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Small is not always beautiful

Banks in Europe claim they are comfortable with lending to renewable energy projects financed on the back of corporate power purchase agreements, but only if the purchaser is a large entity or utility

Explainer:
Long-term loans on decent terms are essential for driving down the cost of renewable energy projects, also if the project’s electricity is sold directly to a user through a power purchase agreement (PPA) The problem:
PPAs for renewable energy projects are relatively new in Europe and banks can be cautious about making loans to projects based on them, especially if they lack trust in the purchaser because it is not a utility or very large company Solutions:
Varied, but may push up costs and the price of renewable energy Key quote:
I don’t sense a reluctance towards corporate PPAs from us or our peer group. Broadly everyone is on board.”
Corporate power purchase agreements (PPAs) for renewable energy have long been established in North America. Now they are the talk of the town in Europe and nowhere more so than among participants at the Re-Source event in Amsterdam at the end of 2018. The big question on the lips of most was whether the banks are comfortable with PPA financing structures. Corporations, renewable energy organisations and utilities all wanted to know if banks were now ready and willing to lend to projects with revenue secured through a corporate PPA instead of the utility offtake arrangements under national law that have long been the norm in most European countries. As yet, renewable energy projects selling their electricity to a corporation through a PPA make up a small part of Europe’s clean energy market, but their share is growing rapidly. PPAs for projects with a combined capacity of around 1.6 gigawatts (GW) were signed across Europe, the Middle East and Africa from January to July 2018, up from around 1 GW for the entire previous year, says Bloomberg New Energy Finance. It expects the market to soar in coming years. With around 13.5 GW of wind capacity alone going online in 2018, the scope for more PPAs in future is considerable. PPA growth is driven by demand from large incorporated businesses looking to buy clean energy, in part to hedge fossil-fuel power price risk. On the sell side, renewable energy project developers need alternative revenue streams as government renewable energy purchase arrangements come to an end. In addition, owners of old projects no longer eligible for premium prices guaranteed by law need to find new offtake partners. Early movers in Europe’s PPA market were project owners in Sweden and Norway, where wholesale electricity prices, supplemented by revenue from the sale of renewable energy certificates, have been low for years. PPAs help make projects more economical. Evidence of bank appetite for PPAs is emerging. Developers and investors have successfully raised long-term debt, generally between 20 and 25 years, for various PPA-backed projects. The Green Investment Group secured PPAs for two large-scale onshore wind farms in Sweden with Norwegian aluminium producer Norsk Hydro in July 2018. These projects attracted senior debt from banks including France’s Credit Agricole, Germany’s HSH Nordbank, NordLB and its development bank, KfW, and the European Investment Bank (EIB). Goya, Spain’s first subsidy-free onshore wind project secured Engie, a giant gas and electricity utility, as a buyer of its electricity via a 15-year PPA backed by €170 million of debt from BBVA, Banco Santander, CaixaBank and the EIB. Delegates at Re-Source said banks could be more proactive in supporting corporate PPA structures, states Sophie Dingenen, a partner at law firm Bird&Bird and based in Amsterdam. PPA offtake arrangements add layers of complexity and many banks are still unfamiliar with the details of the structures”, she says. Lenders keen to back corporate PPA projects exist, but others need to understand they can do this without putting themselves at additional risk”, she adds. Banks like strong PPAs
Lars Quandel, head of energy and infrastructure at HSH Nordbank, says some banks prefer lending to projects where the majority of their cash flow is linked to government subsidies to keep deal structures simpler and reduce risk and the number of counterparties. Alejandro Ciruelos, London-based managing director of energy and infrastructure at Santander, agrees that banks tend to prefer subsidy-backed projects. But I don’t sense a reluctance towards corporate PPAs from us or our peer group. Broadly everyone is on board with the structure,” he says. Corporate PPAs can definitely be bankable with the right buyer of electricity, the so-called offtaker, and contractual structure, states Ciruelos. Quandel welcomes the increase of PPAs in Europe to develop subsidy-free renewables. We think every asset class should try to move away from subsidies,” he says. The implementation of PPAs and deal structures driven by the market price [of electricity] means renewables projects across Europe will start to have more or less the same type of cashflow income. Not every region is the same but they are all moving in the same direction.” Quandel believes this is good for the industry. Whether lenders want it or not, subsidies are disappearing across Europe. A PPA can help mitigate a lender’s exposure to volatile wholesale power prices, referred to as merchant risk. PPAs are useful for banks in terms of managing merchant risk, and even essential under regulations that are no longer providing long-term price stability,” says Clement Weber, a founder of Green Giraffe, a renewables financial advisory firm with bases in Paris and Utrecht. He believes lenders will play a big role in financing PPA-backed projects. Banks really welcome strong PPAs,” says Ciruelos. A PPA with a good quality corporate purchaser is absolutely more attractive than going fully merchant”, he adds. Credit worthiness conundrum
