Pension funds and bond markets warm to wind power

UNITED STATES: European Union governments expect the offshore wind sector to deliver over 40 GW to help meet their 2020 renewables targets.

The new offshore build could require some €110 billion of capital investment in Europe alone, not to mention offshore plans being taken forward by the US and China.

But just where the money is to come from is exercising developers and the finance community alike.

Most offshore wind farms have to date been financed by large European utility sponsors with strong balance sheets.

But as utilities increase their offshore portfolios and wind farms become larger, they will struggle to raise the money needed.

Moreover, wind and renewables are just one part of the massive energy infrastructure capital expenditure programmes that the utilities must undertake over the next 15–25 years.

Only a handful of offshore wind projects so far have not had utility financing during construction, relying on a project-finance model instead.

Most commentators agree, however, that project financing of utility offshore projects, where money is borrowed against future income to build the project, will, of necessity, become more common.

Signs of this already happening are apparent. In 2009 British energy company Centrica raised debt finance for two recently operational offshore wind farms, Lynn and Inner Dowsing with a combined capacity of 194 MW, in its 2009 "Boreas" deal, which also included an onshore wind farm.

At the same time, Centrica sold half the equity in the wind farm package to institutional investor TCW Energy and Infrastructure Group. The deal allows Centrica to fund its pipeline of future offshore projects.

Jérôme Guillet, CEO of Energy Bankers à Paris, is advising offshore wind developers to follow Centrica’s example by making early deals easy for the banks to allow them to dip their toes in the water.

He points out that as a re-financing of three operating UK wind farms, there was no construction risk in the Boreas package.

"You now have 14 banks that are able to say: we’ve done offshore. Next time round they will be able to take a little bit of construction risk or other risk, or maybe more leverage."

Indeed, Centrica is now seeking non-recourse finance, where there is no recourse to the project sponsors should the project default on its loan payments, for its larger 270 MW Lincs project due to begin construction this year.

Centrica owns 50% of the equity, with the other 50% owned by Denmark’s DONG Energy and German industrial giant Siemens.

This will make it the first UK offshore wind project to be project financed during construction.
The first offshore project in the world to pioneer this route was the 120 MW Dutch Princess Amalia wind farm, also known as Q7.

Owners Econcern and Eneco closed the deal in 2006 (Windpower Monthly, July 2006). More recent non-recourse deals have been closed thanks largely to the involvement of the European Investment Bank (EIB) and export credit agencies (ECAs) such as Denmark’s state-owned Eksport Kredit Fonden (EKF) which have underwritten the financings.

The latest to be closed is Belgian C-Power’s €1.25 billion second phase of its 300 MW Thornton Bank project off Belgium in the North Sea.

In the biggest ever project financing of offshore wind, seven commercial banks are providing €950 million in loans with contributions from the EIB, EKF and German export credit agency Euler Hermes.

Guillet, who advised the C-Power deal, reports interest among banks in providing debt finance to the sector.

A lot banks are "sniffing around" offshore wind, he says. "They see it’s going to be a big market; they’d like to get in but they’re just not sure how to do it."

The current difficulties in raising finance are more of a short-term problem; banks are unfamiliar with the technology at the same time as being more risk averse in today’s financial climate, he says.

But one of the reasons that projects have not found finance so far could be that they are not up to standard, Guillet suggests.

Project finance brings discipline through due diligence and contract negotiation. "For offshore wind, there is a clear distinction between turbine contracts that are utility standard and those that are project finance standard," he says.

"Some utilities have been happy to just take the reputational commitment of manufacturers and not worry about the actual legal commitment; some are taking more risk than they realise."

He points out that three offshore wind farms have been project financed so far.

"Two are built and both have 99% availability, both were built within budget and the timetable that the banks had agreed to."

Construction finance trend

Nick Gardiner, director of BNP Paribas’s Energy, Utilities and Infrastructure Group also sees an increasing trend towards banks funding construction—and at least one year of operation while any teething troubles are sorted.

"Then these assets would be flipped to long-term holders: pension funds or life insurance companies," he says.

"There are sufficient funds out there to finance growth in offshore wind but we need to target who is going to invest in the sector other than the utilities and the banks.

"Commercial banks are not best placed to hold long-term project finance assets—and here long-term means 15 years at most."

But the pension funds are not yet active enough in the sector and not enough is being done to educate them about offshore wind power’s potential, he adds.

Fintan Whelan from Mainstream Renewable Power notes that the pension funds talk of the need to match their assets to their long-term liabilities.

"Yet they invest in infrastructure funds of a three to five year life at a very high margin. There’s a profound mismatch which the financial crisis has revealed."

The pension funds will eventually get there but it may take time, believes Henrik G Welch, senior director from EKF. Business case certainty is critical here, he says.

To attract long-term investment it is essential that offshore wind technology works, he says. There is pressure on manufacturers and the supply chain to prove their machines and components are able to perform well over many years in the offshore environment.

