Probe beneath the surface of wind power financing in mainland Europe and it becomes evident that "project financing" -- a standard approach to funding new thermal power plant and wind plant in the United States and Britain -- has hardly played any role at all. The small-scale origins of wind energy conversion in pioneering countries like Denmark, Germany and the Netherlands has meant that the first port of call for money was the local bank. From these beginnings, a wide variety of soft loan options have come into being as governments have sanctioned them, with the banks acting as conduits. Even if cheap government-backed money has not been available, some form of security has been, such as the Danish government's promise to pick up the tab if an owner defaulted on loan repayments.
The net effect of these various forms of financial support -- including guaranteed fixed payments for production -- has been to reduce the risk of lending money for wind turbines. Reduced risk means cheaper money and banks have been able to lend at interest rates which commercial project financiers -- who to attract investors must offer a decent return on the investment -- could not hope to match. The historical consequence of wind's growth in these different fiscal environments is that there are three broad types of financing mechanism operating in the business today.
First, where wind's growth has been among the most rapid, such as in Germany, Spain and the Netherlands, it has been fuelled by state-backed banks or funds with fiscal privileges. These provide money at below normal market rates, possibly taking more risk than is normal in conventional financing because they know the government is there with a safety net. As non-profit institutions, the banks have no shareholders to worry about and can simply pass on costs to the taxpayer if things get dire. Typical interest rates for wind project loans in Germany are 5-7%.
At the other end of the spectrum, is project finance. Wind developments in the US and Britain have been financed on normal commercial terms in deals put together by banks or the small handful of project financiers operating in the sector. Lending levels rarely exceed 80% of the project cost and investors put up the remaining 20%, the equity. Given that equity shareholders generally demand rates of return of 12% or more, in Britain the effective interest rates for projects as a whole has generally been in the 10-12% range. The intensely competitive nature of the Non Fossil Fuel Obligation (NFFO) market structure, however, drove down project rates of return. The successful bidders in the later rounds were often utilities. These were able to use their own funds and set their own, lower rates of return and interest rates dropped to 7-10%.
Third, and half-way between the two extremes, come countries like Denmark, where most of the financing has been provided by high street banks and home mortgage companies, often in the form of personal loans where borrowers have provided their house or another major asset as collateral. Loans of up to 100% of the sum required are not uncommon. Interest rates swing widely, in some cases following those charged to house-owners and in other cases following rates applicable to a long-term overdraft. The average rate today probably lies between 6% and 10%. The kind of rigorous (and expensive) due diligence test that a project financier requires are rarely carried out, but the banks' risk is mitigated, partly by the promise of fixed payments for the power produced, and partly by the existence of collateral.
Utility financing of wind farms in Denmark is quite different. These use "public sector" test discount rates for the projects as a whole and it is assumed that the capital is repaid over 20 years. The money comes straight off the balance sheet -- it is provided in advance by electricity utility customers through their bills. These procedures are quite standard in the public utility sector and lead to significantly lower electricity costs.
All on the cheap
Particularly in Germany, the availability of loans at below high street lending rates has done as much to stimulate wind energy development as the existence of the Renewable Energy Feed in Tariff (REFIT), with its fixed payments for wind power. About 90% of wind turbine projects completed in Germany in 1999 benefited from cheap loans from the government owned Deutsche Ausgleichsbank (DtA), with local banks managing the paperwork. Cheap loans from other sources are also available through further programs at the Länder level. Banks have linked money to developers on the strength of expected earnings over ten or 12 years from selling wind generated electricity at the fixed REFIT prices.
The DtA administers money from two huge funds: the European Recovery Program under the post-war Marshall Plan and the Environment Program. Money from these two sources was used to finance 1450 MW out of the 1600 MW of wind developed in Germany last year. Investors can borrow from both sources for a single project and as much as 100% of the sum needed can be raised in this way, though 75% is more normal. The equity is raised on the private market, often through the launch of a specific fund, though there are fears this source could dry up (Windpower Monthly, July 2000). Once the loan is paid off, the REFIT payments continue, which means the owners have a highly profitable investment, provided the wind turbines perform well.
The government's sale of the DtA to a similar state owned financing institution, the Kreditanstalt für Wiederaufbau, announced in July 2000, will have no immediate impact on the funds for which loans are made to wind projects, says the DtA's Christoph Stein. But in the medium to long term the areas of activity of the two banks will be redefined. At present there are many cross-over points, as both claim to be the support bank for small and medium sized enterprises. He assures that nothing will change this year and probably not for the most of next year. Stein also stresses that both the recovery program and environment program funds will continue to run indefinitely.
