Jon McNair: hello and welcome to another episode of the joint venture podcast that delves deep into the global renewal energy and infrastructure sectors. I'm Jon McNair and this week we are back with the second of two special episodes in partnership with Gowling WLG.
In this episode you will hear a recent conversation I had with Nath Curtis a banking and finance partner at Gowling WLG and Chris Williams head of project finance at the bank LBBW.
Nath, Chris and I focussed in on the financing perspective for UK subsidy free renewables project taking in topics such as the impact of proud price movements, the impact of COVID‑19, what the optimal power purchase agreement looks like and the prospect of subsidy returning to onshore wind and solar.
Other issues on the agenda included the longer term viability of either fully merchant projects, or those of at least some form of merchant exposure as well as how the level of government intervention stacks up against the requirements to meet the binding decarbonisation targets the UK has set.
So let us hear more from Nath and Chris now as they give their perspective on all these issues.
Well, thanks Chris and Nath for joining me today on this episode of the podcast and we are here, of course, to talk about the crucial financing aspect of non-subsidy renewables projects in the UK.
Nath, perhaps we could kick off with you first. What is your general kind of view on the current landscape in the market for financing projects?
Nath Curtis: Sure Jon. Thank you. It is an interesting stage I think in the market at the moment. We continue to see a lot of activity as we have done over the last few years in the secondary market, by which I mean really portfolio refinancing and M&A activity.
While I think there is less certainty and this is not just a function of what has been going on with COVID-19 but has been the case for various factors for several years now, is on the new build/construction side and I think there, developers of renewable projects are facing a number of interlinked challenges.
Which really are created by the level of uncertainty that we have in the market at the moment which creates a real lack of visibility around long-term cash flows and I think there is no single cause of that uncertainty? I think it is a combination of different factors.
But it is clear that until some of those things at least start to become a bit more transparent, I think we are going to continue to see contraction in the construction financing market for new projects.
Jon: Okay. And Chris, your view? Nath mentioned a number of uncertainties there, are you feeling those to?
Chris Williams: Yeah, very much the same Jon. We, as a Landesbank - we are very much focussed on the subsidy projects rather than basically non-subsidy projects but that said, obviously with deals that Nath said are going through re-financing portfolio, re-financings. The old ROC deals, they do have an element of non-subsidy within them anyway so there is an element of market risk and we do look at those transactions but we are not really going to the full non-subsidy deals at the moment?
I think the market itself is very much - with CFD prices on the offshore for example, having fallen to below £40 a megawatt hour now, there is a mix coming through with regard to elements of market risk, more market risk in transactions which is being supported in various ways by the developers and the sponsors to make lenders comfortable or more comfortable and obviously there is a tipping point as to how much leverage can then put into those transactions as well.
I think we are at a crossroads. Certainly from our perspective, we still see that there are opportunities in the CFD market for offshore winds. For example, in Ireland at the moment, RES has just come into play which is a subsidy regime, it is a non-index from a revenue perspective, which we are working our way through as well.
There are definitely opportunities there where we can still see projects with subsidy and from my perspective, we cover UK and Ireland so that is good news to look at those and we are looking at various solar and wind deals at the moment over there.
Jon: And you mentioned CFDs there and RES and perhaps we can come onto those processes specifically a little later - least of all because onshore wind and solar could come back to the CFD process in the UK.
With projects with CFD or projects entirely non-subsidy, you were saying lots of PPAs obviously and on those deals, Nath from your perspective, how is the PPA side of things evolving across this year? Has there been a big impact from things like chief of all, I suppose, COVID and its effect on power prices.
Nath: Yes. I think to an extent there has Jon. If you look at the demand curve for power in this country throughout the year, I think we are about 5% down on a year by year comparison back to 2019 for July in terms of demand.
The August figures I think are due to be release next week, so it will be interesting to see whether that gap is being made up now that people are attempting at least to go back to work and also some semblance of return to normality in social life as well.
There clearly has been an impact on both their head prices, but also the long-term power curve wholesale prices too. But I do not think we can blame that entirely on COVID? There was already some uncertainty I think in the power pricing market before this happened and that is where the CFD instrument, I think, is going to become important again for onshore developers.
We have seen CFDs roll-out into the offshore space, in my view very successfully. I think, by and large, it has done what it was designed to do in the offshore market and it will be interesting to see whether - what comes out of the current consultation.
