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United Kingdom

British market tests waters for project finance

The UK's new market for renewable energy provides perhaps the most genuine test in Europe of the financial community's willingness to finance wind energy. Unlike in some other European countries, there is no cast iron government backed or government enforced power purchase agreements behind British wind farm developers when going to the market to seek debt finance for projects.

Wind power financing in Britain is not only based on market prices for power, but also prices for green certificates, exemption certificates and other related commodities

The UK's new market for renewable energy provides perhaps the most genuine test in Europe of the financial community's willingness to finance wind energy. Unlike in some other European countries, there is no cast iron government backed or government enforced power purchase agreements (PPAs) behind British wind farm developers when going to the market to seek debt finance for projects.

The Renewables Obligation (RO) requires electricity retailers to buy a proportion of their power from renewable sources, or an equivalent amount of renewable obligation certificates. "There are risks under the renewables obligation that you do not have in a German style feed-in system," says Adrian Scholtz of Ernst and Young, referring to Germany's fixed prices for wind power fed into the grid. The RO is a far cry from the UK's previous Non Fossil Fuel Obligation, when projects benefited from 15 year guaranteed PPAs. Combined, the RO and the penalising effects on wind energy of Britain's new electricity trading arrangements has fundamentally changed credit risk in wind farm financing, says Scholtz. The PPA is still all-important, but the credit quality of the power purchaser (offtaker) is now vital, he says. The departure of electricity supplier TXU from the UK market demonstrates that banks can no longer automatically accept the long term financial security of any offtaker, he explains.

Fears about offtakers defaulting on PPAs, he continues, means lenders are also now looking at the long term volatility of market prices for commodities associated with wind energy -- the power, ROCs, exemption certificates from the climate change levy (LECs), and embedded benefits. Potential developers eyeing the market for project finance have pointed out that a government "aspiration" to increase the level of renewables to 20% by 2020, without a commitment to increase the level of the renewables obligation after 2010, does not inspire confidence in the financial community.

Nonetheless, Scholtz maintains that around ten London project finance banks are eager to finance wind power. If a developer has all the necessary siting consents in place, good wind speed data, a robust financial model and shows how the various risks have been mitigated, good terms for debt finance will be available, he says. "Bankers just want the risks to be quantified in numbers." He does note that most projects built under the Renewables Obligation so far have been financed on balance sheet by utilities -- not a single major wind development has been project financed under the RO.

First project financing

Closest to completing a project financing deal is Fred Olsen Renewables for its 50 MW Crystal Rig project near Dunbar, south east Scotland, due online this year. Bank of Tokyo-Mitsubishi (BTM) has agreed credit facilities with the company for up to £46 million. The 15 year senior loan is being syndicated to specialist and relationship banks, while an equity guaranteed junior loan of £8 million is to be retained by BTM. The project has a £95 million, 15 year PPA with Powergen for the sale of electricity and green benefits such as ROCs and LECs.

Another approach is being taken by Your Energy, which has a 10 MW project on Orkney, in Scotland, and a portfolio of projects under development in Wessex and East Anglia. The company's Bill Richmond points out that securing long term PPAs is difficult at present. While utilities already with renewable interests are more open to contracts of 12 years or more, those new to the business tend to offer short term PPAs of up to seven years. "Seven years is simply not long enough to make it work for us," he says. "Banks will need risk free PPAs with a term typically 18 months to two years longer than the debt," Your Energy's Andy Holdcroft agrees. The company is hoping to establish pre-arranged finance facilities for its project portfolio whereby projects meet pre-defined criteria agreed with financiers. Under this arrangement, Your Energy has to find an alternative source of debt for the first one or two projects, he says. Already it has £3.3 million of financial backing from new venture capital firm Mistral Invest.

Crucial issue

The support of financial markets will be crucial for the UK to meet government targets, stresses David Leivesley from EcoWind, which has used non-recourse financing to build its wind projects in the US. "The cost of that money is considerably higher than on-balance-sheet utility financing with its lower interest on borrowings," he says. But while utilities may have access to the cheapest debt around, he maintains that most of the estimated EUR 6 billion to finance the 6000 MW of wind energy needed to meet the UK's renewables targets will come through financial markets. "There is enough comfort for bankers in onshore wind in the UK. For a site with planning [consent] and a wind speed of eight metres per second, I think you will not have a problem in getting finance," he agrees.

Offshore wind, on the other hand, "presents a whole new set of risks, particularly in the early stages of projects," Scholtz says. Non-recourse senior debt for project construction is likely to be limited until credible contractors emerge with enough of a track record to give lenders comfort that contracts can be delivered to time and budget. In case project targets are not met, they have to show they have the financial capacity to withstand claims for liquidated damages. Offshore developers are likely to turn to project financing after construction, when terms will be a lot more attractive, he says. Moreover, he believes that once an offshore wind project has been constructed and been operating for a few months, financing will be much less of a problem.

Jointly liable

It is not just developers, though, that will struggle. Companies in the offshore supply chain are also finding it tough, says Megan Arnold of SLP Energy. Project sponsors are demanding that all the major contractors in projects become jointly and severally liable as a consortium in case of failure of any one of the companies to complete. With experience in designing and building oil and gas platforms, SLP is one of the companies from the conventional fuel sector hoping to secure a chunk of the emerging offshore wind business. "But we are not experienced with turbine technology," says Arnold. "And a turbine manufacturer does not know much about designing or installing offshore structures." The extra risks involved with joint liability make it more difficult for companies like SLP to gain financing, she notes.

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