Fundamentally, wind is an attractive business, says Arvind Rajpal, executive director of structured commodity finance at Morgan Stanley. He expects double-digit growth over the next couple of years, led by the US, India and China. Private investment is flowing into the sector more than for other renewables and a significant proportion of wind capacity is project financed, meaning loans are raised against future revenue. The required proportion of equity to debt is also coming down again. "For the right project, the market is definitely open," says Rajpal.
Wind power, however, is competing for debt and equity with more established industries that offer better returns and lower perceived risk, cautions Rajpal. On the other hand, the regulatory uncertainties that are hampering finance in southern Europe also present opportunities. "As the market (in Spain, Greece and Italy) gets more rational, there will be less opportunity available in established industries," says Rajpul. Capital will return to wind, he adds: "There are returns that are going to be made on both the debt and the equity side."
Return of the banks
While the market in debt finance remains fragile, banks are coming back to wind after their flight at the start of the financial crisis. Xavier Monteau, head of energy and environment at Dexia bank, points out that project spreads - the difference between the interest rate charged by banks and the London Interbank Offered Rate (Libor) - have come down. But he expects this to be only temporary. "When you see the tensions in the market right now, you think - at best - spreads will remain flat and eventually increase again."
The width of spreads depends on where projects are located and, in particular, on national regulatory regimes. In Spain, projects are now hard to finance and margins are high, with interest rates more than 300 basis points, or 3%, above Libor. Lower spreads are to be found in northern Europe, except for offshore wind, which is considered riskier than onshore. In France, they are lower still. "French banks have not suffered as much as other banks," explains Monteau. On small French projects, spreads are less than 200 basis points above Libor; these are better margins than on big projects where several banks are usually involved in providing debt finance.
"What is important is the overall cost of debt. I see it going up again because the liquidity cost will increase," says Monteau. He warns that the banks involved in wind may fear overexposure. "At some point they will consider they have enough wind," he says. "This is happening." There are pockets of liquidity, he says, adding: "But when you look at the amount at stake, this EUR500 billion (for clean energy investments) over the next ten years is going to be very, very hard to find."
Squeeze on utilities
Adding to the pressure on the pool of available project finance will be utility demands, predicts Henrik G Welch, senior director from Denmark's state-owned Eksport Kredit Fonden (EKF), which has underwritten a number of wind power deals. Utilities, with their strong balance sheets, have so far been able to attract fairly cheap finance for projects, including funds from the European Investment Bank (EIB), which is increasingly active in the sector (Windpower Monthly, April 2010). But the EIB has a limited pot of funds, says Welch. And with their huge wind project pipelines, particularly offshore, alongside demands on funds for conventional power and infrastructure projects, utilities will have to resort to project finance to get wind farms built.
Jerome Guillet, CEO of Energy Bankers a Paris, is confident that project finance will be available for offshore wind when it needs it most and once banks become more familiar with the technology. The first billion is the hardest, he says, so it is important to get some deals done to familiarise the banks with the sector.
Pension funds and bonds
Yet there remains "a mountain to climb" to finance Europe's wind ambitions, says Welch. The UK alone has more than 48GW of offshore wind under development. No single source of finance can cope. "The banks cannot do it by themselves, nor the ECAs (export credit agencies) nor the EIB," he says. "We need to go in a completely different direction, maybe using capital markets or pension funds." Moreover, offshore investments cannot be financed on the three-year tenure loans typically offered by the banks. "I would not expect the banks to go out on 15, 18, 20, 25 years," Welch adds. "That is where the pension funds come in."
Finding construction finance for offshore projects is an increasingly hard challenge. "We can develop them," says Peter Sharman, head of finance at RWE npower renewables. He says the company faces a ú2 billion price tag every time it embarks on a 500MW project. "The numbers are huge," he adds. "Even the large utilities have only got so much capital they can re-circulate."
Fintan Whelan, corporate finance director from Mainstream Renewable Power, one of the few non-utility players in the offshore market, believes the construction phase will be increasingly project financed, though with backing from the EIB, ECAs and multilateral development banks. The equity will be taken up by the utilities in conjunction with other pools of institutional capital, private and public equity, he believes. When projects have been operating for at least 12 months and any construction wrinkles are ironed out, the wind farms will be refinanced, releasing project finance for more construction. The bond market could play a major role in this phase, he says.
Pension funds provide a further option. But they have only a small pool to play with, says Tom Murley, head of renewables at private equity investor HgCapital. The lion's share, 85-90%, is invested in highly liquid listed equities and high-grade corporate bonds that can be sold to match assets to liabilities. The remaining 10-15% goes into private equity, venture capital and real estate.
It takes time for the funds to feel comfortable in a new sector: it took 25 years for private-equity allocations from British pension funds to rise from an average 0% to 2.5% of capital under management, says Murley. "We are trying to get these guys to unlock capital at vast amounts greater than that in a shorter period of time." The industry must offer better returns to encourage institutional investors to funnel funds away from other sectors into offshore wind, he says. "The pension funds will get there but it's going to take a long time."
Meantime, the net for wind finance is being cast ever wider. Monteau says Dexia has been seeking alternative sources for years. Having drawn the EIB into Europe's first offshore wind financing, the bank is once more beating a path to the EIB's door for further projects offshore in Europe and on land in North America, he says, as well as trying to tap big institutional funds and even Canadian provincial governments.
The pool of universal banks ready for offshore wind will probably grow slightly as the sector matures, predicts Monteau. "But there is only so much the banks can do, so we have to keep on trying," he says. "I am giving myself a 12- to 18-month horizon where I am confident that we will find these resources. After that I really don't know."