Many industry participants continue, though, to perceive banks as reluctant to embrace PPAs and often question the financial strength of the proposed offtaker. Either potential buyers do not meet the requirements of lenders or their involvement in a project would require more work and extra assurances to mitigate risk that is unacceptable to the banks. While banks are supportive of corporate PPAs as a mechanism, it seems they are cautious about the type of corporation they are willing to commit a loan against. To provide a long-term loan to a renewables project, a lender needs to be sure the energy demand and financial health of the power purchaser will remain stable during the lifetime of the loan. For this reason, lenders often favour PPAs in which a utility will buy the project’s electricity. Utilities often have better credit ratings than other corporations. A number of European utilities are still state-backed and they largely exist to provide electricity to clients. The energy demand of a corporation in a completely different sector might be more difficult to predict, especially as it will be closely linked to its performance. Players like Google, Apple or Microsoft are seen to be as strong as utilities,” says Weber. But for the corporate PPA market to continue to grow and help provide the certainty developers need to realise their project pipelines, it cannot be limited to utilities, technology or industrial giants like Norsk Hydro. Challenges around credit worthiness requirements could arise as the market expands to a wider universe of corporate buyers, says Quandel. PPAs with smaller, less well-known companies looking to enter contracts to buy electricity are unlikely to fly with most lenders. We won’t take long-term [positions] on small companies, it will have to be a really big company,” says Laughlan Waterston from Japanese bank SMBC in London. Smaller companies are unlikely to have sufficient financial strength for a long-term bank loan. Another potential issue as more companies want to buy renewable energy is the lack of industry knowledge inside corporations. The most active corporates in the PPA market so far, big tech and industrials, have tended to be relatively well-versed in the energy markets. Sometimes they have their own energy trading desks so you don’t have to explain anything to them”, says Dingenen. But corporates with no in-house energy and sustainability experts will require more hand-holding to understand how the energy markets work and what makes a renewables project bankable, she says. Managing risks
There are ways in which to manage counter party risk and make a wider pool of corporates bankable. Export credit agencies, for example, can help enhance the credit rating of corporate buyers and provide more certainty for banks. German asset manager Prime Capital showed in October 2017 that this can be done when it brought the 281 MW Nordlicht wind portfolio in Norway to financial close. Nordlicht, owned by a group of German institutional investors led by Prime Capital, secured a 15-year PPA with Norwegian aluminium supplier Alcoa guaranteed by Norwegian export credit agency GIEK. This power purchase guarantee gave the PPA a triple-A rating, the highest rating possible. On the back of this, the project owners raised senior debt for the wind farms from DekaBank and KfW. Under GIEKs power purchase guarantee scheme, it can provide guarantees to companies selling energy to an industrial company in Norway to protect against the buyer failing to fulfil its power purchase contract. It can also provide guarantees for banks lending to such power projects.
Investors and banks that finance wind power need a high degree of predictability,” says Karl Magnus Maribu of DNB Markets, who advised Prime Capital. A GIEK power purchase guarantee, rated AAA, secures payments from power purchasers throughout the term and thereby helps reduce risk.” He adds: In the future, GIEK power purchase guarantees can help create a more efficient market for long-term power contracts because more power buyers and sellers may be eligible as counterparties.” Structuring so-called club PPAs, which include several buyers, can also be a way to address offtaker risk and bring more companies into the market, says Dingenen. A further challenge for corporate PPAs is agreeing the right loan tenor, or loan duration. There is a big difference between traditional project finance and corporate lending. Project finance is long-term, ten years at least and can be as long as 25 years. In renewable energy and the broader infrastructure market, the underlying loan assets, from wind farms to airports and hospitals, tend to be underpinned by long-term government subsidies or state concessions. These offer the certainty banks need to provide senior debt at long tenors. The picture is different when a corporate PPA makes up a large part of a project’s revenue stream. Banks aren’t used to taking long-term tenors on corporates,” says Waterston at SMBC. Typical tenors for a corporate loan would be five to ten years. So, if you’re being asked to lend for 15 or even 20 years to a corporate [backed PPA] then that’s where the challenge lies.” And as the PPA market is still in a relatively early stage, banks might be unwilling to provide finance for PPAs for more than five to ten year for some time, he adds.

Writer: Elza Holmstedt Pell