Feature: The Future Of Renewable Energy Finance Investment
The UK Renewable Energy Finance 2017 report is produced by TLT in collaboration with Clean Energy Pipeline. Senior TLT deal makers Maria Connolly, Head of Energy & Renewables and Real Estate; Gary Roscoe, Partner Banking & Finance; and Kay Hobbs, Partner Corporate reveal some of the findings.
With the sector at a crossroads as subsidy options close, this report examines project finance and M&A activity in 2016 and quarter one of 2017.
CEP data shows that the investment records set in 2015 were broken; and whilst the technology split and balance between M&A and project finance activity may have changed, the overall picture remains positive. The renewables sector is proving to be robust and resilient as it adapts to a future largely unsupported by the government
The overall levels of project finance activity recorded by CEP increased by 5.7 percent, from £17.5 billion in 2015 to £18.5 billion in 2016. However, the appetite for debt financing in solar and onshore wind continued to drop throughout 2016 as the 31 March 2017 ROC deadline drew closer
There was a huge demand from investment funds, yield co’s and infrastructure funds, particularly for substantial portfolios of commissioned sites, and M&A activity remained high. The overall annual deal value recorded by CEP increased by 113 percent from £3.1 billion in 2015 to £6.6 billion in 2016.
The M&A market saw two distinct areas of activity – portfolios of newly commissioned small ticket sites and mature, large scale sites returning to the market either as single ticket items or as part of a portfolio.
The end of ROC and FIT support means that the number of new solar PV and onshore wind projects coming online is tailing off, yet the renewables sector is already looking to the viability of subsidy free projects, either as large scale, standalone developments or linked to private wire, corporate PPAs or energy storage.
Energy storage has been heralded as the technology that will change the face of the sector; and projects, particularly those which can demonstrate a viable revenue stacking income model, are already attracting considerable investment interest.
In addition, biomass and offshore wind continue to play a critical role in moving the UK towards a future where a large percentage of the energy consumed comes from renewable sources. But at this crucial juncture, what can we expect next?
How robust is the UK renewables project finance deal pipeline?
The market remains buoyant. In solar, not only are large portfolios of commissioned projects seeking re-financing, there is also a continuing tail of 1.3ROC and 1.2ROC ground mounted solar projects which have been built-out under equity finance and are now looking to secure more favourable finance terms.
The increase in M&A activity across all sectors is also acting as a trigger point for re-financing. This is particularly apparent where the consolidation of projects is taking place, which is leading to the review of debt funding arrangements.
A substantial part of the sector is now operating with guaranteed long term price support; this continues to make portfolios of renewables projects an attractive source for long term stable returns for both investors and funders
Storage as a standalone project remains a challenge for a pure debt solution, but going forward it will play a part in the overall deal metrics, and therefore project finance deal flow.
There will be challenges as the sector acclimatises to a post-subsidy future, but scale and maturity will continue to make renewables attractive to both finance and re-finance as the secondary market expands.
Review of debt funding arrangements
There are clear signs of bank interest in smaller projects, and an appetite to consider technologies beyond the mainstays of wind and solar. This is without a doubt due to the restricted supply of new build big ticket items in the mature markets of solar and onshore wind.
Where is the most project finance activity, and why?
Interest between the technologies is balanced, but there is a noticeable engagement with biomass projects, despite nervousness about both the technologies themselves and the vulnerability of fuel supply.
Offshore wind may have its own technical challenges, but as projects move through the development cycle we are seeing financing opportunities crystallise as lenders take a percentage of a consortium funding deal. This will continue as substantial projects move through the construction phase towards completion.
Energy storage is starting to play an important role in the renewables sector. What needs to happen to make these projects attractive to banks?
The key to making energy storage attractive is demonstrable revenue streams.
The award of the first National Grid Enhanced Frequency Response and Capacity Market contracts has increased market interest in energy storage projects more generally. The auctions were heavily oversubscribed, which is indicative of the potential influence this technology could have on the sector. Interest from lenders will follow even though now, whilst there is interest from debt funders, most storage developments are still currently funded through less risk averse equity finance.
Developers will continue to look to maximise their projects by “stacking" income from different revenue streams; and as the market matures, developers will be able to present a more informed picture of income verses costs. This should make energy storage projects more attractive to debt funders, as they will be able to better assess where risks and opportunities lie.
However, funders will need to get comfortable with the short-term nature of the revenue contracts, which are some deviation from the 20-year guaranteed subsidy income streams that solar and onshore wind projects have enjoyed to date.
Another hurdle is the still unresolved question of the regulatory framework within which storage will be operating. The absence of OFGEM guidance on what, if any, the impact of co-locating storage with an existing technology where the grid connection is shared will have on FIT or ROC subsidies has been a crucial variable holding back lender enthusiasm.
Banks will also be cautious over contractual issues relating to co-locating storage and will want clarity over rights and obligations where key infrastructure is shared, comfort around planning and land lease provisions, and well thought out provisions that cover the different parties involved – particularly where the developer and battery owner/operator are separate entities
How active will the secondary M&A market be this year?
