Financing the Energy Sector

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New channels of finance are opening up in the energy sector alongside traditional funding routes, as Mike Scott discovers

The world needs a whole lot of energy infrastructure to be built over the next few decades. In the UK alone, the government estimates £100 billion must be spent by the end of the decade, while the European Union says €200 billion must be spent just on interconnectors to link the different markets of the EU to each other to enable a single European energy market.

Much of this funding will continue to come from traditional sources, such as utilities, banks and institutional investors, but a growing proportion will come from less conventional sources, ranging from crowdfunding to yield companies and green bonds.

“Traditional investors will continue to play a dominant role in funding renewable energy projects in the UK, particularly in the wind, solar and biomass sectors. However, newer forms of funding add an interesting dynamic to the market and there are enough opportunities for all parties to participate,” says Vivian Nicoli, a partner at Eiser Infrastructure.

Commercial banks will continue to figure in the financing of large-scale renewables projects, agrees Rinku Bhadoria, a partner in the energy and infrastructure group at King & Wood Mallesons SJ Berwin. “Importantly, they have the experience and capability to take construction risk for well-structured large-scale projects,” she says.

While the role of utilities in direct investment has diminished as their balance sheets continue to shrink, they are nonetheless a crucial part of the market because they provide long-term power purchase agreements to developers, giving them the security of stable cash flow returns and helping them to raise the money needed to invest in projects.

GREEN INVESTMENT BANK

And there is a major new player on the scene – the UK Green Investment Bank (GIB). The bank was launched in 2012 as the first investment bank worldwide to invest solely in green infrastructure projects, which would otherwise lack funding because of their risk profile. The government gave the GIB £3.8 billion to invest, but it is prevented from raising money on the capital markets until the government has brought the deficit under control.

Given that there is little prospect of this at the moment, many people think the GIB, which has so far invested £1.4 billion, is unable to realise its full potential. However, says Ms Bhadoria, it has recently won state aid approval from the European Commission, allowing it to manage and co-invest alongside private capital. This has led to plans to launch a £1-billion offshore wind fund to buy operational wind assets, giving the sector a much needed boost.

Energy funding is splitting into two distinct types, says Richard Goodfellow, head of energy at Addleshaw Goddard. “First is the large-scale funding for infrastructure, such as power stations, where traditional forms of finance will still dominate, with some innovative twists such as Infrastructure UK [Treasury] guarantees.” These guarantees will help certain projects to secure funding by using the government’s balance sheet to underwrite them if commercial backers do not come forward.

“There have been a number of innovative new mechanisms that have helped to channel funds to renewable energy projects in particular”

Among projects set to benefit from the scheme are EDF’s new nuclear power station at Hinkley Point, a number of gas-fired power plants, a wind farm in the Forth Estuary and a biomass generation plant in Bristol.

While the government is looking to encourage more private-sector capital to invest in energy projects, increasingly the very largest projects, such as nuclear power and offshore wind farms, are only being funded by state actors, including the mainly French-government-owned EDF, Chinese state-owned companies, the Danish energy utility DONG and its Norwegian counterpart Statkraft, both of which are government-backed, says Ian Temperton, head of advisory at the investor Climate Change Capital.

The second type of project is at a more local and business level as the energy system becomes more decentralised and decarbonised, Mr Goodfellow says. “Alongside ‘new’ money from pension funds, you have the GIB and allied funds which are very active in the market. Balance sheet businesses are also much more likely to take control of their own energy destiny,” he says.

However, many large investors are holding off making large investment commitments until after next year’s general election because of the growing belief that energy policy has become too political. “The key lesson to learn from other countries is to rebuild the political consensus on energy,” says Mr Goodfellow. “You cannot expect large-scale investment if you are reforming the system itself and a bipartisan approach has broken down.”

In addition, the government’s Electricity Market Reform, although welcomed by many investors, will add an element of uncertainty until new features, such as contracts for difference and the capacity mechanism, are bedded in and the market sees how they work in practice.

There have been a number of innovative new mechanisms that have helped to channel funds to renewable energy projects in particular. It was hoped that the EU Emissions Trading Scheme would provide a big boost to the clean energy sector by making high-carbon projects more expensive, but the carbon price has been too low as a result of political interference and the financial crisis.

GREEN BOND MARKET

A more encouraging development has been the emergence of the green bond market. Green bonds are debt instruments in which the money raised is ring-fenced for climate-friendly projects, such as wind farms, solar parks or energy efficiency measures. The market is growing at a startling rate; it is expected to top $40 billion this year, up from $11 billion in 2013, and according to the Climate Bonds Initiative, $100 billion of green bonds will be issued next year. This is still a small fraction of the global bond market, which is around $80 trillion, but if growth continues at the current rate, it could soon become a significant asset class in its own right.

There is every chance of this happening given that at the recent UN Climate Summit in New York, investors with $2 trillion of assets under management, including Zurich Insurance and Aviva Investors, committed to help grow the market. One of the signatories, Barclays Bank, announced plans to issue £1 billion of green bonds in the next year.

Another new instrument makes use of the equity markets rather than the bond markets. Yieldcos are organisations that raise money by listing on stock markets and use it to invest in renewable energy projects, paying investors dividends out of the income earned by generating power. Many project developers list yieldcos, sell their projects to them and use the proceeds to invest in new developments.

Yieldcos and green bonds are not mutually exclusive. Abengoa, the Spanish energy company, has recently issued a €500-million green bond, and also sold two solar plants and a wind farm to its yieldco.

Crowdfunding is another phenomenon that has shaken up energy investment and it has significant potential to become an established form of financing for small-scale renewables projects for two reasons, says Ms Bhadoria. “Firstly, it provides another source of capital for funding energy projects and promoting more competition, by allowing startups and medium-sized players a route to market alongside the more dominant players. Secondly, it empowers local communities to engage directly with the issues they face regarding energy supply and demand,” she says.

The UK crowdfunding market is growing fast, but remains in its infancy. However, the potential is shown by the German market, where £54 billion has been raised since 2005 from crowdfunding platforms, meaning that 50 per cent of Germany’s renewables capacity is now community owned as a result.