In the Netherlands and Spain, investors in renewable energy plant are able to obtain their funds -- or a substantial proportion of them -- from state-backed financial institutions. Spain's energy agency provides large chunks of money for wind development at below normal market rates, while in the Netherlands loans are available from "green funds" for 100% of the investment needed at rates which are 1.25% to 1.75% below par. Although this finance has been provided subject to scrutiny of the financial strength of the projects, rarely has this scrutiny matched the rigorous nature of "due diligence."
Other fiscal incentives also play an important role in oiling the wheels on all these markets, such as energy tax refunds in the Netherlands and Denmark, regional capital subsidies in Germany and Spain, and general tax incentives for investors.
The availability of tax credits in the Netherlands has been particularly significant. "In fact we've seen the arrival of a new type of high income investor who is only in wind for the tax deductions. Once they've recovered their tax position, or the tax advantages vanish, they will immediately get out of the market," says Mathieu Kortenoever of PAWEX, the Dutch association of private wind turbine owners. The fragility of tax credits was seen last year. After a proposal to strip investment in green funds of its tax immunity, investors bailed out, with the result that there was a sudden shortage of cheap loan capital.
Project finance does play a role in the Netherlands wind business, says Kortenoever, but only in combination with cheap, green funds. Long term, he believes project financing is the wave of the future and says that secure renewable energy development can only be achieved through the creation of a stable European market for renewable energy or for trade in its environmental derivatives in the form of green certificates. "Cheap capital isn't necessary for renewables growth," he says.
Tougher in Britain
Financing has been, and is, very different in Britain than on mainland Europe. Neither soft loans nor tax incentives are available. Under the Non-Fossil Fuel Obligation, retailers of electricity had to secure a certain amount of renewables and they contracted for this at a specified price with wind plant developers. The most recent contracts had a fixed term of 15 years and the existence of a contract meant that developers were able to use project financing structures to get wind plant afloat. With no special financial arrangements on offer, the banks involved took a commercial view of the risks. They also insisted on investor participation of at least 20% -- the equity contribution.
Increasingly in the UK, utilities have stepped forward as developers and have been willing to provide equity or to finance whole projects -- and at a lower rate of return than usually required by project financiers who must return a worthwhile profit to investors. Windfall profits are not a feature of NFFO, however, as the premium payments cease after 15 years.
Financing has considerable influence on the cost of wind generated electricity -- as do wind speeds. The better the wind, the cheaper the wind power. In a comparison of an identical hypothetical project operating in high wind speed Britain and in low wind speed Germany, with the same capital and running costs, the influence of wind speed and financing on the overall cost of producing each kWh is clear (figure).
Under a NFFO 3 contract -- and having secured money at an effective interest rate of 12% for 12 years -- a project which secured the average price in Britain operates in winds of 8.5 m/s and sells its output for EUR 0.074/kWh. If typically lower German winds of 6.6 m/s are applied to the same project, a higher payment of EUR 0.112/kWh is needed for the project to be financially viable as a commercial enterprise. This is more than the fixed kWh rate paid for wind under Germany's wind law. If, however, the project is financed with typical German soft loans at an effective interest rate of 6%, it would only need 0.084/kWh to be viable, which is Germany's fixed tariff rate.
In Germany it is the taxpayer who bears part of the financing costs by picking up the tab for the soft loan, making wind power viable on low wind sites where it would otherwise not be at current REFIT rates. In Britain it is the project that bears all the financing costs. The interest rates are higher because the risk is borne by all involved -- the lenders, the insurers and most of all the project investors, who would not take on that risk without compensation. The lender of a soft loan -- which can be up to 100% of a wind plant's price -- usually passes the risk on to the taxpayer, who carries the can if anything goes wrong.
Significantly, the higher cost of financing in Britain is almost completely accounted for by the need for a greater return on investment. The cost of the army of lawyers and advisors involved in project financing is simply absorbed in the capital costs of the project -- and remains invisible in the end price of power produced, at least compared with German prices. Thus it is revealed that the extra expense of containing all the risk within a project financing structure is made up for by the streamlined efficiency with which projects are developed and operated and the rigorous expectations made of the technology.