Column green energy projects need more bond finance gerard wynn← Homepage
(The author is a Reuters market analyst. The views expressed are his own.)By Gerard WynnLONDON, April 26 Europe needs to engage the multi-trillion-dollar bond market in financing renewable energy projects, but bonds can't altogether replace bank loans, which are contracting sharply. European Union countries lead the world in targets to deploy wind, solar, bioenergy in power generation, but meeting these is another matter following sharp falls in bank lending, the traditional mainstay of energy project finance. Private bank lending to European wind power projects, for example, is now barely a third of peak levels in 2008, according to Thomson Reuters Project Finance International data. That's the worst bank project finance market for two decades, say developers, and doesn't help EU countries that are already way behind their targets. For example, Britain is supplying about 3 percent of all energy from renewable sources versus a target of 15 percent by 2020. To fund projects, a growing argument is that institutional investors and bond markets must be engaged in project finance, perhaps using public sector debt to boost project credit ratings. Bank lending will remain, not least because banks find project finance a good business given low default rates. It's more a question of finding supplements than alternatives, and there's no doubt that capital markets must play a bigger part.
DEMAND Bank lending still accounts for the vast majority of project finance. On the supply side, that's partly because of the small size of many projects, below $100 million, may make the costs of acquiring a credit rating and of marketing bonds prohibitive. In addition, some developers are concerned that bondholders may be less supportive than bankers when things go wrong. When bonds are downgraded, some institutional investors typically sell to vulture funds, whose agenda can be to use legal advice to grab assets. On the demand side, meanwhile, institutional investors particularly in Europe are reluctant to buy sub-investment grade bonds because of the implied risk. That rules out most renewable energy.
Rating agencies list reasons why they can't rate green energy projects as investment grade, including the lack of stable regulatory support (constant chopping of support levels), a lack of strong developers (such as utilities with credit ratings) and inadequate data. Regarding the latter, a case in point is a European bond issued by the unfortunately named Breeze Finance, which was one of the few wind farms to win an investment grade rating but was then downgraded to junk because its site had less wind than expected. That emphasises the need for sector-specific expertise to assess risk, which European investors don't tend to have and, in a Catch 22, are unlikely to develop until more projects become available. More experienced teams with sector-specific professionals could analyse risks and buy sub-investment grade assets with high returns. That process could be helped as investors become increasingly wary of climate risk - the chance that climate change may be worse than feared and lead to disorderly policy changes that could damage fossil fuel assets. Investing in renewable energy projects would protect against such a risk.
GOVERNMENTS ENGAGE There are powerful reasons to engage bond markets, which presently only account for about 5 percent by value of European renewable energy project finance. The sharp drop in loans partly reflects banks' bruised balance sheets after the global financial crisis and regulatory reforms that are forcing them to put aside more capital against bad debt, raising their long-term lending costs. An argument runs that institutional investors are better suited, anyway, to fund projects with a 30 to 40 year term, given that pension funds and insurance companies need predictable cash flows over such timescales. EU leaders have cottoned on and are trying to draw in bond markets. One route is through export credit agencies, which provide public loans or guarantees to support equipment purchases overseas. In October, for example, Denmark's export credit agency guaranteed 10 billion Danish crowns ($1.8 billion) worth of debt finance made available by the Danish pension fund, PensionDanmark, primarily for wind projects. An alternative is for governments to guarantee directly some level of debt, effectively reducing risk and so enticing nervous institutional investors. Britain's Green Investment Bank (GIB) launches this year and is expected to guarantee project debt or make loans on generous terms as well as take equity stakes in projects, initially targeting offshore wind, waste and energy efficiency. The GIB marks a shift from more ad hoc grants and lending, channelling funds through a permanent, arms-length agency, which will also be able to borrow on capital markets from 2015, providing another route in for institutional investors. In time, bank lending will return from the perfect storm of regulation, downgrades and euro zone instability to support ideally a deeper project finance market with more players.