Alternative energy investment is increasingly popular with banks that are seeking to diversify their project finance portfolios. Silvia Pavoni reports.

That energy and alternative energy sources are hot topics for consumers, suppliers, producers and governments around the world is not news. What might be less obvious is how hot this topic is for bankers.

Banks are looking at alternative energy sources ventures with increasing interest. In the past five years, the value of syndications on renewable project financing around the world grew by 400% to almost $5bn, according to data provider Dealogic.

The renewable sector is driven mainly by three factors. The first is increasing oil and gas prices, which encourage the development of alternative energy sources. The second is carbon credits and legislation trickling down from the Kyoto protocol to governmental level supporting green energy. The third is security of supply: the desire to reduce oil and gas imports from politically charged countries such as Russia, the Middle East, Nigeria and Venezuela.

Although the International Energy Association forecasts that fossil fuel will continue to dominate energy supplies, with oil, natural gas and coal meeting 81% of primary energy demand by 2030, it also forecasts that renewables will expand at a fast rate. The energy market should therefore expect the number of renewable ventures to increase, and with it lenders’ appetites for them.

All the same there are big risks. “There are still people who think projects can be brought to the market even with technology that hasn’t been commercially proven, and projects have failed in the past as a result of that,” says Richard Burrett, managing director of sustainable development at ABN AMRO.

The realm of alternative energy projects is particularly varied, ranging from mature market ventures, such as onshore wind energy, to new markets, such as biofuels. The newest technologies, such as the generation of electricity from hydrogen and fuel cells in a very efficient way, remain the domain of private equity investment. Bank lenders do not expect to be involved in such areas during the next five years.

 Risks and rewards

The highest risk in renewables project financing is regulatory risk. Renewable energy needs governmental support to compete with traditional energy sources because production costs are still too high, even in the most mature markets, like onshore wind. Banks lend on the back of favourable regulation and the possibility of regulatory changes constitutes a crucial risk for them.

“Banks don’t create the market, banks will follow regulatory or governmental initiatives which are designed to encourage development of the renewable industry,” says Stephen Crane, head of structured finance at Mitsubishi UFJ Financial Group.

Green energy supporting policies have expanded from international agreements to legislation such as the EU emission trading scheme (ETS) and national regulations supporting renewable energy ventures.

In Europe, the ETS enables companies that have reduced their carbon dioxide emissions to issue and then sell CO2 credits to companies that have exceeded their quota. This is a strong incentive for the production of green energy and the development of renewables projects.

Government support is also given at national level and schemes vary from country to country. The UK has set up the renewable obligation certificate (ROC) scheme, under which producers of renewables receive ROCs and energy suppliers that do not purchase enough green energy pay a penalty. The value of each ROC is the sum of all penalties divided by the total number of ROCs in the market. Currently, the value of an ROC by far exceeds the price at which green energy is sold. The existence of this mechanism has a strong impact on how favourably lenders look upon renewable projects.

“Not everybody has gone into the renewable energy sector yet. The biggest issue to get our minds around is regulation and how firm it is,” says Andrew Jameson, head of power at Royal Bank of Scotland.

The link between regulation and market, however, can create a vicious circle. “Regulation can only support industry when the industry is mature,” says Emmanuel Rogy, head of energy project finance Europe, Middle East & Africa (EMEA) at BNP Paribas. “Today, there is regulation sustaining solar energy in some countries like Spain but it remains very small because it is so expensive that there isn’t an industry supporting it.”

 Generation costs

This is perhaps the pattern of all new markets and it was certainly the case for the onshore wind industry. Ten years ago, the onshore wind industry was small and, even though it was supported by regulation, it really only took off when machines went from producing 500 kilowatts to up to 2.5 megawatts per hour, at almost the same price. The cost of generating energy from wind has made it a profitable business and attracts all industry players, from producers to technology designers, maintenance companies to equity investors. Last to come to the table are the lenders.

Not all countries have regulation that lenders feel comfortable with. Some banks are reluctant to take on aggressive structures when the rules are unclear. Although some believe that in a liberalised market, lenders must take market risk, others prefer to stay out of niche markets and leave the work to local banks. These have a closer relationship with sponsors and the supply chain and feel more comfortable with less rigorous regulation, and can exercise heavier political pressure should regulation change.

In developing countries, renewables also display another characteristic: the potential to drive local development and regeneration. “Bioethanol projects sustain Brazilian regional development,” says Osanan Lima Barros, regional managing director EMEA at Banco do Brazil. Biomass energy, which includes bioethanol, supplies 27% of the Brazilian market. Mr Barros’s bank lends to the companies in the bioethanol supply chain at extraordinarily favourable rates – the government matches the difference between the low rate and the agro business average rate – thereby sustaining and bringing together local farmers.

 Income versus growth

With stable and clear regulatory frameworks, renewables projects’ consistent and secure cash flows are an excellent tool for diversifying banks’ project finance portfolios.

“They produce nice, steady income streams over a 15-year period. There isn’t a great deal of growth in profitability but they provide a good source of income. That’s why financiers go for this sector,” says John Dunlop, renewable energy finance manager at HSH Nordbank, which is involved in projects in North America and Europe.

This aspect has also attracted investment funds that are seeking income. In some cases, the financing is arranged for these funds rather than for a project sponsor. For the Viridis Energy Capital deal, for example, HSH Nordbank provided debt finance for a portfolio of five wind farms in Germany that the bank brought to Viridis, an Australian fund. “This is another typical deal [compared with the traditional sponsor-driven kind of deal] where we originate the investment opportunity for the income-seeking funds and provide them with the debt finance for it,” says Mr Dunlop.

 The nuclear option

Even though renewables are the greenest complement to fossil fuel energy, they do not, and some say never will, provide an alternative to oil, gas or coal. Energy produced from renewables is still relatively limited.

There is, however, already a source that does offer such an alternative for the electricity sector: nuclear power. Although it can be labelled “green” because it is CO2 emission-free, nuclear power is the most controversial energy source. The problems of storing radioactive waste for indefinite periods and the potential for possibly severe radioactive contamination by accident or sabotage have yet to be resolved safely.

“The problem with nuclear [energy] is that first you have risks in terms of image. It is not politically correct,” says Michel Anastassiades, global head of project finance at Calyon.

Some believe that nuclear plants should not be a target for project finance professionals anyway, and that they should be left to other financing solutions, such as corporate finance products.

“You can’t blindly finance [nuclear] power stations and [at the same time] you can’t ignore that [nuclear] power stations are part of our energy mix. They are part of reality,” says Mr Rogy.

The alternative energy source community is diverse, intricate and, most of all, expanding. Whatever the energy source of choice, whatever the maturity of the market, renewables projects are increasingly becoming a sought-after resident in project financiers’ portfolios.

FINANCING OF ALTERNATIVE ENERGY SOURCES

  • Onshore wind; Hydro Technology: mature Financing: debt and equity
  • Biomass; Bioethanol; Biodiesel; Geothermal; Offshore wind; Solar; Tidal; Waste Technology: developing Financing: debt and equity
  • Fuel cells Technology: new Financing: equity

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