Towards the end of 2012, UK marine landlord the Crown Estate published a report warning that the country may only reach 12GW by as late as 2030 — a long way off its ambitious goal of 18GW of installed offshore wind capacity by 2020.
Among the many challenges that may prevent the UK hitting its 18GW target, the availability of money to finance new projects is key. The UK Offshore Wind Market Study — Final Report, written for the Crown Estate by Redpoint Energy and GL Garrad Hassan, cited previous research by accounting firm PricewaterhouseCoopers (PwC) showing that UK’s offshore ambitions are likely to require anything between £36 billion and £68 billion (€42-80 billion) for the period 2011-20. The PwC research also flags up a potential funding shortfall of £7-22 billion by 2020 between what is needed and what is available through traditional means of project finance, such as utilities’ balance sheets and bank debt.
The UK has created the Green Investment Bank (GIB) partly in response to the anticipated funding shortfall and, so far, the institution has taken part in two offshore wind financings (see box, below). Both of these deals have focused on "recycling" developers’ capital. This concept of freeing up cash from operational projects to re-invest in new schemes seems to be the main mode of financing currently being employed to encourage non-traditional investors into the offshore wind sector.
Government-backed investor
In March, a new fund called UK Greencoat Wind was successfully floated on the London Stock Exchange. Supported by the UK government’s Department for Business, Innovation and Skills, which bought £50 million of shares, the Greencoat initial public offering (IPO) also saw utility SSE buy £10 million in shares. SSE itself stands to benefit from the IPO float, as Greencoat UK Wind will buy some of its operational UK wind farms, as well as stakes in RWE projects. Greencoat’s interests in six onshore and offshore wind farms will comprise a net capacity of 126.5MW, and it has already announced its acquisition of stakes in RWE’s offshore Rhyl Flats project and onshore Little Cheyne Court wind farm, which together represent a £107.7 million investment by the fund.
This is a significant chunk of money for RWE to free up ahead of Round 3’s 9GW Dogger Bank development, as part of a consortium, and its own 1.2GW Atlantic Array project in the Bristol Channel.
There have been similar deals for other utilities: Centrica sold off equity stakes in its Boreas portfolio of offshore and onshore wind farms to Dutch Pension fund PGGM and private-equity player Ampere Equity Fund, who both also invested in a stake in the Walney offshore wind farm (see box, below). In addition, Centrica refinanced its remaining equity stakes in the projects through bank debt.
Recycling utilities’ capital is driven by two factors. First, utilities are the dominant developers in UK offshore wind, but are struggling to raise further debt at the corporate level without negatively impacting their credit ratings. Second, there is a perception that the majority of alternative investors, such as pension funds, want to avoid construction risk and are therefore happier to be a part of refinancings once projects are operational. There has been one notable exception in the UK: PGGM and Ampere’s investment in Walney was made during construction, and the funds were later refinanced with bank debt once the project was operational.
Utilities too dominant
Meanwhile, alternative investors are also being sought due to an assumption that banks are keen to avoid the sort of long-term commitments that offshore projects need — driven by regulations such as the Basle III banking rules that require banks to hold higher levels of capital against the loans they make. As a result, the loans being offered by banks are short term and costly.
However, some argue that this perception is wrong. Only UK government-owned banks Lloyds and RBS are offering severely restricted terms, they say. The real reason for the lack of affordable long-term bank debt to project-finance UK offshore wind is the dominance of utilities and the country’s lack of a project-finance history. Indeed, while the bulk of projects in countries such as Belgium and Germany are project-financed from construction, there has only been one so far in the UK: Centrica’s financing of its 270MW Lincs offshore project last year.
"The appetite [to lend] is there," says Jérôme Guillet, managing director at financial advisory firm Green Giraffe Energy Bankers, which specialises in offshore wind. "Banks are actually frustrated that there are not enough good projects to finance. I don’t know why people say there is a lack of bank debt, that’s completely false in my opinion.
"And banks are willing to lend long term — you can’t finance construction if you can’t take long-term risk," Guillet adds. "Even the projects financed in offshore wind in 2012 managed to obtain 15-18-year debt, including construction risk. Japanese, German and French banks are still able to provide long-term debt. Some of the UK banks have more severe restrictions on long-term lending, but they are actually outliers, and are being squeezed out of deals, even domestic ones."
If there are problems in funding offshore development, it is not due to banks, Guillet insists. "It is due to developers not doing their homework or choosing not to accept bank requirements," he says.
Another potential barrier to long-term project financing for UK offshore projects is the change in the incentive regime from renewable obligation certificates (ROCs) to the contracts for difference (CfD) feed-in tariff (FIT), where generation is subsidised only when the price of electricity falls below an agreed level, known as the strike price.
Unequal terms
While the majority of Round 3 projects are being developed by six big utilities, there are three projects that do not include firms with access to the UK electricity retail market: Moray Firth, developed by EDP Renovaveis; the Hornsea zone, developed by Siemens Project Ventures, Mainstream Renewables and Dong Energy; and the Isle of Wight zone developed by Eneco.
The absence of an obligation to buy electricity from renewables generators — as was the case under the ROC regime — is driving up the price of UK power purchase agreements (PPAs) and making the cost of financing projects independent of utilities prohibitively expensive, says Fintan Whelan, corporate finance director at Mainstream Renewable Power. "At the moment, you can get PPAs from the big six players, but they’re on desperately bad terms compared with the way they used to be under the ROC regime," says Whelan. "The discount against market index starts at 10% and grows to 25% over a 15-year PPA. It used to be 5% — end of story. The equivalent numbers are 2% in Spain and 1.5% on Nordpool. The PPAs are expensive and have the effect of driving up the strike price — and therefore the cost of electricity to consumers — if the returns are to be there for the investor. Imagine skimming 10% off your revenue, let alone 25% — it’s just unfeasible."
These kinds of reductions in price being offered by utilities to independent developers make it virtually impossible for the projects to secure any sizable amount of long-term bank debt, as their revenues would be unable to service high levels of debt.
Whether they should open themselves up to more project financings driven by bank debt or offer more reasonable terms for PPAs, the UK’s major utilities hold the key to releasing more funds to flow into offshore wind construction. If they are really committed to the growth of offshore wind, they will need to relinquish their dominance of the sector.
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