Gemini financing: what it means for the market
The recent closing of the largest offshore wind farm financed to date on a non-recourse basis sends positive signs for the industry and provides a good overview of today's banking market and new type of investors interested in entering the sector.
Offshore wind is still more expensive than other technologies to generate power, and thus its development is overwhelmingly driven by the need to have a supportive regulatory framework.
Key regulatory drivers include the price regime but also permitting mechanisms and access to the grid. All of these influence the economics of offshore wind projects and how they can ultimately be financed.
Funding these projects requires equity and, potentially, debt. Equity-only transactions, or “balance sheet” investments have been typically made by utilities. Non-recourse debt in addition to equity has typically been used by smaller developers lacking the funds to build the projects on their own, or by financial investors seeking to create leverage and increase equity returns.
Approximately a quarter of the 7GW of current operating capacity has been financed with debt, but the proportion has been increasing in recent years (to around 40% of new projects), and the increasing strains on utility balance sheets (due to a drop in wholesale prices, itself caused by the increasing penetration of renewables, which replace traditional plants in the merit order supply curve) have made them either consider project finance themselves, or sell all or part of their projects to investors that do.
The equity market
With utilities increasingly active on the sell side, investors have been able to find opportunities with varying risk profiles – and thus enabling the entry into the equity market of new players such as infrastructure and pensions funds, private-equity groups or corporations with specific market strategies. The first sector to see regular activity has been the market for already-built offshore wind farms, with investors willing to take long-term operating risk but reluctant to take construction risk.
However, as more offshore wind assets have come up for sale, the universe of investors has grown even more, with IRR targets going down. Some investors are thus now looking to take construction risk to improve returns (and obtain the double digits IRRs no longer available for operating assets).
In 2013, the Butendiek transaction was the first time pension funds and infrastructure funds took full construction risk in offshore wind, highlighting the increased sophistication of investors and the increasing understanding by financial markets of the risks associated with construction at sea. Ongoing transactions with respect to the Westernmost Rough (UK) and MEG1 (Germany) projects suggest that more investors are willing to take such risks today.
The debt market
Over the past three years, project finance funding has represented around 40% of the net amounts invested in offshore wind, and the market is increasingly mature, with predictable commercial terms and requirements from the lending market. Due diligence standards and main covenants are now well understood by lenders, advisors and experienced developers, across the various European countries where the industry has developed.
Offshore wind is now unambiguously “strategic” for many banks. The commercial bank market is broadening, with more actors expressing their appetite each year. More than 30 commercial banks have taken offshore wind risk so far and more are interested to enter the market. In fact, banks were actually frustrated last year not to be able to lend more to the sector, as too few projects (of the requisite quality) came to the market.
The Gemini project (600MW, the Netherlands) was able to raise more than €2bn in lending commitments just a few weeks ago (more than double the size of the previous largest such transaction), taking advantage of such favorable conditions, as further described below. We estimate that at least €4-5bn could be provided by lenders on a yearly basis on commercial terms, and we see signs that commercial banks are willing to consider underwriting good projects.
Multilateral finance institutions, development banks and export credit agencies have been and remain instrumental to get deals done, typically providing half the liquidity in any given project, and terms largely similar to those accepted by commercial banks. Their main advantage is to provide large individual commitments, allowing a reduction in the number of parties involved in any given transaction. During times of stress following the financial crisis, they also provided valuable funding capacity to the market.
Non-recourse finance requires a specific discipline
A number of rules must be respected to gain access to project finance. Beyond a general requirement for more conservative assumptions than the investors with respect to production levels, constructions contingencies or operating expenses, banks tend to demand more influence than usual on the contractual structure and commercial terms, as well as more transparency on technology, supply chain and contractors than investors and in particular utilities are used to.
It has thus been advisable to involve banks – or advisors familiar with the requirements of lenders – already when structuring the corporate and contractual structure of any offshore wind project.
The Gemini precedent
The financing for the Gemini project closed on 14 May 2014, for an amount of €2.1bn in long-term debt, making it by far the largest offshore wind financing. Lenders include 12 commercial banks (which provide €1bn altogether, also the largest commercial tranche ever), the European Investment Bank, and three export credit agencies (Euler-Hermes, EKF and Delcredere/Ducroire).
Most of the terms of the financing are in line with previous transactions, such as a gearing of 70:30, debt sizing over the full life of the tariff regime, and stringent due diligence requirements.
Nevertheless, the financing of such a large scale project (at 600MW) provides a number of insights for the industry:
- Banks continue to be willing to take construction risk for well-structured projects, with a general trend towards a very limited number of construction contracts (two only in that case).
- The universe of banks active in the sector continues to grow, with several newcomers in this transaction coming in and relying on experienced players who took more active roles.
- The size of commitments provided by commercial banks is growing and allows developers to raise substantial amounts on a non-recourse basis on market standard terms.
- There is no need for a utility to be involved in such a large project: Gemini was developed by a small but very experienced developer (Typhoon), and was purchased at financial close by a consortium led by Northland Power, a Canadian IPP with a substantial track record in power-sector project finance but no previous exposure to offshore wind. The strong contract negotiation, project management and financial structuring skills of the owner group were seen by the banks as one of the key features of the transaction.
- The Contract for Differences mechanism in place in the Netherlands was accepted by the lending community and will likely be seen as a relevant precedent for future UK transactions.
- As per the standard line of GGEB at conferences, “there is enough money for good projects” and Gemini demonstrates that beyond any possible doubt.
Sophie Cherrier is a director at Green Giraffe Energy Bankers