moving to the mainstream and alternative investment opportunities lack
appeal. But the power sector's fall from favour has made wind an unwitting
victim. Fighting for fair recognition is the battle of today. Not that it is all bad news. Wind is becoming a bright spark on the power finance horizon
Time and again we hear that securing finance for commercial wind projects is difficult. As Randy Swisher of the American Wind Energy Association puts it, financing is one of the biggest problems facing developers. Yet the word is that wind has a great future and it is high time to get involved. Indeed, banks are competing hard for lead roles in arranging wind project finance and they have a lot of appetite, says Shane Bush of Australia's ANZ Bank, one of the emerging key lenders to the wind sector. "Banks are becoming more aggressive in trying to win new mandates," agrees Guy Thackwray of Babcock & Brown in London, which advises on wind project finance. Nonetheless, the wind watchword for the financial community is "caution."
The reason for that caution lies outside wind power. Just as the wind industry has come of age, the energy related financial sector is licking its wounds after a series of crashes in the traditional power sector. The distressed financial situations of the former Mount Rushmore of energy companies, ranging from Enron to Dynegy to TXU Europe, has surprised and deeply disturbed the financial community. Power purchasers dropped markedly in credit quality, political and regulatory risk emerged, merchant power lost favour and large project financed power stations suddenly belonged to the banks.
Wind is facing the consequences. "In the last four to five months of 2002, a number of energy companies and independent power producers ran into very serious trouble. It became clear that even with a power purchase agreement (PPA) in place, if the counterparty went under, there was not much you could do about it apart from sit down and try to renegotiate," says Andy Griffiths of HypoVereinsbank in Germany. "There has been an across the board change in attitude for banks to focus on greater credit quality." So, while wind is seen as one of the few bright sparks in the gloaming, the path towards the light is proving tortuous and even angst-ridden.
Liquidity is lifeblood
The discipline of project finance has changed significantly in light of the industry's wake up call -- and the buzz of activity from new entrants is not necessarily in the best interests of the wind industry. "Name recognition matters, particularly now, and this is holding up a number of transactions for smaller developers," says Nick Gardiner of Fortis Bank, a major lender to the industry. The first deals bankers will do is with their existing clients, both because they are known to the bank and, importantly, are likely to be known to other banks, thus increasing the chances of a successful syndication in the market, he explains.
The lifeblood of banks is "liquidity," which translates as the depth of demand for a loan. Liquidity allows banks to sell on portions of their loans to other banks, reducing their exposure and freeing up capacity for them to make new loans to the sector. To have real liquidity, there must be a mixture of banks, some doing the heavier lifting and structuring and others just lending. Wind currently has many heavyweight lifters but not enough straight lenders. "There is not a lot of depth and general liquidity to the market at this time," says Gardiner.
Furthermore, stronger credit structures and higher loan pricing are required than in the past. "There has been a shift in the banking market strategic use of non-recourse project finance capital," Griffiths says. Recourse is the extent to which lenders may look to the sponsor's other assets if the wind project is not sufficient to repay the loan. Non-recourse loans were intended to allow borrowers of all types to raise capital for their projects. "Non-recourse project finance as an asset class has taken some big knocks over the last couple of years," says Griffiths. "The banks are now more cautious. This is a permanent change."
The change has been felt. "Counterparty creditworthiness is a bigger factor than ever before," says Michael Skelly of Zilkha Renewable Energy, an American wind project developer. "Having a PPA is fine, but the utility holding that PPA must also be creditworthy to attract financing to the project." He notes that as well as the general change in attitude of banks, the weak dollar is also hitting home in the US, while low power prices are straining returns. "Wind developers have driven prices to very low levels," he says. "The returns for ownership of a wind project are probably as low as it has ever been. Investors look at this and see returns that are too low."
In the current market, even borrowers which appear well heeled enough to arguably not need non-recourse finance are sometimes finding it necessary to provide recourse support for elements of their non-recourse loans. Developers may agree to foot the bill for any extra costs incurred in construction, or pledge to pay for a follow-up wind survey once the plant is complete.
An increased perception of regulatory risk has also added to the banks' demands. "There has been a gradual appreciation that regulatory risk is more of a feature in energy than had been presumed," says Griffiths. He acknowledges that it has been less apparent in the wind sector. "But, the markets are converging and wind is becoming more competitive and therefore under more pressure from regulators to compete without subsidies. It is not unreasonable to expect a paring back of the subsidies in the future. You need to assume that over the next 15 years the regulators will probably squeeze the industry. This is why you need structural protection in the loans."
According to Gardiner, regulatory risk is the single hardest item on which to satisfy credit committees -- and no longer is risk restricted to certain countries and regions; it is now standard for all geographies. ANZ Bank's Bush adds that breaking the philosophy of sweetheart deals for local operations is also difficult. "The market generally has been characterised by local banks financing local projects. Now we are seeing a trend towards cross border activity by developers and this is causing a problem," he says. "Banks will struggle to go cross border because of the uncertainties involved."
Small can be good
In this climate, smaller developers, with limited financial resources and often smaller projects, would appear the most vulnerable. Not all financiers take this view. "A deal is not bad just because it and its sponsor are small, non-utility companies," says Charles Liebenberg of Investec Bank (UK), which has just completed its first loan to a small UK wind farm. "Development costs for small deals are such that they can reflect a large portion of the equity requirement, meaning that sponsors with advanced projects are often unusually committed and issues of finding the equity at financial close are reduced."
