Jonathan McNair: Hello and welcome to another episode of The Joint Venture, the podcast that delves deep into the global renewable energy and infrastructure sectors. I'm Jon McNair and this week we return after a short break with the first of two special episodes in partnership with Gowling WLG. In today's edition we will be heading straight into a conversation I recently had with Gareth Baker who is a partner specialising in renewables at Gowling WLG, as well as Barney Coles, a director of Clean Energy Infrastructure at renewables investor Capital Dynamics.
Gareth, Barney and I got together to chat about the development of new projects in the UK renewables market with a particular focus on those being progressed without the support of government incentives. We took stock of where the market is right now, how COVID-19 had affected Gareth and Barney's ways of working as well as how the lockdown had impacted electricity prices and the knock on consequences for projects business cases.
Then we moved on to talk about the tantalising prospect of the return of solar and onshore wind to the UK's contract for difference support framework and what that might mean for developers and investors who might have given up entirely on ever being able to access that revenue stream again after several years without it.
Well, why don't we dive straight into the discussion to hear what was said on all of these topics as well as many others.
Well Gareth and Barney, thanks for joining me here today on the podcast and we are here obviously to talk about the development of UK subsidiary free renewables projects at the moment. So just to kick off very generally, firstly, and perhaps starting with you Gareth. What would you say are the key considerations for project development and subsidy free segments at the moment?
Gareth Baker: Thanks Jon. Well, the developers we are working with are focussed on the skills and the areas in which they continue to excel and be excellent and those really comprise making sure that they are getting the right kind of lands rights, making sure that they are getting a good deal and fair deal on a grid connection. But also looking at the planning and on that, as an area, we are seeing a number of projects where perhaps they didn't quite make it in the original subsidy phase and as they are right now they still don't add up economically. So a number of developers are going back in and they are looking at how they can adjust that planning in order to make the project work which might be, for example, to make a wind farm reach higher heights on its tips or it might be the size and scale of a particular development. What I would say finally is that I think a number of them are finding it refreshing that they are not necessarily chasing the next quarter. There was an awful lot of outside pressure in the rock days of that degradation date coming if you didn't get to a particular milestone by a particular date.
Jonathan: Yes, so freeing in a sense and Barney, so what's your take on how the land lies at the moment.
Barney Coles: Yes, looking at things slightly from a more financial perspective. I think if you consider the developers main drivers. They were developing with traditionally up until 2016 with a rock subsidy in mind and with that comes circa £100 a megawatt hour price for the power that those projects were going to be generating and obviously once the subsidies fell away that revenue stream is halved and as a result developers, in order to hit the similar development premium that they were getting previously, are having to really rationalise their costs and optimise their sites. Gareth mentioned the tip point extensions. That has been a major aspect of what we have seen on the development side. Then also trying to really push the underlying contractors, maintenance providers, construction contractors on price and I think what that is doing is putting more pressure on developers. It means they have got to be a little bit more potentially commercial and have really got to sweat every penny. It is much more of an American style model that we are used to seeing in places like the US but I think the other main aspect or main inspiration for developers is really on an uptake strategy and how that links to the ultimate finances of these projects. So before under the subsidy regime not a huge amount of thought really needed to go into that because developers knew the projects would end up being delivered under the rock of whatever quite [unclear] amount it was it was always going to get a rock and that was always going to be appealing to most of the financers out there.
Now the developers have a choice. They can either engage with private off takers of the power under long term arrangements with a certain buyer ultimately in mind or they might choose the more merchant room which potentially doesn't deliver as much value to them but it allows them to get projects away and sold and recycle that capital quickly. So these are the sort of things they didn't have to think about so much before. These are really very much on their, part of their thinking now and who is going to end up buying these and when.
Jonathan: Obviously we had a pretty tumultuous year this year to say the least, but in broad terms across the society and economy through COVID-19. Now lots of people tout the resilience of renewables and other kind of infrastructure sectors in the face of that but there were, perhaps back at the start of the crisis, reports of widespread construction cessations and delays. So to what extent, Barney perhaps stay with you for this one, to what extent did you experience that on projects that you have and how perhaps will things change in the construction going forward.
