Institutional money for renewable investments: hard work to make a ‘natural fit’ suitable
November 2014 | SPECIAL REPORT: ENERGY & NATURAL RESOURCES SECTOR
Financier Worldwide Magazine
Investors who are managing long-term institutional money, such as for life insurances, pension funds or family offices, seem to be the logical partners for renewables developers in their preparation for more complex future markets. The general parameters for long-term investment into European renewables are positive. Developers have the market access and the expertise while institutional money is looking for investment opportunities. However, both sides still need to do a lot for a mutual understanding.
Over the last two years, many incumbent players perceived the renewable markets as being in a critical status across Europe: would there be sufficient and reliable further support for renewables (or would coal ‘win the race’), and would there be a place in the market for the ‘traditional’ set of players, such as developers, innovative manufacturers, project financing banks, cooperatives or retail funds (or would the even more traditional utilities win).
As of today, we can be fairly certain of Europe’s long-term support for a transition towards renewable energies – not necessarily because everyone would be convinced that a ‘greener’ Europe is going to be a better place, but because renewable energy sources are the only resource that Europe does not need to import, and because onshore wind and photovoltaics have generally proven not to be far more expensive than any conventional method of generating electricity. The new ‘Guidelines on State aid for environmental protection and energy 2014-2020’, in force from 1 July 2014, provide a comprehensive statement of Europe’s current ideas for integrating renewable sources into the power markets.
However – and that reservation could be an important one – the methods in which Europe is supporting renewables will change substantially over the next few years. The European rules already require member states to abstain from many national peculiarities and to apply market mechanisms instead of protectionism. In future, these fundamental principles will also apply to the electricity markets. Subsidising a new interconnector with your neighbouring countries? Yes. Creating a national capacity market to support flexible gas fired power plants? Perhaps rather not, unless you are able to convince the Commission in Brussels that there are no other ways to avoid the hibernal blackout; and in a single market, there could be many other ways.
Not unlike other transitions, such changes to the support mechanisms will often hurt as much as they create opportunities for new entrants. So, despite general support for renewables, it seems that one should expect changes among players in the market. The new state aid rules require that power plant operators take a certain market risk, and that support levels have to be determined through competitive tenders, which means that the concept of uncomplicated feed-in tariffs is already set to be phased out. Marketing electricity will have to reflect that it does not have identical value 24/7 around the year, which may include the fact that operators will be unable to sell every single kWh produced as they did under feed-in support schemes.
This said, if complexity increases, and income becomes more volatile, individual power projects will need more buffers built into their financing models, and should envisage less debt leverage. In view of future operators’ marketing (and balancing) obligations, the advantage could be for those investors who are able to group a bigger number of generation facilities. Future tender participation rules in the different member states still need to be developed, but they may well include minimum financial requirements and more investment before the necessary support is granted. All indicators seem to point in the direction of higher equity requirements, namely during development and construction. Examples such as German developer Windwärts show how quickly a scarcely capitalised company can run into a challenging situation.
Some developers will simply be taken over and become part of bigger organisations developing and operating power plants, including utilities companies. This type of consolidation is already occuring. In many cases, however, family-run and mid-cap companies would prefer to remain independent, in which case it looks like a perfect solution for them to enter into partnerships with financial investors: managers of long-term institutional money could become their periodic customers, set up funds, provide financial guarantees, back construction finance provided by commercial banks, etc.
However, there are a few gaps to be overcome between developers who are used to focusing on the technical qualities of the projected plants and investors who are concentrating on the long-term, risk minimising placement of their funds. Many asset managers acting for insurers or pension funds are relatively new market entrants who still need to become familiar with the concepts of market risk arising from the new European rules. Regrettably, many developers are not the ones who would bring that type of know-how to the table, as they are typically used to establishing their calculations based on feed-in tariffs using only wind yield as a variable.
Still, there are developers and investors around working on making such partnerships a success story. Developing a common understanding of the opportunities in the developing European markets seems to be the starting point for such ventures. Full transparency of all relevant risk factors, and sharing of potential upsides, can then establish the basis for broader cooperation. Finally, repeat business with established standards between the partners can help reduce overhead costs – and preserve parts of the margin which otherwise would fall victim to market change.
Jochen Terpitz is a partner at Simmons & Simmons LLP. He can be contacted on +49 69 90 74 54 51 or by email: firstname.lastname@example.org.
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