"And with more and more offshore project deals being closed, that will hopefully bring pension funds into play."

Enter the pension funds

A sign that this may be happening is PensionDanmark’s purchase of 50% of the equity in the five-year-old Rødsand wind farm in Denmark’s southern coastal waters off the town of Nysted.

The pension fund is the first to enter into a direct agreement with a major Danish industrial partner in offshore wind, comments Torben Möger Pedersen, CEO at PensionDanmark.

"We believe that the model chosen can serve as a breakthrough for the investment of pension fund assets on a large scale in green technology and other infrastructure."

The bond market is seen by some as another potential source of money for long-term holders of debt capital in offshore wind once the construction phase is over.

Sean Kidney, Chair of Climate Bonds Initiative points to a number of developments in global finance that could pave the way for bonds to play a big part in helping to finance the wind build needed to enable countries to meet their low carbon commitments.

He notes an "extraordinary" level of recent investment flowing into bonds from institutional investors, driven largely by pension funds trying to match their assets to liabilities.

Several large funds in the United States have shifted their portfolios from 20% fixed interest to 80% fixed interest, he says.

Moreover, some have made policy decisions to "green" their funds, while at the same time increasing their investments in energy as equity and bonds.

"Renewable energy investments are ideal for bonds as a rule," says Kidney. "High capital cost, low, very predictable running costs and very low inputs."

What is more, renewables do not have the hefty—and usually uncertain—back end liabilities associated with nuclear or, for that matter, the input problems of coal and gas and their volatility to energy prices.

"I think the bond market will grow incredibly in renewable energy in the next few years."

Governments must share the risk

But he warns that the quantity of finance needed can only be raised with some form of public balance sheet guarantees to take on part of the risk in renewables investments.

This would be through organisations such as the World Bank, EIB and other multilaterals or through "green" or climate investment banks.

He expects to see governments provide some risk minimisation in the first large securitisation of funds for renewable energy—perhaps later this year.

Yet so far, bonds have played a very limited role in wind farm financing except for a handful of projects in America. In Europe, ratings agencies have downgraded the bonds issued by Breeze Finance for a portfolio of German and French wind farms (Windpower Monthly, November 2004) to below investment grade.

This was due to cost over-runs, below average wind conditions and lower than expected operational availability.

Despite the poor experience with Breeze, Whelan believes the bond market cannot be ignored as a pool of capital for refinancing wind farms to release project finance into further construction phases.

The public equity markets offer a deep enough pool of money for the equity investments in offshore wind farms, he says. But where is the senior debt to come from in refinancing, after project finance has organised and de-risked construction?

To bond or not to bond
"It seems to me impossible not to think about the bond market," he says.

"We need to debate what it will take to get debt capital markets able to add offshore wind farm debt to their fixed income portfolios."

This may mean a number of offshore wind farm loans bundled into a bond. If offered by utilities, the bond would not only be asset backed, "it would also have recourse to consumers’ rock solid demand for electricity," he says.

"What we’d have then is a connection between the cause and the solution. It would have the benefit of de-risking the proposition for the investor, reducing the required capital eventually and minimising the cost of delivering the electricity."

Taking a different view is Xavier Monteau, head of energy and environment at Dexia bank, who does not see a bond market for wind projects emerging any time soon.

"Wind farms do not offer sufficiently stable revenues." In any case, project sponsors would only look at bonds for very long-term finance or if they have a large portfolio of projects in different countries and with different regulatory regimes, he comments.

"Bonds are not usually the right product for wind farm financing."

Tom Murley, head of renewables at private equity investor HgCapital, is also not convinced that bonds are the answer for financing offshore wind. "One reason people do not use bonds is because you get better returns from the banks," he says.

And investors need to see returns from offshore investments. "They need to see utilities make money; the fact is no one has really made money out of offshore yet; people have flipped permanent assets and made money but we’re talking about long term operation.

"We need track record."

The pension funds are never going to be among the first to invest in wind bonds, he adds. And it is not an easy matter to achieve investment grade.

Based on current agencies’ ratings, even the best onshore wind projects are not going to be rated above triple B minus—the lowest investment grade, he says.

Murley also points out that the debt financed by bonds is hedged out long term to allow insurance and pension funds to match their obligations.

Wind farm owners have to be certain that they want their projects to be locked in to the 14–15 year term of the bond, he warns.

"You can’t repay the debt; there are huge repayment penalties and enormous break costs. So you have to be sure you want that debt for the time you’ve got it at the cost of that money.

"For a lot of people who want to refinance, take the upsides and not be locked into long-term debt, that bond market isn’t such a good deal," he says.

"You have to think about the trade-offs." Wind farm owners would like to have that long-term debt.

"But knowing that they will be unable to refinance it when rates come down they’ll say: no thank you, I’ll stay with the banks."

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