Barney: Fortunately we didn't suffer from that. I think to a large extent it was fortunate that the timings of our projects just happened to have missed that lockdown window. But as you said a number of others out there who did suffer some experience issues as a result of the lockdown. I think generally speaking the lockdown was hard. I think construction, whilst it was locked down for a period, was locked down for less of a period. I think construction was the last to lock down and the first one out due to the fact, I guess, that social distancing is slightly easier in that kind of world. I think what we are seeing now in terms of our projects that we are sort of hoping to construct this year and next year, we are seeing probably two main things. We are seeing the lead times on the delivery of wind turbines, particularly, have been pushed out. For a number of reasons the constituent elements of the turbines come from all over the world and everybody has different rules on imports and exports and delivery of parts and so that is something that turbine manufacturers are considering in the programmes that they are promising the buyers of their turbines. Also, they are not going out materially but it is a couple of months here or there. And then on the actual construction side of things, the underlying contractors, we are not seeing to a large extent at this moment in time, there is not much factoring in of COVID lockdown. But that said, I think as asset owners and those are that managing that construction process, we have to be mindful that that could be a real possibility so we do need to give ourselves sufficient cushion at the back end to deliver in time, whether that is a financial deadline or whether that is a grid connection deadline or whatever. And if those deadlines look at all at risk, it is paramount to have early engagement with the network operator or your finances or whoever. And generally speaking I think though the industry has been very understanding of the situation and everybody needs to really get together and find solutions when these things come up. Fortunately nothing in our pipeline is suffering or will suffer but the industry needs to pull together really to work our way through any issues.
Jonathan: And Gareth, what are you seeing in that sense. Does the crisis create more work in your in-tray and more things to consider when you are working through on deals and projects?
Gareth: Yes. I mean it certainly has created issues for the industry and I would echo the comments that Barney made, that people are trying to be pragmatic on these things and again the comments that I made earlier that the fact that you are chasing a rock deadline allows at least some breathing space. What I would say we are seeing is I would draw a distinction between the subsidy free projects where candidly they are not necessarily in construction yet, they are too early for construction and I will come onto those in a moment because there is a longer term impact. And then those projects which are in construction which typically on our desk is often EFW projects and offshore wind. And yes, there have been issues there. There have been some insolvencies in the supply chain and there have been some delays and that is certainly going to cause issues under the construction contracts where there are debates about on the one hand if you are a developer I would like some liquidated damages and on the other hand if you are constructing these things you want to say that it's a force majeure event or things like that. That is detail. But those kinds of discussions are going on and of course as Barney has alluded to where you have got finance in there, you have got a whole other range of questions to consider like, is this going to send you into a default of your finance documents, what happens?
But as I have said, we are not seeing that in the merchant world because frankly we are not seeing widespread construction activity there yet. A lot of stuff is earlier than that. But I think we are seeing two things happening. Naturally the supply chain coloured by this experience is more risk averse so as Barney has said there is more building in of lead times. We are finding the debates on terms harder and I think on pricing I would say our experience is that at the start of the subsidy free phase the supply chain really did cut its cloth because it knew that it was vested in helping this industry become its success that I am sure it will become. But we are seeing that pricing hardening or going up now as a result of what has happened frankly.
Jonathan: And so Barney returns, obviously you noted a few points there, longer lead times on supply chains and other such issues. What impact is that having on the bottom line?
Barney: I think it might not be a function of the timing of our deployment more than anything but I think we have been quite fortunate in the sense that it has been factored into I guess the returns that we are looking at when we are looking to acquire projects so, we are not in a situation at all where we have acquired projects and suddenly this has hit and suddenly we are having look at potential three, six, twelve month delays which of course if that were the case you would then really start to drag some of the return figures and those issues, I think potentially just because, not necessarily by the line, but the way that we time a lot what we have done is, you have managed to avoid those kind of problems. But without doubt there were those who worked in construction were locked down for three or four months and had staff furloughed and things like that. Clearly there will be some kind of drag on the financial return, specifically with banks, but my sense speaking around the industry is everybody is in the same boat here and everybody has got requirements and pressures and everything. The feedback I have heard is that the industry have been very accommodating around this and it seems to be self, it's been quite refreshing really to see the industry, to realise that renewables is quite a relatively small sector in the terms of the people involved and actually as an industry we have really got to pull together. Renewables is key and there is a bigger picture here other than just - audio issue]. We have all got to pull together and bring renewables to the forefront and those kind of issues that might arise within the industry are secondary really in this situation.