We are talking about the impact of COVID of course. Really basic impact it has had, including the delay to the consultation period under the CFD onshore current consultation - that was pushed out by a month because of COVID. We are still waiting to see what the shape of that will look like and what capacity and over revenue caps the government will seek to place on the overall CFD scheme and indeed, whether it will - as I think it is minded to do - create or go back to the creation of a Part 1 Scheme to establish technologies excluding offshore wind so that onshore wind is not asked to compete with offshore wind.
We are just going to have to wait and see how that process plays out, but I think if we are talking about unsubsidised projects in the absence of a CFD, then I think it remains difficult.
There has been lots of discussion, for a long time now really about the availability of corporate PPAs. What we are seeing is that they remain fairly elusive? Particularly on the long-term price certain basis that developers need in order to get asset life cash flow certainty.
And then, there are some - there is some semblance I think of a return to the utility floor PPA model? And again pricing under those contracts I think is difficult to make things work economically because of the impact of COVID but also other factors on the long-term power price curve.
Jon: And just picking up on that last point and throwing it to you, Chris. Nath said, it could be difficult to make the economics work on those kind of deals. Is that what you are seeing as well?
Chris: what we are seeing is the electricity prices for various reasons, including COVID have fallen. I still think there is a way you can make deals work. Whether you buy financial structuring and other ways of changing the economic. You may not have the leverage that you had originally in a transaction, or pre-COVID but deals can still work and also, the design life of these assets is getting longer so therefore there is also a natural ability to either look at re-powering or basically, extending again after a term.
I think there are ways we will be able to manage these. I think it will be different from what we had before. But least, at the moment, what Nath was saying about 5% down on prices at the moment on the wholesale market, we have definitely seen that and maybe a little bit more to be fair, as a consequence of the Q1 numbers that came through for 2020 pre-COVID/post-COVID and the expectation that it will take a few years for those prices to ramp back up again.
So all of those things are going to have an impact. We are still seeing deals close! The good thing is, the market is still as robust as it has been pre-COVID and I would say we have seen an awful lot of opportunities coming through across our desk.
If you look Seagreen which was the latest offshore wind transaction that closed almost in the eye of the storm. It started pre-COVID. Closed slightly into May and effectively was underwritten, got away.
Deals are still being done. Yes there was a spike in reduction in electricity prices. Increases in costs of funds. All of these things had to work their way through. But I think we are getting back to much more normality now in terms of costs of funds but for banks than we were at the beginning of COVID.
Electricity prices will take a while to come back, but deals are taking longer to close - we have definitely seen that! But they are still closing! And we look forward to seeing the next round of green field deals coming through but there are still those opportunities which may have been put on the back burner from a refinancing perspective - taking a bit longer to be done. But they are still being done.
We closed a refinancing in the middle of August which was an onshore wind portfolio. So the deals are still out there to be executed, which is great news.
Nath: And I completely agree with that and I think, if you look at the long-term position. The fact is, which makes the UK renewable industry so attractive remain very much in play. We have to get to net zero by 2050. The estimate is that we need a hundred gigawatts of new low carbon electricity generation in order to be able to hit those numbers.
So that is a huge amount of development that remains to be required in order to reach those ambitions and I think if you combine that with - as Chris was alluding to, the advancement in technology - albeit it there are still, for onshore deals, some planning restrictions which make taking full advantage of those advantages slightly more difficult.
But also, the lowering of the costs in the supply chain which is remarkable really. If you look at where we were five years ago even, in offshore wind, people are now getting CFDs for under £40 a megawatt. It is just incredible advance in supply costs.
For those reasons, there will be, over the long term, tremendous opportunity in the renewables market and some of that will have to be unsubsidised because the subsidies are not going to be there for every project.
The good developers will - as they have been doing already, take advantage of those market conditions in order to be able to get new projects away.
Jon: Picking up on something you said there Nath. The massive reduction in costs we have seen over the past few years and the development of technologies. Perhaps if I turn that to you Chris, lead us onto perhaps the prospect of pure merchant projects.
I know that is not something that you - or particularly many people do - at the moment, but what would it take for that to become a viable reality?
