While the long-term investment fundamentals of the European wind sector remain strong -- and got only better with the EU's recent approval of binding renewable targets for its 27 member states -- the big issue for wind developers seeking to move projects forward is how to solve short-term financing problems in an extremely tight credit market. Debt financing is harder to come by and more complicated than it was a year ago. Moreover, with caution and security the current watchwords, the proportion of a project's capital cost that its sponsors can expect from debt providers is a lot less than it was. Recourse to the public markets is not seen as a viable alternative in the short term given the tumbling stock market valuations of recent times. Cash really has become king.
On the brighter side, new sources of finance have emerged in the last few years to help lessen the negative impact of the current liquidity crisis. Utilities, which may be able to side-step the debt financing market and make the hefty investments required for projects on balance sheets, have increasingly invested in wind and are seen as the dominant market players of the moment. Their advantage is expected to remain even more pronounced in offshore wind power, which has not yet gained the kind of track record that makes banks comfortable with lending to them, particularly in times of tight liquidity.
Alongside the utilities, institutional investors and infrastructure funds are stepping up to invest in wind while the policy-driven European Investment Bank (EIB), the EU's lending arm, says it is willing to loosen the purse strings a bit more for the renewable sector and the bulk of its funding in that department has traditionally gone to wind. "We clearly see bank lending is slowing, but we have different channels of investments," says Christian Kjaer, CEO of the European Wind Energy Association.
New financing sources, however, are unlikely to be sufficient to completely compensate for the lack of debt financing available. At the European Wind Energy Conference (EWEC) in Marseille in March, where Kjaer was speaking, participants heard from Emerging Energy Research (EER) that new installed wind capacity in Europe will fall nearly 20% in 2009 compared to 2008. But liquidity is expected to improve towards the end of 2009, notes EER, allowing Europe's capacity figures to resume an upward trajectory in 2010. Meantime, as well as a short-term slowdown in development, projects are also being reduced in size as developers struggle to close financing deals.
New sources of money
Making up for some of the financing shortfall, the EIB has increased its funding for renewable energy in recent years and plans to continue to up its lending to the sector. The EIB finances projects designed to enact EU policies and its shareholders are the same 27 member states which are now facing both binding renewable targets and more difficult financing conditions. According to the EIB's Matthias Kollatz-Ahnen, the bank's renewables lending jumped from EUR 0.5 billion in 2006 to EUR 2.4 billion in 2008 and the lender plans to do a minimum of one-third more, or EUR 3.2 billion, this year. Wind projects accounted directly for about one-third of the EIB's renewables lending in 2008 and even more when loans for multiple sectors of renewable energy are included. Not that the wind sector's financing problems are instantly solved. "We cannot make up for the market," says the bank's Christopher Knowles. "There must also be equity and co-loaning."
Long term, low risk
Like the EIB, institutional investors and infrastructure funds have been increasingly keen on clean energy investments. The longer term prospects for them pumping more money into the sector are seen as particularly good. According to information provider New Energy Finance and Deutsche Bank Climate Change Advisors, which surveyed more than 100 institutional managers and owners, 75% of institutional investors say they are likely to invest more in clean energy investments by 2012. Institutional investors' view on the current credit crisis are not particularly glum: 23% of respondents are "more likely" or "much more likely" to invest in clean energy now, while 53% say they expect the current financial turmoil to have no impact on their investment decisions.
Infrastructure funds are looking for long-term, low-risk and low-return investments, although Philippe Raybaud of French law firm CGR Legal notes that the definition of what is a low return tends to be somewhat higher now than it was a year ago. Mortimer Menzel of investment bank Augusta says the internal rate of return (IRR) for private equity investors for onshore projects is now around 9-12%. This is up slightly from indications of just about 7-9% a year ago, but still significantly below the nearly 20% seen in 2002-2003. Menzel also points out that financial investors have raised their IRR expectations for "leveraged" deals -- those with a substantial proportion of debt to equity -- up to a minimum 14%.