Jonathan: One thing perhaps we haven't seen commented on much certainly in my corner of the press is how you guys are experiencing things like deal origination and execution in it may be changing back to the old way now potentially. But through platforms like Zoom and remotely during lockdown how was that and how different is it and is it changing back to the old way or is it here for good now?
Gareth: I have to say I am a little bit sceptical of going forward and working from home and doing it that way, being remote and not having water cooler moments and that kind of thing. But I have been pleasantly surprised, as I think my wife has as well, about how it has worked and to a large extent how seamless it has been transitioning to this kind of working arrangement. Certainly lockdown was a different experience and with a two year old not being in childcare that was obviously quite challenging but actually it worked very, very well and I think it feeds well into this green economy, green recovery story around how move out to a new way of being and a more sustainable way of living. Avoiding congestion in London and overuse of transport and that kind of thing. So all of that is going to be positive.
On the actual work side and the deal side. I think one of the interesting, we didn't really see any tailing off of any activity in the sector and it is quite a hardened, insulated business line, business market, and we saw that with the levels of trade activity that were going on in the renewables side, particularly in the M&A side. Our approach has always, again, been on more partnering the developers over a long term period and being there and taking their projects on a continuous basis as opposed to participating too frequently in one off M&A processes where you have one dealing with the developer and then you move on. So I think our approach is slightly different. So as we moved into the lockdown a lot of what we were doing was essentially legacy M&A work with the same parties. So these relationships are already there or we know the guys very, very well and you haven't got a lovely investment bank in the middle pushing you around. You have good relationships with the guys and you can jump on Zoom calls and have those and get through to the commercials quite quickly. I think that was a real positive for the industry and that really maintained itself all the way through lockdown and to the current day. We are seeing now, straight after lockdown we saw a lot of auctions being launched and a lot of teasers and IMs come across our desk pretty much straight after lockdown. So those were obviously building up and then happened afterwards but we certainly weren't reliant on those sort of processes to get transactions done as we had these legacy long term relationships that kept us going.
Jonathan: Moving to the projects themselves again. Electricity demand obviously changing and dropping massively during the heavy lockdown we experienced across a number of European countries and obviously that had a knock on effect on to electricity prices which seem to be recovering. But I think there was a feeling that prices were softening for a while now anyway and people were downgrading their mid to long term forecasts. So I am just keen to hear, firstly from you Barney, how is that feeding into how you are looking at the business case for projects. Particularly as we are in a non-subsidy world largely where a more merchant element could possibly be expected.
Barney: I think probably the first point to note is that our investment at Capital Dynamics is very much on building out renewables with fixed price uptake. As a result it means that some of the price softening that you mentioned has not really impacted us as severely. But there is no doubt that we have seen those numbers soften. What we have also seen quite interestingly is on the independent long term forecast front there is a bit of a divergence in those forecasts. So there are a number of consultants out there and certainly one or two of the major ones have seen the big softening in their forecasts over the last six to 12 months. But then there are others who have maybe maintained a slightly more bullish view so navigating those long term curves is clearly a key focus for the likes of the likes of ourselves as the long term financial buyers of those. So it is interesting and sure there was a softening. Prices fell 15-16% or whatever it was in late March and those with high degrees of merchants only would have felt that. But as you say there has been quite strong recovery actually in not only the current day ahead pricing but also in the season ahead and year ahead, two year ahead pricing and it is back to the level that we were previously. So, yes, it is interesting but even that volatility in there and the reaction of pricing to the pandemic it really makes us a bit more hardnosed in our need and approach of finding that long term uptake. Whether it's through corporate DPAs or the like or other forms of subsidy which I am sure we will cover at a later point.
Jonathan: Of course. Gareth, before we do, it would be interesting to hear from you and maybe some of your colleagues who are working on those offtake negotiations. Is it feeding into that particular area when prices are jumping around so much and people are maybe looking further afield and seeking lower prices than perhaps was previously the thinking?
