The end of 2011 and start of 2012 saw a flurry of project financings for onshore wind farms in the UK reaching financial close. These include the 46MW Carraig Gheal wind farm in Argyll - which secured £94 million (EUR113 million) in debt from UK banks Lloyds and Royal Bank of Scotland (RBS) - and the 24MW Hall Farm wind farm in Yorkshire, which signed a £28 million loan from RBS. After a fairly barren 2011 in terms of onshore capacity added - 403MW, the lowest level of additions since 2005 - 2012 promises to be a strong year for UK wind installations.
However, most developers would agree that this is a temporary spike resulting from the Department for Energy and Climate Change announcement in October that the renewables obligation that requires electricity retailers to source a proportion of their power from renewables by buying renewables obligation certificates (ROCs) will be cut from April 2013. This means onshore wind projects will only receive 0.9 ROCs/MWh rather than the current 1 ROC/MWh.
Although the rate is technically still under consultation, the market has been treating it as the final word. Several deals that had been held back are now moving forward. This increased deal activity is likely to continue throughout the year as developers look to finance and build projects before ROC rates fall.
Industry commentators believe that the market is beginning to slow for projects beyond the 2013 ROC rate-cut deadline. One of the greatest barriers to capacity growth beyond 2012 looks set to be the growing lack of long-term debt available from banks to finance wind.
Apart from wind farms built by the big utilities, which tend to use their own balance sheets to finance projects, most developers rely on banks for 70-90% of their project's cost via a relatively low-interest loan, which is then paid back by a portion of the project's revenues, typically over a period of ten to 15 years.
However, due to a combination of many European banks facing heavy losses as a result of the eurozone crisis and - most significantly in the long run - a likely requirement on banks to hold higher levels of capital for every loan they issue, long-term bank debt is likely to disappear as an option for wind developers in the UK.
Time is also running out for a lending programme for UK onshore wind intermediated by the European Investment Bank (EIB). Under this scheme, launched in November 2009, projects with a total value of £20 million-£100 million could access long-term financing from one or more of three commercial banks - RBS, Lloyds and BNP Paribas - and their loans would be matched by the EIB. The EIB promised up to £700 million in loans for wind farms being built in the three years following the scheme's launch.
Euan Cameron, CEO of developer Wind Prospect, questions whether there is much left of the original money from the fund, adding that the end of this programme would exacerbate the shortage of long-term debt for onshore wind.
An EIB spokesman declined to reveal what funds remain but said: "This engagement with the UK wind industry, in close cooperation with three UK-based banks, will continue and further financing considered once funding under this programme is exhausted."
Instead of the industry-standard tento 15-year loans, the wind market is likely to see banks increasingly offering miniperms - short-term loans that are not fully paid off during the loan period (see box, below).
While miniperms are used regularly in markets such as the US for wind financing, they are rare in the UK. For Jaz Bains, risk and investment director at developer RES, the uncertainty and refinancing risks of these loans make them extremely unattractive. "If miniperms were the only option open to us (from the banks), personally I would look to see how we can structure any form of long-term financing without using the banks," he says.
Alternatives to bank debt
As lending from banks becomes increasingly unattractive to developers, what other options are available for financing a wind farm? Assuming developers want to avoid selling off substantial chunks of their project stakes to private-equity firms, the solutions for non bank-funded project debt largely boil down to either bond financing or the use of debt funds or a mixture of both.
Wind Prospect and green-electricity supplier Ecotricity and have both successfully launched retail bond products to help finance projects. Although these have been for relatively small amounts - Wind Prospect's Rebonds raised £10 million - transmission network owner National Grid successfully launched a retail bond in October 2011 that raised £282.5 million in finance, illustrating the potential of going directly to individual investors.
The more traditional wholesale bonds, launched on the capital markets, could be achievable for a portfolio of wind farms, says Bains. On a single project basis it is likely to be more challenging, although it could become a way of paying off a miniperm financing early. "You could take bank project financing for construction and then flip that into a bond," he says.
The main barrier to this approach would be achieving a credit rating that would attract capital-market investors such as insurance companies and pension funds. Significant bond market liquidity in Europe only really exists for credit ratings at BBB+/A and above, but the underlying rating of renewable-energy projects typically falls short of this.
Another new vehicle institutional investors are using more are infrastructure debt funds. Many have sprung up in the European market over the past year, and while most currently favour a co-financing arrangement with bank debt, one or two are beginning to provide full debt solutions. Jim Fitzgerald, an associate partner at consultancy Advisory House, says UK onshore wind could prove attractive to such funds, and not just because it is seen as a "safe" technology for investment. The underlying buyout price of the renewables obligation is inflated according to the Retail Price Index, and inflation linking is one of the key investment criteria these funds are looking for.
However, these funds are very new and, Bains says, they are yet to prove price-competitive with other forms of finance for wind projects. Instead, he suggests a more tried-and-trusted avenue of wind financing should now be considered for the UK: the use of export credit agencies (ECA). Countries such as China use these to finance projects by domestic companies in other parts of the world. "Developers should now be talking to wind-turbine manufacturers to see what sort of finance they can bring (from their national ECA)," Bains says.
In a world where turbine prices and manufacturers' profits are falling, competition is fierce. Those manufacturers that can bring ECA finance to the table are likely to find themselves at an increasing advantage ... cue a Chinese invasion of UK wind?
HOW DOES IT WORK? THE MINIPERM WAY OF BORROWING
Miniperm is a short-term loan for four to eight years whereby not all of the debt is paid back by the project's revenues.
There are two types of miniperms: "hard" and "soft". With hard miniperms, all outstanding debt must be repaid at the end of the loan period. This creates a big refinancing risk for a project, as new debt and/or equity has to be found to make the miniperm's final payment.
A soft miniperm is less drastic in recouping outstanding debt: the banks carrying out "cash sweeps" at agreed points during the loan's tenor and at its expiry. Once a cash sweep is triggered, some or all of the project's free cash flow is used to pay off the debt rather than going to shareholders.
Sometimes the cash sweep is structured so that, for example, 50% of free cash flow is "swept" for debt payment in the middle of the loan period and increases to 100% in the final loan year. This continues until the project's owners find a way to refinance and pay off the debt.