit from project financing?

Many climate-related investment projects - especially in the energy sector - are particularly suitable for project financing due to their structure and financing requirements. The key aspects here are

  • Capital intensity of sustainable technologies: technologies such as renewable energies, biofuels or hydrogen are often capital-intensive: they require high initial investments and have long amortization periods. The long duration of the project contracts and the involvement of a wide range of investors, companies and banks make it possible to provide the required capital funds over the long term. This makes investments in climate protection scalable and bankable.
  • Special risks: Green innovations are often associated with particular uncertainties - of a technological, political or economic nature. In addition, regulatory framework conditions (e.g. CO₂ prices) are difficult to predict. Project financing enables a targeted distribution of risk among several participants without the sponsors having to be liable with their total assets.
  • Blended finance: Project financing often serves as a lever for mobilizing public and private funds. Development banks such as KfW or NRW.BANK participate as lenders or through guarantees, especially for infrastructure, energy and environmental projects. The state funds often have a multiplier effect here, as they attract additional private capital. In addition, income from the sale of CO₂ certificates - for example through savings thanks to energy efficiency measures - could also contribute to refinancing.
  • ESG compatibility: As the use of funds is extremely transparent for project companies, they are suitable for impact investors or financial institutions that actively pursue their ESG goals and key figures.

Given these characteristics, it is not surprising that project and special purpose vehicles are the norm for the operation of wind farms and larger photovoltaic projects. According to a global survey conducted by the International Renewable Energy Agency (IRENA) in 2023, project financing was chosen in 88% of cases. Balance sheet financing, on the other hand, was only chosen for 6%. However, the cash flows of the projects were secured through a variety of mechanisms, such as power purchase agreements (43 %), feed-in tariffs (22 %), contracts for difference (14 %) or renewable energy certificates (10 %).

In the case of renewable energy projects, however, greater attention is paid to the technological maturity and experience of the project partners, as these are crucial for the longevity of the plants and the long-term repayment capacity. Project financing in this sector generally has a term of around 20 years, which corresponds to the technical and regulatory service life of many wind turbines. Ultimately, project financing is only an option for self-sustaining ventures and is therefore not suitable for experimental technologies or projects with unclear profitability.

Where can companies find further information?

Public development banks

Private banks and financial service providers

Further information on energy projects

Contact person