Gareth: Yes, well I share the comments of Barney in that clearly we saw an immediate collapse in commercial and industrial demand which put the power price through the floor. It seems to be the case that's causing, and this is a real generalised, averaged view of the 20% drop across Europe in prices. If you look at a number of the funds who are needing to really make market statements, some of them are saying that they will not be recovery and indeed that long term power price is something they are modelling at 20/50. So overall I think it is down. Overall that means returns for everyone are going to be down. What does that mean for those who are in the market writing the PPAs? Well my view, based on what we are seeing, is that there was an awful lot of corporate PPA work coming through the system and in many of those instances there were off takers involved somehow anyway in those arrangements. But confidence has been shaken, of course, because if you are an FD or an energy purchasing manager are you going to write a long term ten year deal seeing what the current price is at the moment. So I think the way that has come through is it means that other off takers may be hardening on their terms because there just isn't the supply of options out there at the moment. That is just anecdotal things that we are seeing coming through. What I would say is that our route to market teams are as busy as they have ever been and where they are not doing PPAs they are doing balancing type arrangements. So there is an awful lot going on in flexibility right now.
Jonathan: OK. Why don't we jump straight to the CFD then as you mentioned it, Barney – obviously the news came through a number of months ago that there is the potential for onshore and solar to return to the CFD process in the UK. There was a consultation that ran a couple of months back, I think it closed at the end of May. Just keen to hear from you guys what are your expectations on that front and perhaps we can delve into some of the effects and impacts that will be felt as a result of that change. Firstly, Gareth, what are you expecting to see from the CFD changes?
Gareth: Yes, well there is an awful lot of noise around allocation round four at the moment isn't there and we are all waiting to see what the outcome is. I have found it is dangerous to predict even a range of outcomes with this that is something I have learned previously. But the industry I think believes that the outcomes are going to be possibly a modified version of two pots or a third pot with offshore wind put into that third pot. We do not know and will not know the detail that will be crucial of course which will be: what is the amounts, by which I mean pounds or megawatt per pot, and what is the overall opportunity? Is it an overall number? Can you have movements between the pots? So it is difficult to know and we will see, the government seems to be spending a lot of money so we'll see how much it has left over for this frankly. In terms of the merchant opportunity generally I would say that there are some developers who are definitely seeking to configure their projects predicated on getting a CFD and others who are saying well that might be there but that isn't my investment thesis so that's a nice to have if we get it. It may be that the competition is so intense that it is not worthwhile. My own view, finally, is that I think that definitely it is a good tick in the box of bankability to have a project like that. Will it mean that is worth more? Will it mean that returns are improved overall? Well we will just have to see won't we but I am not convinced of that.
Jonathan: And Barney, Gareth mentioned the investment thesis there and you said, just a moment ago, your approach is looking for projects for fixed price offtake deals. Does the CFD fall into that for you?
Barney: Absolutely. It is such an interesting area because I think it took, we have all been pushing for wind and solar or onshore wind and solar to be returned essentially to the allocation rounds of the CFD so that is obviously welcome. We weren't necessarily expecting the consultation and obviously that was great. So a lot of our plans have been around how we do this through private arrangement. I think a number of things are going to be interesting, I think Gareth touched upon the main one there in terms of the amount of allocation and buckets and which pots are going to go where and everything else. I think the other question is around price and what that delivered price is going to be and there is going to be a lot of gaming between developers and how that is going to work out. We can touch upon the Irish results in a moment I am sure which were very, very interesting, and how that may well be an example of how, again, some unexpected results and how that all plays into it. From our perspective what we are seeing on the corporate PPA front is, again, a bit of a split or bifurcation from different types of off takers which actually results in slightly different pricing. Again, this might just be anecdotal but there are different classes of long term off takers, there are those who are looking at buying power with the forward curve in mind. So looking to get a decent deal versus the medium term forecast and pricing over a ten year period, say, or longer. Then you have got the corporates who are truly looking for additionality and looking to actually secure power in order to enable new infrastructures to be built. That is the really interesting thing because I think, we discussed earlier the oil and power pricing, what that seems to have done, at least through our analysis, is actually put a bit of an additionality premium for those looking for new build. There seems to be slightly different pricing for the additionality off takers than there is compared to the more utility or trading business off takers who are looking to trade power essentially in the wholesale markets thereafter. So you look at that delta and pricing and then you have the CFD auction coming up for onshore and you are going what could that end up clearing at so you benchmark it against the offshore CFD pricing from earlier this year or last year and you think the only onshore and wind projects and technology have been typically less risky to develop than offshore. So in theory pricing should be even lower. We are beginning to consider what it looks like compared to the corporate arrangements and whether it looks more like an additionality which in theory it should do given that the CFDs were only allocated to new builds or are they not. We question whether the corporate route might actually be more lucrative if you can get your head around the credit worthiness of the off taker. So it is interesting, it is very, very interesting. It is going to be a lot of jostling and testing the market to see the best approach. But for sure if the pricing of the CFD is as aggressive as we think it will be it will still work for the largest most efficient project. My suspicion is that it is the huge utility scale 100 megawatt plus projects that will clear on the CFD auction where you can really get below the 'levelised' cost of energy and the corporate world will be focused on mainly slightly smaller to medium sized projects where corporates have a fixed loan in mind which might be slightly less. So it will be interesting. It is a fascinating area and the economics that are behind it are extremely interesting.