In Europe, renewable energy investors such as Netherlands-based DIF, Germany's Allianz and Akuo Investment in Luxembourg, which is expected to get a large portion of its "deal flow" from captive French renewables developer and operator Akuo Energy, are among those whose infrastructure or renewable energy funds have targeted wind investments. Raybaud says the deal flow of infrastructure funds has not been significantly reduced by the credit crisis.
He notes that the valuation of wind farm projects has gone down and there are more projects coming to the market as developers increasingly run into financing difficulties. Infrastructure funds are not immune from the credit squeeze, however, as they tend to invest with a high rate of leveraging and, like other market players, are finding it more difficult to get bank financing quickly. A minority of funds, such as those run by Allianz, shun taking on a debt partner and put up 100% equity for full ownership.
One clear impact of the credit crisis on infrastructure funds, which aim to diversify risks both geographically and in terms of preferring to invest in projects using a broad range of turbine suppliers, is that they have become even more risk-averse. "No development risk is to be taken on by the infrastructure fund, no construction risk is to be taken by the fund and an important and more recent trend is that funds are even refusing to take on financing risks," says Raybaud. Since infrastructure funds will take only very limited risks, this also means they want the best projects available.
Project financing VITAL
The market for project finance, in which loans are secured against project revenues rather than against an equity player's capital holding, has tightened considerably. Re-opening this channel of financing is seen as vital to allow the industry to move forward to meet wind's 2020 objectives in Europe. Project finance deals are still happening in the wind sector, although under quite different conditions than were par for the course in 2007 and early 2008.
"Before, no risk was bad enough, now [people want] none at all," says Jérôme Guillet of Dexia, a European bank specialising in public and project financing. "It took us many years for us to get banks comfortable with merchant risk," adds Mike O'Neill of New York-based independent power producer Element Power, referring to wind facilities which sell their power directly into the wholesale electricity market. "Now the M-word can no longer be mentioned." Senior debt for development pipelines is also almost out of the question, says Augusta's Menzel.
It is not wind projects as an asset class that is the problem, notes Nikolai Ulrich of HSH Nordbank. "It [wind] would be healthy for project financing, but there is just not enough liquidity available. If I could get more funding at a reasonable price, I would lend more. There is still a fundamental uncertainty about the balance sheet quality of banks...it's not a wind problem at all."
More equity required
Bank lending now comes with more stringent financing conditions -- and not just for the wind business. To begin with, much more equity is required for projects. According to Menzel, about 25-30% equity is needed for even a very solid onshore project right now, up from 10-15% in 2007 and early 2008. Loan maturities have shortened, while interest rate spreads over the interbank Euribor and Libor rates have increased. The impact of the widening spreads, however, has been mitigated by the cut in European base lending rates. As a result, the overall cost of borrowing is actually fairly steady and in some cases may even be down slightly, says Menzel.
For the big project financings that are getting done, there is a predominance of club deals, in which several banks are lined up from the beginning to take their share of a loan. Previously, standard procedure had been that one or two banks would underwrite a loan and then syndicate it with a larger pool of lenders. "Quite simply, there is no syndication and banks are not doing underwriting," notes Guillet. While the lack of syndication is not a problem for small deals, larger projects may be downsized or delayed and bankers report this is happening.
At the same time, portfolio deals, in which several projects are bundled together to diversify risks and to bring down overall transaction costs, are also on hold. They were in vogue in the wind sector not that long ago, but are too large for banks to handle. They may also be overly complicated for a market that is clearly emphasising simplicity and worried that greater risk may actually be hidden within the details of package deals.
"We need to go away with boring deals that are easy to understand," says the EIB's Kollatz-Ahnen "We are very much asked if we really know what's in our projects and the more anonymous and bundled something is, the bigger a problem it is." While the EIB may be known for its conservative lending stance, its approach to wind financing is rapidly becoming a common one in the sector. "One of the lessons is that complexity is out," says Paul Dowling of Scottish & Southern Electricity renewables' subsidiary Airtricity. Like a string of other EWEC participants, he ruled out the concept of bond financing as a solution to the financing woes of the renewables sector. Not long ago it was an idea that had been gaining ground.
