United Kingdom

United Kingdom

Corporates rising to dominate market

The profile of British wind power will change under the new Renewables Obligation, with the long term nature of the new market likely to attract big corporations whose financing strength will push out smaller businesses less able to cope with market risk

Small renewable energy developers are likely to be hit disproportionately hard by higher costs of finance under the UK's new renewables support mechanism. This will lead to fewer players in renewable energy as larger companies acquire smaller renewable energy businesses, predicted members of Britain's finance community at a conference in London in late September on renewable energy financing.

Speakers at the Renewables Finance Forum, organised by Euromoney, agreed the new Renewables Obligation legislation -- due to come into force in January -- creates more uncertainty for financiers than the UK's previous support system, the Non Fossil Fuel Obligation (NFFO). As well as political uncertainty there is a lack of understanding in the financial community as to how the market for renewables obligation certificates (ROCs) will work, said Jonathan Boyers from KPMG Corporate Finance.

The Renewables Obligation will require electricity retailers to provide 3% of their sales from renewable sources for the first 15 months from January 2002, rising to 10.4% by 2010. They will demonstrate their compliance by owning a sufficient number of ROCs, which will be awarded as certification of their green power sales. If they fail to buy sufficient renewable electricity and thus do not own enough ROCs to meet the percentage target, they will be able to pay to buy out of part or all of their obligation to retail a fixed proportion of green power.

The certainties and attractive contract terms for renewable generators associated with the NFFO -- such as guaranteed off-take of power, a strong credit-worthy counter party and 15 year index-linked contract term -- are no longer guaranteed under the new obligation. "The uncertainty means that debt providers in particular are going to be very wary of financing projects under the renewables obligation," said Boyers. "It is possible that after time it will settle down and bankers will gain comfort from the way the market is operating. But the next year or so is going to be a very challenging time."

Increased risk

The increased risk attached to projects leads to investors demanding a higher rate of return, increasing the proportion of equity needed in a project finance package, said Boyers. Melville Haggard from Impax Group agreed. He believed the 90%/40% debt to equity structures common under NFFO will give way to nearer 60%/40%. "The certainty of NFFO contracts is not likely to be replicated. That is not an adverse comment on the Renewables Obligation, but it is a different structure. People expected the fixed certainties of NFFO to appear under a different name, but they will not."

Boyers commented: "It is going to be more difficult for smaller companies to raise equity for small projects than larger companies who will probably be looking at larger projects, but will also have stronger balance sheets." Larger corporate entities will be able to source equity from their corporate facilities and will come to "dominate" some of the smaller renewable development companies, he said.


Main sources of equity for projects will be large trade investors and utilities who will have to comply with the renewables obligation. They will buy stakes either in the projects or in the companies that are developing the projects, Boyers believes. "Increasingly projects may well begin to look like joint ventures, with major corporates linking up with smaller companies across Europe. The industry will increasingly collaborate to solve the financing issues that arise from the proposed changes."

This will lead to increasing mergers and acquisitions, with a trend towards more corporate companies operating in the market and the larger entities acquiring small businesses, he said. Small companies are going to be under pressure to sell. "With a number of projects in the pipeline and perhaps struggling to get planning consent, they will also be finding more difficulty in raising debt to fund the projects."

Valuable human capital is tied up in many small companies across Europe, Boyers pointed out. This will be attractive to electricity retailers (the supply companies) who are seeking development expertise to help them meet their renewables obligation. "Also, we are being increasingly approached by European businesses, from specialist energy development companies, who are keen to invest in the United Kingdom." Other large players interested in acquiring small developers are related industries, like construction companies and equipment manufacturers, he said.

Banks want big

The greenness of renewable energy cuts little ice with the financial community, claimed Haggard. "Banks are agnostic about renewables; they are looking to see that rational criteria are met." And, of course, they prefer dealing with larger finance packages: "The sooner we can get larger portfolio sizes and larger commercial size, the sooner we can whet the appetite of financiers."

The length of the renewables obligation, running to at least 2026, makes the renewable sector attractive to investors, Haggard said. The value of the "buy out" levy, the proceeds of which will be recycled back to compliant suppliers, could be much higher than people have given credence to, he claimed, adding: "Suppliers who do choose to buy out, do have to consider that buy out payments will be recycled to their competitors."

Another uncertainty for investors is contained in the contracts for renewable output under the renewables obligation: what value can be attributed to ROCs and Levy Exemption Certificates (LECs). LECs are issued to electricity from renewable energy which is not liable for the climate change levy -- the tax on the business use of energy. "The climate change levy and renewables obligation certificate elements of the deal are not transparent," warned Haggard, adding that this leads to higher equity and lower debt components in financial packages.

The need for greater transparency in the contract prices being struck for output from renewable energy plant was an issue of concern to several speakers at the conference. Without price transparency, generators will not know how much they receive in the contract price of the benefits from ROCs, LECs and recycled buy out payments, said Jonathan Johns from Ernst and Young. "The danger is that smaller developers find it difficult to get appropriate prices from the larger players. If they were getting appropriate prices they would probably be able to finance their projects." More transparency would also inform the customer how the LEC and ROC benefits were shared between the retailer from whom they were buying the power and the generator from which it originated, he added.

NETA complication

A complicating factor is the UK's new electricity trading arrangements (NETA), which by penalising variable output makes some forms of generation -- particularly wind -- less attractive to retailers because of the added costs of the penalties. "The effect of NETA is to force bilateral deals to bundle up the ROCs with the green electricity," says Johns. "Because of the intermittent nature of wind, a lot of wind suppliers are going to be forced to sell their ROCs at the same time as the electricity.

"There needs to be some way of reporting what is the share out between the various constituents because bankers will want to know what it is." He urged the industry to call for transparency in its responses to the government's statutory consultation on the details of the renewables obligation.

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