Jonathan: Just a reminder to our listeners. So you mentioned offshore wind and allocation amount three so £39-41 per megawatt hour it cleared at in 2012 prices. Then Ireland, the last auction l last saw in early August €74 per megawatt hour in total so that was solar and wind. So I am just interested, both of you very quickly, roughly where do you think let's say AR4 has a reasonable enough allocation for onshore wind and solar. Closer to the offshore wind in CFD3 or closer to Ireland?
Barney: It might be it comes down to Gareth's point around the amount, the capacity they are going to procure. In Ireland they have very strict amounts of power or infrastructure that they need to build quickly and I think time is a key factor there. The way that auction worked was to get as much procured as quickly as possible and that created a form of competitive pension. I think if the GB auctions are restricted much more severely I think you will find pricing will be probably at the lower end.
Jonathan: And Gareth, what about you? You mentioned you had spoken to people who are perhaps looking at this as something nice to have and just pursuing a strategy. Others may be going for it with some gusto. What kind of competition is that going to create and impact on prices?
Gareth: I'll give you a one word answer. Low.
Jonathan: To flick around then did you think the Irish prices were high then? That's what it initially seemed to me. Obviously it's a first iteration of a new process.
Gareth: Well exactly and Barney said it well so I don't need to repeat it but it depends how you set up the auction and what you are trying to procure and how. So I do think that that was a different set of circumstances and therefore provoked a different kind of pricing outcome. So things could change, crikey they always do don't they, but I am not seeing other than a very low outcome. But I would be delighted to be proved wrong by the way.
Barney: I couldn't agree more.
Gareth: When I started doing development work in the subsidy phase I am not sure I could have quite understood how successful an industry could be built and how quickly it could be built. We are seeing now, every week we hear about records broken and what storm is causing record wind speeds and loads and if you look back that has been over a relatively short space of time and there is a lot to be proud of. The industry should be proud of that and I think what is really, really interesting is everyone predicted the demise in coal and that's happened. But look at gas right now. I am not sure any of us could have predicted a couple of years ago the demise of gas and that feels real right now. So this is going in that direction and the opportunity in this merchant phase is even greater than it was in the original phase. So there is an awful lot of work to be done and I just think there is a fantastic opportunity for many people and it is a vital part of growing our way out of this particularly nasty economic phase that we are in. So I just think it is a great opportunity and one that we should feel very proud of.
Barney: I couldn't agree more with Gareth's comments there. I think the renewables industry itself has come such a long way. You were talking about maybe lesser in Ireland, but here some of those CFD pricing from previous rounds and talking about procuring offshore wind at 2012 pricing but £39 of megawatt hours is extraordinary. Again, not necessarily to be negative about nuclear, but we know some of the CFD pricing on some of the big nuclear plants that are being built over the next decade and whilst you cannot compare oranges and apples of course it is really telling how far this has come. The future I think looks very positive in the sense that there will be further electrification of what we do, whether it's working from home, whether it's in the automobile sector. General digitalisation of what we do is going to be put a strain on the energy system as it already is and renewables is there and ready to be the source of energy of choice. I think that is great. You look at some of the geopolitical issues in the world right now and having a domestic source of energy as that grows and grows has got to be a huge side effect as well. It is a very, very – whilst times are dark right now and the suffering that is happening in the world right now, I think there is a real positive outlook and I think renewables are going to be a real cornerstone for that.
Jonathan: Thanks very much to Barney and Gareth there for their time and insight. The Joint Venture will return soon with another episode in partnership with Gowling WLG. This time drilling further into the financing market for UK renewables. We also have a number of other episodes in the pipeline looking at all sort of other topics in both renewables as well as infrastructure. So please do look out for those. In the meantime don't forget to subscribe if you enjoyed the podcast and haven't done so already. But for now all that's left for me to do is thank today's guests once more and thank you for listening. Goodbye.