Chris: I think the points that you make on the lower end of the cost of the capital expenditure, the design life of assets make the ability for an asset cost to be looked at differently with regard to an unsubsidised, maybe a corporate PPA as you said that is there.
From my side? If you go back to corporate PPAs you have got to have the right one. Are you comfortable with it from a lending perspective and basically it is underpinning the electricity generation.
There will be opportunities here and subsidies are coming down, they are getting lower all the time so there is going to be a need to replace this. Particularly as Nath said, with regard to net carbon - zero by 2050. The amount of turbines that are going to be needed to generate that electricity.
I think I read something only today which was suggesting it was about another six and a half thousand turbines. I think these things will evolve! I think that people have been very used to the subsidy regimes and the way things have been done in the past. It is a learning curve for everybody to go on a different journey in a different way.
That takes time. There have been some deals that have been done and in other jurisdictions you see more of that, already. In Scandinavia for example.
The UK market has not had to see that to date because of the way the subsidy regimes have worked. It will just evolve over time I think is how I see this and it will evolve as quickly as people can get themselves comfortable with the risk profile that exists.
Jon: In terms of getting comfortable Chris, you mentioned PPAs there and the right PPAs. What does that specifically look like for you at the moment?
Chris: The right PPA is going back to the basics. Strong counterparty, underpinning. Whether it is just the PPA - not seeing floor prices in the PPAs anymore. But it is just a route to market PPA. But it is whether the right counterparties have got lots of experience in this. You are seeing different ways of people approaching the bay ahead market and the intraday markets now.
You just want to work with the right people that understand how dynamic our environment is, with regard to electricity at the moment - and it is dynamic. It really is dynamic, so you just want to work with those people that have a very good understanding of it.
Jon: Okay. And then, Nath on deals you are seeing. Are you seeing any coming across your desk these deals with a sort of sizeable merchant element at all? Or is that still some way off?
Nath: My sense is that it is still some way off for UK renewable generation projects? There are some sectors where people have been able to raise limited recourse which are essentially banked on a merchant basis and in particular the storage sector I think is interesting.
Somewhat counter-intuitively it will be interesting to see whether we can learn some lessons from what has happened in storage and apply these lessons into more established sectors. But one of the issues is the sample size for that technology is very small and deals tend to have been done on a very bespoke basis.
So whether you can draw real conclusions from those deals that have been done in the market and apply them generally, I am somewhat kind of sceptical about that.
The other option that some developers will have, of course is to wrap an element of merchant risk into bigger portfolios. Particularly where they have assets - operating assets especially - they already have access to ROCs or FITs or CFDs and can use those projects to leverage additional capital to be able to fund the build-out of unsubsidised/merchant risk projects, but equalising the risk to lenders in particular because of the portfolio effect.
Chris: I was just going to say, that is a really good point because effectively you can bring your existing portfolio together with new green field development and wrap it together so that you are equalising that risk for lenders in such a way that you have got a portfolio diversification approach.
You have got a wrap of lots of assets together and effectively overall, one piece of it could be seen as merchant - fully merchant but effectively it is in a portfolio with lots of others that are wrapped by ROCs and FITs etc. CFDs. I think that is definitely one way that you can start to see that moving forward for developers with their existing portfolios.
Jon: We have spoken a moment ago about power prices and what happened this year on that and where we are compared to last year. What are you both hearing on the longer term forecasts for power price? I am sure it is something you keenly keep an eye on, particularly if you are investing potentially longer term or working on deals or assets that are very long-term now.
It did seem to be a sense that they were softening anyway before the crisis this year? Where are we headed over the next year's power prices? Chris, perhaps if you want to go first.
Chris: I think there was a softening. I think there was a softening coming anyway. As you have got more in-store capacity coming through anyway, which just seemed to be a natural evolution as we go closer to carbon neutral by 2050 as well.
But I think it was exacerbated by the fact of COVID and the fact that the supply and demand dynamics completely changed with lockdown and no-one working and no need for that utilisation of energy, electricity.
I say, I think it was quite stark at the beginning of April when effectively you started to see how much was not being used. Gas prices fell, oil prices fell. Everything was in the same boat and it has taken a while for that to come back. If you think we have been in lockdown for nearly six months now and we are only now just starting to see tentative steps of coming back to offices and people coming back.
