Banking Community Holds Key to Wind-Power Targets
London’s Square Mile, not forgetting Edinburgh’s financial community, is deeply conservative and suspicious of anything that smacks of innovation – and the renewables sector is no exception.
By Uillean Cameron
Banks are very wary of projects where Government support or subsidy is required to enhance the fundamental economics of the project concerned. This is simply because a change in policy could leave those projects very exposed and, potentially, a stranded asset.
Caption: Offshore windfarms are now becoming a reality – but banks see renewable energy as a risky investment and could, as a result, slow the pace of development.
BANKERS and financiers could emerge as the key players in helping the Government to reach its medium and long-term targets for harnessing wind energy.
Those plans took a major step forward a few weeks ago with the launch of the second marine renewables licensing round, which could lead to thousands of wind turbines being installed in the Wash, Thames Estuary and Morecambe/Liverpool Bay areas. But concerns are starting to emerge over how to secure funding for these new projects.
Offshore wind projects bring with them numerous new risks not previously seen with on-shore projects. These risks should be addressed as a matter of some urgency if the banks support is to be guaranteed. When considering how Britain may achieve its target of 10% of its power needs coming from renewable sources by 2010, offshore wind was often cited as the linchpin to these efforts.
The Government has now endorsed that assertion as its plan is for offshore wind to account for 9% of UK generating capacity. It is therefore crucial that these projects come to fruition.
The new risks connected with these projects are neither insurmountable nor unmanageable, but if wind power is to become a reality, these risks will have to be addressed if funding is to be secured.
The banking sector appears perfectly comfortable with the risks associated with onshore wind projects. Price risks on long-term, Government-backed contracts are mitigated sufficiently under the NFFO, SRO and AER regimes, for example. The risks connected to volume, construction and technology issues are similarly well managed. But offshore projects bring with them a whole raft of hitherto unexplored new issues.
We at KPMG have pinpointed several areas of uncertainty and risk. For example, by its very nature, offshore wind generation capacity is some way from the load centres, and transmission losses en route can have a material effect on the actual output at the grid and the cost of production. In addition, the regulatory and insurance risks have yet to be truly tested. For the former, the concern rests with policy beyond 2010, which is currently unclear. Until there is clarity, the banking community will be concerned as to the future price for ROCs (renewable obligation certificates) and the chance of regulatory interference.
Banks are wary of projects where Government support or subsidy is required to enhance the fundamental economics of the project concerned. This is simply because a change in policy could leave those projects very exposed and, potentially, a stranded asset.
As for the new risks, many evolve around questions that simply have not yet been answered satisfactorily. Take weather constraints, for instance. Can you actually build an offshore windfarm efficiently to preset time and cost schedules? Although there has been some experience of this in Denmark, nothing has yet been built in the wilds of the North or Irish Seas.
Similarly, how do you maintain one of these plants in the middle of winter? Do you lower a man on a winch from a helicopter or from a boat at sea? If you have ever tried to disembark from a rib in a force six, you would know that this is an unattractive option.
There is no experience of this either - at least not in the generation sector. Having said that, offshore oil and gas construction companies may be able to provide advice and skills in this area and are already evaluating opportunities.
There have always been issues concerning the "scaleability" of turbines, even for traditional thermal plants. This will be a concern if larger turbines are needed to compensate for offshore wind transmission losses or to take advantage of the purer quality of the wind as the technology to support this is still unproven. While an answer may no doubt be forthcoming in time, banks are unlikely to be happy acting as an indirect R&D benefactor for turbine manufacturers or sponsors.
Banks will also be concerned over who takes the price risk. They are unlikely to accept a volatile wholesale power or ROC price that, although high now at about £45 per megawatt hour, is forecast to range between £40 and £60 in the future.
However, depending on the uptake of renewables and the supply of ROCs, this price could fall to any level.
What we are seeing is a direct response to the demise of Enron and TXU, and bankers are certainly refocusing their minds back on the basics. It means that if and when offshore wind projects are deemed fundable, it will be on a much more prudent basis than in the past.
The leverage made available is likely to be reduced, while stringent financial covenants and increased recourse to the sponsor - who will have to be credit-worthy - will be introduced.
To get even that far, though, the banking community has to be assured that the new risks associated with these projects, while plentiful, are manageable. I do believe that offshore deals are bankable, but the risk allocation and recourse to the project counter-parties will mean that the larger developers and utilities are the most likely winners in the race for finance.