Paradoxically, for some companies and projects it may actually be easier to get project financing now. "Even if banks do have limited liquidity, when we have high quality projects and high quality regulations, we are seeing it is easier, or let's say cheaper, than before to do a project on a project finance basis," says Luis Adao da Fonseca of EDP Renovaveis, the renewable energy subsidiary of Portuguese utility Energias de Portugal. For now, however, EDP Renovaveis continues to finance most of its projects on balance sheet.
"Clearly, the small independent wind farm developer will have a more difficult time," says Tom Murley of renewables at UK investment company HGCapital. Independent power producers (IPP) in the wind sector will need solid track records of successful project development. "Banks want relationship-based lending and for mid-sized developers and IPPs it will be on a very case-by-case basis depending on what they've done in the past," says Murley.
Despite the generally choosy attitude of banks towards transactions, some project finance deals are nonetheless also in the offing for offshore wind projects and there is a degree of longer term optimism for financing projects off Europe's coasts. "Offshore wind is a huge opportunity," says James Donaldson of private investment bank Investec. "It's crucial to meeting EU renewable targets and a huge amount of capital is required. Most projects are likely to be financed on balance sheet by utilities over the next few years, but I wouldn't write off project financing for offshore. Some utilities' costs of corporate debt is approaching that of project finance."
As is the case for onshore, the quality of the sponsor is vital -- and counts more than ever when it comes to offshore, where everything from financing to construction and plant operation has a short track record. "High quality sponsors will get the better deals," says John Dunlop of HSH Nordbank. The ideal sponsor, he says, is one with a key client relationship with a turbine manufacturer, in-house technical expertise and a reputation for building the right kind of projects.
Those who know how to build the right kind of wind projects, on or offshore, may also be rewarded with higher valuations. While valuations for wind farm projects in general have declined, Da Fonseca of EDP Renovaveis says a more selective approach on the part of investors has helped to sustain valuations of the best wind projects on the market. "Most of the value in quality wind farms is still there. Before there was over-hype in value, but no distinction in the value of a project."
Menzel agrees. "Fully developed projects sold at turnkey are not getting that much less now," he says. "And [the developers] are actually getting more money because the price of turbines has come down." Wind asset valuations are holding up because there are few good, fully financed or operating projects on the market right now. History shows that these projects tend to receive significantly higher prices when they are also sold with their management team, he notes.
Generally speaking, however, Menzel says that the equity market for wind has moved from a sellers' market to a buyers' market. "There is still a significant amount of equity, but investors can afford to be very selective. Bank financing is available only to the best developers and projects." This has led to cash-strapped developers selling projects under development and a glut of non-financed development projects.
What is normal?
As the wind industry waits for liquidity to start flowing again, far from all industry players believe the market's pause is an entirely bad thing. A new emphasis on the quality and solidity of projects and an end to indiscriminate sky-high valuations could help form the basis for more sustainable growth. At EWEC 2009, conference participants debated when the market would return to "normal," but then asked whether the industry's pre-crisis period could actually be described as a "normal" business.
"I don't see the last three to five years as being normal at all," said Element Power's O'Neill, who was previously commercial director at the UK's Renewable Energy Systems. "It turned out to be a financial modelling exercise. Many developers made healthy profits in the short term, but that's not sustainable in the long term. The excesses of the past years are gone and I think that's a good thing. It's not in our interest for companies to go out of business." Menzel of Augusta agrees that the environment is a healthier one now. "The problem is, it's not tenable without liquidity," he adds.
The consensus at the financial discussion at EWEC 2009 is that liquidity will return, although just when that will happen is a matter of debate. Since banks are in the business of risk analysis and onshore wind farm risks are well understood by now, Dexia's Guillet expects that project financing for these projects will be one of the first segments of the market to rebound once liquidity becomes more readily available. He believes the market will restart with club deals, which have become the modus operandi for wind farm project deals under the credit crisis. As for the financing sector as a whole, O'Neill believes "there will be no normality this year and much of next until banks truly unwind their positions, but the capital is still there if you can find it and deliver on projects."