Fast-changing finance could see new role for corporates

As the offshore wind energy industry has developed, so new sources of finance are coming to the fore, including power purchase agreements and hedging

New, more flexible sources of finance for wind energy are coming to Europe, which is perhaps just as well in the UK, where access to the European Investment Bank is in doubt and questions continue to be raised about the role of the Green Investment Group.

Late November 2017 saw the Environmental Audit Committee launch a green finance inquiry to scrutinise the government’s strategy to develop what the May administration has described as “world-leading green finance capabilities”.

Among other things, the inquiry will examine the measures set out in the government’s Clean Growth Strategy, whether the Green Investment Group (formerly the Green Investment Bank) is fulfilling commitments made by its new owners Macquarie, the UK’s future relationship with the European Investment Bank (EIB) after Brexit and whether the government’s policies are likely to deliver the levels of investment needed to meet the UK’s national and international environmental commitments.

As Environmental Audit Committee chair Mary Creagh MP noted at the time that the inquiry was announced, “The UK needs billions of pounds of public and private investment to decarbonise the economy and upgrade our transport, energy and industrial infrastructure. The government says it wants to be a global leader in green finance. We will scrutinise its plans in the Clean Growth Strategy … and examine what will happen to UK climate investment if we leave the European Investment Bank.”

Macquarie has committed to the GIB’s target of lending £3Bn (US$4Bn) of investment in green energy projects over the next three years. It also announced that the bank will operate under the name Green Investment Group to overcome the legal and regulatory barriers to using the term ‘bank’ in some international markets. It said it will pursue a vision “to invest in green infrastructure internationally and positively contribute to the globalisation of the renewables industry”. The EIB is an EU development bank owned by member states. In 2012–2016, it invested more than €31.3Bn (US$37.1Bn) in the British economy, including more than £13.4Bn in ‘climate projects’ including onshore and offshore windfarms.

As law firm CMS noted in a recent report, creating an attractive environment for investors in infrastructure is no easy task. Politics and policy can make or break private participation and the flow of investment – something that has never been clearer than in this year’s CMS Infrastructure Index, which ranks 40 jurisdictions in order of infrastructure investment attractiveness.

The Netherlands secured top spot in this year’s index, with a vigorous economy and transparent and efficient procurement process, together with a multibillion-Euro pipeline of road and water public private partnerships that have created an attractive, highly competitive environment for investors.

It is a different story for the UK, however. Ranked fourth after the Netherlands, Canada and Germany, Brexit and political uncertainty are having a considerable impact on the pipeline of projects, and the National Infrastructure Commission has warned of significant challenges unless there is stronger, strategic planning around infrastructure. The UK economy has slid from a relative position of strength to registering the slowest GDP growth rate among G7 nations in Q1 2017. Meanwhile, the country’s sovereign credit rating was downgraded by the world’s three main rating agencies – Moody’s, Standard & Poor’s and Fitch – in the aftermath of the Brexit referendum, losing its prized AAA rating.

As CMS noted, the lack of political consensus over new megaprojects has been the root of frustration and delays for years, with Brexit only exacerbating the situation in the short term. Any pipeline of infrastructure projects – as well as renewable energy programmes – may be affected by the scale of work required by UK institutions in preparation for Brexit, which will dominate the agenda of government and national agencies for the foreseeable future.

The renewables industry has faced headwinds over the past few years, with support for solar PV and onshore wind withdrawn, although offshore wind continues to enjoy access to incentives under the contracts for difference framework. In September 2017, the results of the second auction round were announced, with the winning projects coming away with strike prices that are in some cases half the value of the first round, most notably 3.2 GW of offshore wind capacity.

At the same time, as CMS noted, the withdrawal of subsidies for more established technologies is driving the UK renewables market towards the development of subsidy-free projects and an environment in which developers are exploring opportunities outside the remit of government policy, such as private offtake agreements or power purchase agreements (PPAs) with corporates or large industrial energy users, many of which have an increasing appetite to buy renewable electricity. PPAs alone, however, are unlikely to deliver the level of investment required, so government needs to create a financial environment that helps enable future projects.

In a related development, a report from WindEurope and Swiss Re suggests that hedging will play an increasingly important role in wind energy.

By 2030, only 6% of Europe’s wind energy capacity will be unexposed to market risks through support schemes, down from 75% today. This means that the transition to auctions allocating renewable energy support comes with more exposure to price risk.

One new way to address uncertainty on project revenues is hedging against volume risk, according to The Value of Hedging, WindEurope and Swiss Re Corporate Solutions’ report.

Hedging is emerging as an instrument to cover the resource risk of variable wind generation or ‘volume risk’. Auctions, feed-in premiums and PPAs take away some of the price risk. However, they still leave asset owners exposed to a degree of volume risk due to the uncertainty in the total amount and timing of wind output. If there is less wind in a given year, hedging will help to reduce the variability of returns and improves cash flow predictability to asset owners.

Due to the seasonality of wind, project owners can expect 30–45% more wind during winter than summer. An average windfarm of 30 MW may need to hedge for +/-10% annual variations in its production forecast. By reducing the variability of the returns, cash flows move closer to the profile of a fixed-income investment, similar to a bond. The increased certainty improves the capital structure of projects by reducing their cost of capital.

Risk management services such as hedging could extract a value worth €2.5Bn (US$3Bn) for new wind assets installed between 2017 and 2020. This may go up to €7.6Bn for new wind power installations between 2017 and 2030.

WindEurope’s chief policy officer Pierre Tardieu said “Installed wind capacity in Europe could double to 323 GW by 2030. With the growth of the wind energy sector and its increased exposure to price and volume risk, there will be a need for a variety of revenue stabilisation mechanisms.

“Hedging instruments are emerging as a viable solution to mitigate some of these risks. They transfer the risk of the variability in generation from the project company to a counterparty willing to take on that risk. What they offer windfarm owners is more certainty on their income. Certainty can reduce the cost of capital for a project. That is significant now that debt represents 40% and 70% of the capital requirements for offshore and onshore projects respectively.”       

Institutional investors add to CIP’s green war chest

Copenhagen Infrastructure Partners (CIP) has raised €2.8Bn (US$3.4Bn) for its Copenhagen Infrastructure III fund, which it intends to use to invest in green energy projects, including offshore wind, in North America, northwest Europe and the Asia Pacific region.

After nine months of fundraising, CIP’s new fund, CI III, closed on 27 December 2017. CIP is targeting a total fund of €3.0Bn. CI III will be open for investor subscription until March 2018. The fund has a €3.5Bn hard cap.