With utilities struggling to finance offshore wind farms, institutional investors are being asked to step in. What financing challenges are facing the sector and what are the developments helping facilitate cheaper capital, asks Charles Yates
Massive upfront capital costs, and high perceived risks are among the biggest challenges facing planned offshore wind developments.
The challenge of cost-effectively raising the huge sums of money needed to build projects at sea, means many projects struggle to get off the ground. Financing costs for offshore wind farms are a key driver of the overall profitability of the projects and, as such, have a major impact on the size and timing of the project pipeline.
The UK aims to become a leader in offshore wind. Its most recent estimate of the pipeline of infrastructure investment in the UK included £60 billion ($99.5 billion) of investment in offshore wind farms from 2013 to 2020. This will require access to new sources of capital, including institutional investors such as pension funds and insurance companies, because UK utilities, until now the principal financiers of offshore wind projects, are in general cash-poor.
Institutional investors are attracted to investment in infrastructure, as it provides secure, long-term cash flow while also giving a 'yield pick-up' on the low returns available from government bonds. A well-engineered and procured offshore wind farm with the right contractual and legal structure satisfies institutional investors' requirements.
In many cases, pre-operational offshore wind farms are totally equity financed. However, debt has been used in some cases and has provided 70% of the capital for some wind farms. For example, in June 2012 Centrica raised a total of $1.55 billion of debt from a consortium of commercial banks for the $2.26 billion Lincs wind farm, which was then under construction*.
Competitive cost of debt
As offshore wind farms continue to build a commercial track record, debt for the construction and operating stage is expected to get cheaper. Investors are becoming more comfortable with the technology, and institutional investors are competing with banks to fund projects.
Alternative debt solutions, such as bond financing, will play a significant role in reducing the margins on wind farm debt. In November 2013, a bond financed the acquisition by Balfour Beatty, Equitix and AMP Capital of the offshore transmission link for the Greater Gabbard wind farm.
This bond had a spread of 125 basis points (bps) over the Gilt**, which compares with margins for bank debt for similar, earlier projects of 210-220 bps***. This is a potential margin reduction of about 1 percentage point which on, say, £300 million of debt saves £3 million each year.
Early investment is more attractive to institutional investors if the development and/or construction risk is borne by a co-investor such as a utility, construction company or the public sector
Lower margins from bond finance are a result of access to a larger pool of investors. We expect that bonds will be used to refinance operational wind farms to bring down the cost of debt and increase shareholder returns. This approach plays to the ability of banks to manage construction risk and of bond investors to provide long-term, efficient debt once successful operations have started.
Another approach that is producing competitive debt is the participation of state banks, multilateral banks and export credit agencies in the financing of offshore wind farms. For instance, the European Investment Bank (EIB) has provided a total of around €1.5 billion of debt for five offshore wind farms since 2005. For project developers, this debt has more attractive margins than commercial bank debt and enhances the overall cost of finance for the project.
In addition, offshore wind is one of the core sectors for the UK's Green Investment Bank (GIB) whose investments include approximately £45 million of debt for the Walney wind farm. Having the GIB as a co-lender is a positive for commercial banks and encourages them to offer more competitive terms.
Other European state banks such as KfW have also funded offshore wind projects while export credit agencies, such as EKF of Denmark, finance projects built with Danish equipment. PensionDanmark has committed $1.8 billion to fund export finance debt through EKF.
Recently, the EIB's Project Bond Credit Enhancement (PBCE) and the UK government's Infrastructure Guarantee scheme have been used to support offshore wind projects by shielding investors from part of the project risk. The EIB provided £45.8 million of credit support for the Greater Gabbard bonds under the PBCE model, which resulted in a one-notch upgrade in the project's credit rating from Moody's. Under the PBCE, additional liquidity will be provided for the project if required, and the PBCE will be the first investment to take any losses.
The Neart Na Gaoithe 450MW wind farm in the outer Forth estuary in the UK is eligible for an Infrastructure Guarantee under which the government would act as a guarantor for part of the investment in the project, giving private lenders confidence that they will get their money back if the project cannot pay.
Institutional investors and pre-operational assets
Institutional investors are interested in acquiring equity in offshore wind farms, particularly in operating assets. A recent example is the investment by PGGM (a major Dutch Pension Fund) in equity in the Walney wind farm.
There are encouraging signs that the required financing for offshore wind is likely to be available as projects access a larger and varied pool of investors
Many investors, including institutional investors, tend to invest in projects providing long-term predictable cash flows with a low risk profile (low construction, technology and regulatory risk for instance). Precedent transactions in the UK offshore market, such as the sale by Marubeni Corporation of half of its stake in the Gunfleet Sands wind farm to Development Bank of Japan show that operating wind farms are an attractive proposition for a variety of investor types.
On 4 December 2013, six major UK insurance companies announced that they will invest £25 billion in UK infrastructure, including offshore wind, over the next five years. While low-risk, operating assets are typically the core investment focus for institutional investors, they are also increasingly interested in financing offshore wind farms in construction where risk is appropriately managed. As such, they could be a new source of capital to support delivery of the offshore wind pipeline.
However, the risk profile of wind farms in construction does not typically match the institutional investor's investment criteria. Early investment is more attractive to institutional investors if the development and/or construction risk is borne by a co-investor such as a utility, construction company or the public sector.
Dong Energy has taken the construction risk on a number of wind farms and by so doing has attracted investment from financial institutions during the construction stage. While de-risking the asset for institutional investors is likely to be key, a stronger track record of investment in offshore wind, along with regulatory stability, is also likely to play an important role in attracting institutional investors to offshore wind farms.
Investments made by sovereign wealth funds in UK offshore wind such as Masdar's $640 million investment in London Array at the construction stage are a positive signal and should set a precedent for financial investors entering this market at scale.
Finally, equipment manufacturers sometimes provide finance for projects buying their turbines, etc, which has been the case with Siemens, which is an equity partner in the $2.58 billion Gwynt y Mor offshore wind farm in the UK.
In conclusion, there are encouraging signs that the required financing for offshore wind is likely to be available as projects access a larger and varied pool of investors. Specifically, institutional investors, sovereign wealth funds, banks and corporates are increasingly providing equity and debt at different stages in the life-cycle of offshore wind farms.
Charles Yates is an associate director in the energy, cleantech and sustainability team at Grant Thornton UK LLP
* Source: Infrastructure Journal, Transaction ID 17534, last update 30 July 2013
** Source: Infrastructure Journal, FC for UK's Greater Gabbard OFTO, 27 November 2013
*** Source: Offshore electricity transmission: a new model for delivering infrastructure, National Audit Office, 22 June 2012