We expect secondary M&A market activity to increase this year. The final ROC qualifying projects are expected to come to market after reaching operational status, and it is likely that we will see a spike in activity for newly commissioned projects from quarter two onwards. In addition, there will continue to be a healthy number of large scale projects and portfolios that are reaching the end of their 4/5-year investment cycle and are returning to market.
There continues to be considerable interest in commissioned assets and projects with a guaranteed subsidy income stream are now seen as “low hanging fruit". This means that competition is high and pricing is extremely competitive – it certainly is a seller’s market.
The more assets that an owner can bring into a portfolio, the more that owner can benefit from economies of scale such as proportionately lower portfolio O&M and asset management costs. In addition, the resulting reduction in the cost of capital will allow the owner to be even more competitive in its pricing going forward. As a result, there will be a continued trend of consolidation in onshore wind and more particularly in solar.
Has there been much M&A activity around energy storage?
The recent National Grid Enhanced Frequency Response and Capacity Market auctions have kick-started interest in energy storage and we have already seen a reasonable amount of M&A activity. Immediately prior to the auctions we saw several parties come together and enter into joint venture arrangements. We also saw a number of parties acquiring project rights to storage sites which were to be submitted into the auctions.
This trend has continued and a number of players, including those who would have previously only been interested in mature technologies with a preference for operational assets, have been acquiring the project rights for large standalone battery storage projects. This is indicative of the highly competitive nature of the secondary market which is forcing investors to consider other areas of investment, even if they currently provide an alternative risk profile to those previously adopted. This has resulted in rapidly growing M&A activity around energy storage.
We have also seen, and continue to see, a number of opportunities to co-locate storage assets with existing operational generation projects, particular in a portfolio context which brings economies of scale benefits. We are witnessing an increase in joint venture site finding/development arrangements and project rights acquisitions. However, co-location has its own challenges, particularly where the generation project and storage project will be under separate ownership
One thing to note at this stage is that all energy storage activity is currently equity funded. We have no doubt that debt funders will be active in the energy storage arena once revenue models are developed and de-risked, and project owners have a track record of successful revenue stacking; but in the short term, energy storage remains an all equity play.
Another thing that does appear to be relatively consistent in M&A activity around energy storage projects, including co-location, is that the equity investors have a strong preference for the original developer to remain involved in the project, either by way of an equity stake or a profit share asset management role. No doubt it gives the equity investor some comfort to know that the original developer still has “some skin in the game", with an impetus to ensure the project is successful. In addition, this presumably improves the risk profile from the equity investor’s perspective.
What impact has Brexit had on the investment in UK assets from firms outside the UK?
The UK renewables sector is unlikely to be significantly affected by departure from the EU. The EU has traditionally been helpful in requiring member states to consider domestic energy policy and meet set targets in respect of renewable energy generation, something which future UK governments will not necessarily be required to do, or be accountable for doing.
With no binding post 2020 targets and the recent change in the UK government, the renewables sector was facing significantly reduced support prior to Brexit, and Brexit is not likely to change this. It may be that Brexit could actually help the sector in some way, for example, if the EU-imposed anti-dumping regulations in respect of solar panels are removed, the market may be able to access significantly cheaper panels outside Europe.
In our view, the renewables sector will remain attractive to foreign investors looking for stable long term revenue streams, which is what current operational ROC and FIT projects provide. The market is mature at one end and developing at the other, offering scope for all levels of investor risk tolerance. Solar and onshore wind are secure and large enough to attract continued investment. For those with an appetite for the less tested, there are opportunities in the less developed technologies such as storage, anaerobic digestion, wave, tidal and biomass.
What does the end of the subsidy regime mean for renewables projects?
For renewable electricity generating technologies, 2017 will mark the end of the Renewables Obligation subsidy era for most projects. Following the early closure of the scheme last year to solar projects, even those projects that benefit from grace periods will have had to be commissioned no later than 31 March 2017 to secure ROCs.
For other technologies, including onshore wind, the formal closure date of the scheme was also 31 March 2017, meaning only a limited number of projects that benefit from grace periods will be able to be commissioned after this date and still secure ROCs.
As expected, onshore wind and solar will be excluded from the next Contract for Difference (CfD) auctions. The government’s indicative CfD budget notice published in November 2016 envisages that projects eligible for the second CfD auction round, to be held this summer, will be the less established technologies of offshore wind, Advanced Conversion Technologies, anaerobic digestion, dedicated biomass with CHP, wave, tidal and geothermal.
The notice also indicates that for projects of this kind which are due to commission in either the 2021/22 or 2022/23 delivery years, and so are eligible to participate in the auction this year, the overall pot of money available will be £290 million per delivery year.
What role will corporate PPAs play in the development of subsidy free projects?
We expect to see more and more projects looking to secure PPAs with large corporate counterparties rather than licensed electricity suppliers.
In a subsidy free world, we anticipate seeing further interest in private wire PPAs in particular, given the scope for securing a premium price over regular grid export PPAs.
For projects exporting all generation to the grid, the same opportunity to secure a significant premium will not apply. However, corporate PPAs where generation is “sleeved" from the project to the corporate customer via a licensed supplier intermediary - essentially by way of the output from the project on to the grid being used notionally to match electricity taken off the grid from the customer at one or more of its sites - will still be of interest to many developers, given the scope for securing long term price security.