Renewable Energy Project Finance in Japan 1 (General Overview) | Articles

1. Overview

This article explains the practical aspects of renewable energy project finance in Japan. Project finance involves setting up a special purpose company (SPC) as a project company to ensure that the project is insulated from the sponsor’s other businesses. Through this SPC, funds are supplied on a non-recourse basis (relying solely on the revenue generated from the project without recourse to funds of the sponsor) based on the cash flow generated from the goods or services produced by the specific project.
In contrast to corporate finance, which relies solely on the sponsor’s creditworthiness, project finance relies on the cash flow generated from the goods or services produced by the specific project.

2. FIT/FIP under the Act on Special Measures Concerning Renewable Energy

Since 2012, Japan has implemented the Feed-in Tariff (FIT) system under the Act on Special Measures Concerning the Promotion of Use of Renewable Energy Electricity (“Act on Special Measures Concerning Renewable Energy”), which is widely used for project finance in renewable energy power generation projects. In brief, the FIT system requires electric power companies to purchase electricity generated from renewable energy sources, such as solar power, at a government-determined price. This system effectively guarantees long-term, fixed-price purchase contracts for all generated electricity, minimizing off-take risks (risks related to electricity price fluctuations and the amount of electricity that can be sold).
From 2022, the FIT system has been revised, and large-scale solar and wind power projects are transitioning to the Feed-in Premium (FIP) system. Unlike FIT, where electricity is purchased at a fixed price, FIP adds a premium (subsidy) to the selling price when renewable energy power producers sell electricity on the wholesale market. Under FIP, unlike FIT, power producers must secure their own buyers for the electricity.
With the transition from FIT to FIP, power producers must choose between selling electricity at market prices through the wholesale electricity market or supplying electricity under negotiated contracts with retail electricity providers. This transition allows power producers to retain the environmental value of the electricity generated from renewable energy (such as the effect of not emitting CO2). Power producers can enter into PPAs (Power Purchase Agreements) with retail electricity providers, including the environmental value, enabling corporate PPAs (long-term purchase contracts of renewable energy by corporations or municipalities) involving three parties.

3. Process of Renewable Energy Project Finance

To proceed with a project, a project company needs to:

Secure land rights (lease agreement or land use right agreement).
Conclude a fuel supply contract (for coal-fired or biomass power generation).
Sign a power purchase agreement (PPA) with the off-taker (electric power company).
Conclude an engineering, procurement, and construction (EPC) contract with a contractor.
Sign an operation and maintenance (O&M) contract with a service provider.
Conclude construction loan agreements and other financing-related agreements (including security agreements) with financial institutions. Typically, once construction is completed and the preconditions for operation are met, these are converted into term loans.

(1) Securing Land Rights

If the SPC does not own the land, a land use contract must be concluded. Land use contracts are often in the form of lease agreements or land use rights agreements. For solar or wind power generation, where the power generation facility does not qualify as a “building” under the civil code, it is difficult to establish a business-use fixed-term leasehold (Article 23 of the Act on Land and Building Leases). Additionally, under the Civil Code, the maximum lease period is restricted to 20 years (Article 604, Paragraph 1 of the Civil Code), which is generally insufficient when considering the construction period and the 20-year procurement period under the Feed-In Tariff (FIT) system.
Therefore, for solar and wind power projects, land use rights agreements are often preferred over lease agreements due to these constraints.

(2) Fuel Supply Contract

For coal-fired and biomass power generation, where fuel costs constitute a significant portion of the costs and influence the project’s cash flow, the fuel procurement contract is as important as the power purchase agreement.
Biomass power generation, subject to the FIT system, may not allow transferring fuel price fluctuation risks to the off-taker (electric power company), requiring special arrangements in the fuel supply contract.

(3) Power Purchase Agreement (PPA)

In a PPA, the project company sells part or all of the electricity it generates to the off-taker (electric power company). The PPA is concluded as a “specified contract,” and the off-taker is positioned as an “electricity utility” under the Act on Special Measures Concerning Renewable Energy.
The PPA is crucial as it underpins the business revenue of the power generation project and provides the repayment source for the lending financial institutions in project finance.

(4) Engineering, Procurement, and Construction (EPC) Contract

For solar power generation, it is common to have EPC contracts where a single contractor manages procurement, assembly, construction, and connection to the power grid, all under a one-stop manner (also known as full turnkey contracts).
In contrast, in wind power generation, due to the need for direct contracts with manufacturers for complex components like wind turbines, it’s often preferable to separate the supply contracts for parts from the construction contracts for the Balance of Plant (BOP), which includes surrounding equipment.
Construction delays can result in lost power sales revenue and incur additional costs, such as penalties for failing to supply power as promised to the off-taker (electric power company). To mitigate these risks, EPC contracts typically include provisions for liquidated damages for delayed completion. These liquidated damages are presumed as predetermined compensation for damages, not as penalties, under Article 420 of the Civil Code. Liquidated damages are generally considered valid unless they are excessively high and violate public order.
These compensations help offset lost power sales revenue and are used to cover ongoing expenses such as land rent, insurance premiums, and interest on project finance, making them important for lenders.