Investors warm to cleantech just as fears over a double dip recession set in
26 September 2011, Electricity, Nuclear, Solar, Wind
Historically, large-scale renewable energy capacity in Europe has been built on the balance sheets of major utilities which have funded themselves through capital markets. However, as the amount of capital available to finance large infrastructure projects contracted between 2008 and 2010, many utilities shunned investments in offshore wind (arguably one of Europe's most prominent growth markets). Utilities were also put off by the much tougher terms (including shorter payback conditions) that lenders imposed at a time when utilities had to reduce their leverage to protect their credit ratings and other demands for their capital.
However, 2011 saw the return of major European utilities' investment in clean technology (cleantech), particularly offshore wind. In the earlier part of the year, project financings were being completed successfully: bank balance sheets were slowly being rebuilt and liquidity reappeared, as did lender appetite, notably from pools of around 10-15 commercial banks whose understanding of the sector and its risks has improved. There was also evidence that debt underwriting may be returning for well-structured deals.
The pool of those investing in utilities is growing, from new and expanding classes of funds requiring non-correlated, passive, and predictable yields, to multinational companies such as Google, Ikea, and Audi servicing their new strategic interests. There is also growing appetite for long-dated assets from sovereign wealth funds and private equity funds. The cleantech industry, particularly offshore wind, is reaching a tipping point between on-balance-sheet financing and increasing levels of non-recourse project finance.
Large-scale, low-carbon infrastructure technologies such as offshore wind require large amounts of long-term reasonably priced debt and equity finance to be able to produce power as competitively as possible and generate sufficient margins to provide equity investors with the required returns. Yet for the offshore wind industry to gain traction with corporate and private equity investors, and, most importantly, institutional investors (those with long-term liabilities and trillions of dollars of assets which are looking to earn adequate risk-adjusted returns through appropriate market structures) the industry will have to address several limitations.
The greatest of these limitations is the lack of engineering, procurement, and construction guarantees for financial investors that are unwilling to assume any construction risk. Continual innovation from insurers on how best to serve the growing renewable market is paramount. Another significant hurdle relates to the lack of operating history in the form of operational performance benchmarking.
Renewable generation is characterized by high capital intensity and low variable costs, where the key operational benchmark is the average plant capacity factor. Very high proportions of fixed costs to variable costs in renewable energy generation (compared to fossil fuel generation) mean that small changes in capacity performance dramatically impact the financial returns of projects. However, while capital cost data are increasingly well documented, detailed operational data remain sparse. Without long-dated historical operating data, institutional investors will struggle to evaluate the risk, a problem which is not alleviated by debt rating agencies' absence from the sector.
The Basel III regulatory standard on bank capital adequacy and liquidity will force banks to hold larger amounts of capital to corporate debt. Refinancing offshore wind assets off over-burdened bank balance sheets through bond issues will prove a challenge as pension fund and bond market investors are still a few years away from genuinely embracing cleantech's full investment potential.
However, other financial products currently exist or are starting to make an appearance, from early-stage grants and equity co-investment to mezzanine debt and the purchase and securitization of project finance loans. Investment in tradable offshore wind funds has also been proposed, which gives investors rights over the power a wind farm produces.
Be that as it may, the overall availability of finance is once more being questioned as concerns over a double dip recession take their toll on liquidity availability (despite the fact that investors have warmed to the sector). However, the long-term investment outlook is definitely one of growth, even if short-term pressures will cast a sizable shadow over utilities' ability to finance projects.
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