That is going to take an awful lot of time to get back up to the levels that we were pre-March but it is going to happen. The forecast is very much softly growing back. As I say, probably over a 4/5 year period to where they were before, but I think the trajectory is always going to be towards lower long-term electricity prices anyway. I think that was always going to be the end game in terms of where we get to.
We have had this spike, this dip because of COVID but effectively they will be flowing that way on a long dated basis.
Nath: Yes that is absolutely right and I think we would not be able to say that the renewable energy industry as a whole had been successful if we were not seeing that long-term trajectory towards cheaper power prices. The whole point of why we all turn up to work, in that regard it is both inevitable but also welcome as well.
The flipside of that is it is more difficult to get projects away than the market has to respond to that but the answer is not to wish for higher long-term power prices necessarily.
I do think that playing into this will be the further electrification of transport and also heat and it will be interesting to see what impact those things has on the power price and the electricity market long-term.
As we move away from diesel and petrol fuelled cars. Particularly in public transport too. And to see whether we can get a proper electrification of heat industry in this country or whether we will continue to rely on fossil-fuels for heat over the longer term. I think that will be a really interesting development but I do not think anybody really knows quite how quickly that change is going to come about at this point in time.
Jon: Well if you take personal vehicles on their own and maybe come to heat in a separate conversation. There is something like thirty million cars in the UK - private vehicles. If even a chunk of those go electric anytime soon that will surely have an impact would it not? I mean what do you think Chris?
Chris: Yes. I think it will do. I think that the infrastructure has to be there for the vehicles though and certainly been hearing various people say that we would consider moving to electric vehicles if there were more charging points, for example. We were not worried about having to look at an app to make sure that I was not going to run out of distance before I could get to the next one if there was more of those around.
I think it will go in that direction. Having worked from home for the last several months I have seen more electric cars around now than ever before and I think it is going that way but I think it needs the infrastructure to support that move - maybe in a more focussed way at the moment to enable people to then make a more informed decision as to say, well actually yes I now feel that I can go to an electric vehicle.
Obviously price point has another impact on all of this and obviously probably there is still a bit of a way to go to bring that price down as well. I think it is moving that way, but there is a few things that the cars can be built but effectively users need that infrastructure behind it to support it.
Nath: Yes. That has got to be right and there is no doubt that there are some issues with that at the moment. There are a number of people providing the infrastructure but my sense is, it is not yet fully harmonised? Such that people want to have certainty they are going to be able to find somewhere to charge them to, that when they do it will be compatible with their particular make and model.
There is also, I think, some of the pragmatic concerns that people are beginning to raise and find as electric vehicles become slightly more popular.
One is around security. Particularly where people are trying to charge late at night into dark corners of car parks where charging stations have been placed and do not feel particularly safe? That sounds like a slightly ridiculous example, but actually that is the kind of thing that really will affect people's decision-marking about whether to go and invest in an electric car or now.
I think where the market is more buoyant is where the vehicle operator can control the infrastructure a bit more? By that I mean particularly in public transport, so buses and also HGV fleets. We are seeing now, and a client of this firm actually is developing a product they are leasing the battery or the batteries for the vehicles but also installing them and maintaining the charging infrastructure on site at the client's premises as well.
So offering integrated infrastructure and battery solution and I think those kind of models that clearly they are only viable where there is critical mass within the client, but those models are interesting and they put the developer in a position where they can solve the infrastructure problem at the same time as providing the battery solution.
There is some work being done around that but whether and how quickly that will spread into or cross over into the private vehicle space, I think remains to be seen.
Jon: If we bring it back to renewables generation and I wanted to pick up on the CFD. I mean we mentioned it a few times and we spoke very briefly on the consultation that happened this year, about re-introducing onshore wind and solar and ways in which that could work.
I guess, it depends - the impact that will have will depend on the ambition and the size of offering that could come about for onshore and solar. What do you think Nath? Is that a correct assessment?
Nath: Yes. I think that is exactly right and I mentioned at the beginning that there is uncertainty in the market at the moment. If I am a renewable energy - I am an onshore wind developer and I am looking at this at this point in time, then I am constrained by a number of different uncertainties and one of those uncertainties is: what is this 2021 round of CFD's going to look like?
What will be the expectation around the strike price? What will the availability be? Who will I be competing with and clearly we are not going to know the answers to those questions until we hear back from OFGEM with the results.