Small developers with large projects face a different challenge. "Non-recourse finance is often the only option in these situations," says Babcock & Brown's Thackwray. "These projects have to be even more robustly structured. However, smaller developers with operating projects have the opportunity to explore different types of structures, not unlike the deals some of the utilities have done."
While utilities are presumed to be the only winners in today's tight banking market, they have been major casualties of the energy sector implosion, suffering a rapid deterioration in credit quality. While they may aspire to own the entire wind sector, the fact is they can not afford to do so. The political demand on utilities to increase their renewables generation is highly unlikely to be financed on their balance sheets, given the requirement for the parent companies to demonstrate to the financial markets that they have reduced debt levels. Market recognition of the separate value of the environmental attributes of green power is a help. The existence of Britain's Renewable Obligation Certificates, or the green tags attached to much of North America's wind power, provides utilities with the means to attract third party owners and financiers of new wind plant, while the utilities agree to buy the green attributes. More than one large utility with wind holdings is considering plans to "use someone else's greenbacks to get our green tags."
The promise of portfolios
The concept of centralising borrowings of wind farms to create greater efficiencies is expected to increase. Larger loans tend to attract liquidity and thus perhaps better pricing -- and they can be packaged in different, more appealing ways. Greater size might also open up new, important funding sources. "The sector requires consolidation of its financing around management with credibility in the capital markets. We are working to provide the scale, efficiency and experience that is needed," says Edmund Lazarus from European private equity firm Englefield Capital.
One such consolidating option might be pooling the assets through a technique called "securitisation," something well tested in mortgage loans. According to Ron Borod of law firm Brown Rudnick Berlack Israels, the wind sector has the right characteristics for securitisation due to its long term cash flows and the aggregate industry borrowing needs. Securitisation would allow sponsors to borrow from public bond markets, creating a potentially vast new source of funding aside from the bank markets.
For this to work, the right combination of assets and cash flows must be assembled to ensure long term and predictable revenue streams. Where fixed price PPAs are not obtainable -- such as in Spain with its politically controlled variable wind tariff -- diverse portfolios and hedging agreements have to be in place, says Borod.
Banks are also looking more towards portfolio finance. The classic arguments for a portfolio are based on the diversification -- geographic, technological, or otherwise -- a large grouping of projects would bring. Interestingly, not all lenders agree on the benefits. "We would rather build a portfolio ourselves, diversifying by borrower as well as geography and technology," says Liebenberg. "We believe this gives us the best benefits of portfolio theory." Borrowing portfolios may also have different characteristics, such as a single, contemporaneous loan to multiple projects, as opposed to a loan covering smaller projects to be built sequentially. "Smaller wind farms may be able to justify the cost and complexity of a non-recourse facility if such a sequential, cookie-cutter approach is adopted," adds Thackwray.
The issue of pricing, though, is causing concern, with several bankers suggesting loan pricing has become too low. "Pricing on the continent has got close to government-guaranteed project pricing, which wind is not," says Liebenberg. "However, in the UK current pricing reflects a far more reasonable trade between risk and return." Even with the current constraints, the availability for onshore finance appears strong, with post-construction loans of up to 15 years available in western Europe. Within certain countries, particularly Spain, problems with getting development permits continue to cause challenges for construction finance, forcing sponsors to explore alternatives other than non-recourse finance.
The situation is uncertain for offshore finance, which remains long on talk and short on experience. Many show an active interest in offshore, but as Liebenberg says, "The technology is not yet proven and does not yet have the credibility for non-recourse project finance. It will be better for utilities to do it on balance sheet, prove it and then perhaps refinance it." Gardiner agrees that at present securing offshore construction finance is a struggle. "It's a steep learning curve," he says. "The terms are not quite there, but I am confident the sector will get there."
It is not all doom and gloom. The genuine interest in offshore wind from banks is significant. Perseverance from developers is the next step. They will need to painstakingly break through the wall of ignorance behind which the financial sector is hiding. Things are changing. "One or two of the banks are actually separating themselves from the rest as a result of their own homework and efforts to research the sector and form views on the various sets of risks," says Mike O'Neill of Britain's Renewable Energy Systems. "Certain Irish banks, for example, are working hard to bridge market gaps, to be creative and to help get deals done for their smaller clients," agrees David Tyndall of wind developer EcoWind Power. "It can sometimes be as much about the individual as about the institution."
Remove the blinkers
Greater effort, co-operation and understanding is essential between borrowers and lenders. While lenders want to get involved earlier in projects, this often meets with resistance both from within banks (with bosses seeking a quick closure and immediate returns) as well as from developers (looking to retain flexibility on the ultimate choice of lender). A key missing element is the early and ongoing involvement of experts to assist in helping structure commercial documentation for the requirements of the financial markets, says Griffiths. "Advisors have an essential role in bringing parties together," he adds.
O'Neill has the last word: "Developers have to take the lead in finding new structures, but banks have the responsibility to remove their blinkers and look at the wider perspective. Joint efforts are critical. Banks can either be led by the hand or dragged kicking and screaming. I don't mind, but I prefer the former."