Mitigating default risk in large-scale PV projects through credit default swaps
An international research team led by Concordia University in Canada has created a new financial instrument that can help reduce default risk in solar PV projects.
The novel approach utilizes credit default swaps (CDS) to provide an extra layer of financial security for PV project developers. A CDS is a contract between two parties in which one party buys protection from another party against losses from the default of a borrower.
“While PPAs have traditionally served as the cornerstone of revenue certainty for renewable energy projects, they do not fully protect against risks such as default scenarios, resource data inaccuracies, or changes in tax and market conditions,” the researchers said. “A CDS offers a mechanism to transfer default risk from lenders to third parties, functioning similarly to an insurance contract.”
In the study “,” published in Energy Economics, the research team explained that the proposed framework implies the presence of a sealed PPA in a project finance deal. Furthermore, it assumes that a special purpose vehicle (SPV) acts as the protection buyer by paying a premium to the protection seller, which compensates the SPV in the event of a default.
Under the terms of this agreement, the SPV is obligated to make periodic premium payments to the protection seller until either the CDS deal expires or default materializes.
The new risk mitigation strategy also includes the utilization of a closed-form formula for the evaluation of the default probability (DP) over a specified period, which the scientist said is key for pricing the CDS.
The framework was tested through Monte Carlo simulations on a 10 MW solar PV power plant located in Iran. For the analysis, the group relied either on satellite-based solar irradiance data or ground-measured solar data through site adaptation. “This analysis demonstrates the impact of solar irradiance data quality on default probability and CDS pricing, highlighting the financial sensitivity of utility-scale solar PV projects to variations in resource availability and accuracy,” the academics said.
The plant was assumed to be built at €600 ($624)/kW installed and to have secured a PPA price of €45/MWh. The project service life was estimated at 30 years, while the loan had a 20-year duration.
The scientists said their simulations showed that the proposed approach significantly reduces default probability, while improving leverage ratios and project feasibility. “We also highlight the critical role of Power Purchase Agreements (PPAs) in stabilizing revenue streams and mitigating post-construction risks,” they added. “Our sensitivity analysis reveals that maintaining a minimum PPA price threshold is essential for ensuring project viability at higher leverage ratios.”
Looking forward, they want to extend the new methodology to other low-carbon projects and regions with different incentive structures and mechanisms. The team also included researchers from Australia's Engineering Institute of Technology and the Tarbiat Modares University in Iran.
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