You would like to think that there will be something which is reasonably ambitious? But we have been through this so many times before. Where there have been fairly positive signals that have been then subsequently not quite lived up to expectation and one example that I would cite of that dynamic is the capacity market where people really struggled with pricing, fairly early on really relatively and the genesis of that particular support mechanism.
I do not think anybody is going to be getting carried away until they see the size, the shape and the detail of that support.
Jon: Chris, you mentioned right at the start, CFD projects are something that you obviously target and feel comfort with. Will there be a decent enough offering available do you think for guys like you and if there is, will those projects be so competitive compared to others outside of that framework?
Chris: Yes. I mean, just taking a step back I thought it was extremely positive to hear the noises that solar and onshore were going to come back into the market with CFD. I agree with Nath with regards to, we do not know what that is going to look like until we know what it is going to look like but I certainly take a lot of comfort at this point that they are thinking about this. They are moving things in the background in the right direction because effectively we need - we cannot just have overall reliance on offshore wind all the time so we need to be looking at the onshore and the solar and seeing where we can actually increase that.
I would like to think that there is possible for separate buckets? For different types of technologies, that would be helpful. So that you are competing with the same, not against other asset classes? Whether that comes to fruition I do not know but certainly that would be useful.
I do see that for us to get to this 2050 position that we want to get to, we have to be looking at all different asset classes to get there and effectively no over reliance on one technology is no bad thing.
Jon: And if you had to stick a finger in the air. I mean, in terms of prices - obviously traditionally onshore wind was cheaper than offshore wind - much cheaper, in the earlier iterations but we have already noted such great strides made by offshore over the past rounds.
With onshore coming back in, do you have any idea of where roughly that would sit alongside offshore?
Chris: I would not like to second guess it Jon, to be perfectly honest. I would agree with you though that basically if you see where offshore has got to, and where onshore started and so. We are going to see - it is going to be extremely competitive. Got to be extremely competitive and going back to the costs of development, the cost of manufacturing - every component has fallen in terms of its price, which is a positive, so therefore the strike prices will be lower. I would not like to put a finger in the air to say where it could go to, but if you look it is £39 on offshore now so it is going to be lower than that.
Whether we do start to see significant reductions from that level for offshore and solar, the trajectory looks like that is going to happen and that shows that the market is performing in the way that we expect it to perform but basically the cost of subsidy is reducing over time. The cost to the consumer is coming down over time.
All of those things are important and it is a drive down to make it sustainable, make it efficient at the least possible cost.
Jon: Just a final question then Nath, for you. Would the CFDs potentially on the horizon for onshore wind and solar, I am just keen to understand your experience of - in what sense do you think that developers are now looking at that and counting on that potentially? Participating in those situations or do you think it is just no, no-one is counting those chickens just yet and they will react and proceed on the basis they got used to over the last few years.
Nath: I think that is a really good question Jon. I was talking to the CFO of a UK renewable developer just last week actually and I will not name names, but it was a developer that had an interesting role shall we say in the position that the government has now taken, whereby it is has brought or saying that it will bring back onshore wind and solar into the CFD regime.
Therefore I think his view is a good barometer of the market view because he has been very active and vocal in that process and he was saying, we just do not know what is going to happen around this. We are really hopeful and we are actually quite optimistic but we have to be because, otherwise, what was the point of the work and the lobbying we have done to achieve this latest concession over the last few years?
They are probably as close to anyone around trying to predict what is going to happen? But there view is, look we have just got to wait and see and that is really the onshore wind space but it crosses into solar as well.
Solar is probably a bit easier to be honest? To develop in the absence of that CFD certainty. There are more sites available. You do not have the same - geographically that is - you do not have the same planning issues that you do with onshore wind and the competition for the best sites is potentially a bit easier.
But I think for both technologies nobody is counting their chickens but it will be a substantial boom for the sector if the news that comes out of the consultation process is material and significant.
Jon: Thanks very much to Nath and Chris there for offering up their expertise on what is the ever-evolving financing market for UK renewables. The joint venture will return very soon with more episodes on the global renewables and infrastructure sectors, but in the meantime do not forget to subscribe if you enjoyed this podcast and have not done so already. But for now, all that is left for me to do, is thank today's guests once more and thank you for listening. Goodbye.