The main issue is where third-party financing will come from, and what it will require from both sponsors and the industry.
With great expectations placed by Germany and the UK, among others, on a significant offshore wind rollout to meet 2020 targets, we look at some of the funding issues faced by project sponsors and how they could affect their future financing model.
Balance sheet no longer
Tens of billions of euros will likely be needed to build Europe’s offshore wind power generation infrastructure over the next decade or so. With much of the project pipeline owned by a few utilities and other oil and gas majors, and an immature contracting environment making it hard to accommodate lenders’ needs, most have had to rely on their balance sheet for finance, increasingly re-financing after completion to free capital and capture a premium for removing the construction risk.
Hopes are being placed on attracting capital from long-term yield based investors who are showing interest.
The last decade however, has seen a gradual deterioration of these utilities’ credit ratings (see Figure 5). Leading European utilities with high investment grade ratings (A+ and better) in 2001, are now mostly at or below A- level – the crucial ratings floor, beyond which coupons on new bond issuance can increase materially. Half these ratings also currently have a negative outlook.
Boards are increasingly careful about allocating large sums to the sector when liquidity might be tight and their own capital costs increasing.
The main issue is where true non-recourse third party financing will come from, and what it will require from both sponsors and the industry.
The outlook for project finance
Project finance loans will become more expensive in the run up to full Basel III implementation in 2018, because Basel will lower banks’ return on equity in their project finance businesses.
Structured finance to the rescue?
A structured finance market for offshore wind projects would help counteract Basel III on cost and availability of project finance loans.
It seems unlikely, though, that these opportunities will arise without credit enhancement from bodies like the European Investment Bank or Green Investment Bank.
Investors are likely to be very cautious about securitization of offshore wind project loans. Construction and operational risks are higher than for onshore, and the sector is so new that no significant project has yet seen its financing package fully amortize. With no track record it is hard to see how the sector can become established without public or quasi-public sector involvement.
As well as this, credit markets need to recover before offshore wind deals can be considered, which will take several years.
Implications for the industry
In addition to renewed quasi-public involvement and continued policy support, we see a couple of trends over the short-to-medium term that will be key to the sector’s success:
- "professionalization" of the industry, which, with much greater planning, improved project management and delivery capabilities, will reduce construction risks
- "industrialisation" of the industry, which, through volume, a more competitive supply chain and improved delivery capabilities, will reduce costs.
Implications for project sponsors
In the next five years sponsors will allocate balance sheet and project financing to their best projects, leaving a portion of consented but un-built megawatts waiting for nothing more than affordable capital and an "industrialized" version of today’s industry. To drive the sector’s professionalization some market makers will need to go beyond their core business activities.
- a significant level of highly structured refinancing with large institutional investors, as project sponsors look to capture a premium as they recycle capital;
- strategic frameworks and other strategic M&A activities among key equipment and service providers, capital providers and project sponsors as they look to create demand to justify hefty R&D and capability building commitments.
The sector will need continued faith in the regulatory framework around which it might develop. The UK’s recent renewable obligation certificate banding review has been a good signal for the sector, as have Germany’s recent commitments.