Uncertainties around emissions, power plant licensing, local opposition to new infrastructure and the amount of government support for new technologies continues to blight banks’ enthusiasm for Europe’s power sector. Sarah Rundell reports.
It’s hardly surprising that lenders have shied away from Europe’s power sector in recent years. Overcapacity has plagued the market, with the economic downturn coinciding with new renewable, gas and coal generation coming on stream, and European governments not putting the policies in place to encourage project development.
Amid all the confusion however, there is one area of consensus: the need to overhaul ageing power plants and to support Europe’s transition to a low-carbon economy in time for new pollution goals. In the UK alone, taking installed capacity out of the mix (in line with European legislation) amounts to the dismantling of 12GW of power generation – equivalent to 13% of total installed capacity, according to research from the Clingendael International Energy Programme (CIEP). Investment in renewable generation also needs to be accompanied by interconnectors, storage capacity, smart grids and networks to transport electricity, representing €1,9tn of capital requirements according to the International Energy Agency.
Electricity demand is also starting to pick up, with the Economist Intelligence Unit (EIU) expecting electricity consumption in Europe to increase by 23% between now and 2025, led by growth in Central and Eastern European economies particularly. There may be enough supply to bridge the gaps for now, but Europe’s power providers need to begin extending their capacity and modernising. The industry is calling for governments to put in place loan guarantees, export credit support and, above all, clear regulation to get the sector moving.
Lack of viable projects
Commercial banks will play a crucial role in securing funding for Europe’s power sector. Newfound liquidity was on show last year when banks lent around 70% of the €2.8bn required for the Netherlands’ 600MW Gemini wind farm project in the North Sea – for which Siemens supplied 150 wind turbines. “Banks have got appetite to invest in the sector and have the capacity and liquidity. The problem is a lack of viable projects,” says Ralph Lerch, global head of export finance at Commerzbank. It’s a common complaint amongst lenders, who say that the quality of European power projects on offer and their level of development is the biggest pipeline bottleneck: well-structured projects that combine strict Equator Principles (EP) compliance with rules around banks’ capital requirements are thin on the ground. Even finding European projects that meet lender requirements around long-term electricity offtake agreements are challenging.
Additionally, downgrades in sovereign bond credit ratings have seeped through to national utilities, with the credit rating of Greek, Italian and Spanish utilities all downgraded since the credit crisis. As a result, some banks are favouring less risky transmission or distribution assets rather than power projects.
In another trend, although banks now have the liquidity and appetite for European power, Commerzbank’s Lerch points to changes in the structure and skills within the banking market, which have led to fewer banks being involved in the sector. “The number of banks with the capacity to assess sophisticated and complex power projects has shrunk, as has the number of banks who can actively do projects on a large scale, because of the different regulatory requirements,” he warns.
In fact, Europe’s shifting regulatory environment is one of the biggest challenges lenders face. In Germany, where the government is phasing out nuclear power and overhauling its energy policy in a shift from fossil fuels to renewables, priority is given to renewable energy in the grid. This has led to dramatic growth in renewables, with solar now meeting up to a third of the country’s generation needs, according to the Institute of the Renewable Energy Industry (IWR).
When solar and wind power arrives on the grid alongside other more steady streams, it forces other generators to switch off, and puts pressure on prices in a market already characterised by declining demand. This is creating uncertainties around investment in Germany, where gas-fired power stations have been mothballed, but also in neighbouring countries. For example, Germany’s renewables-led power surpluses have resulted in cheap electricity exports to Poland, causing a drop in investment there too.
According to research by Morgan Stanley, European utilities’ capital expenditure fell 10% in 2013, driven by the drop in conventional power generation. This in turn has impacted power plant equipment suppliers, like Alstrom and Siemens, with the bank predicting that “most countries in continental Europe will probably not build new fossil power plants this decade”, in a recent research note.
It’s not just conventional power plants that have been affected by new regulations. Regulatory changes have blighted renewable investment in countries like Spain, Italy and Greece, where governments began scrapping incentivisation schemes during the economic crisis in “an inconsistent approach that leaves projects bereft of the long-term stability they need”, according to one London-based banker.
Italy is planning to halt all solar incentives from its renewable energy support schemes, with major banks’ exposure to the Italian solar sector estimated at around €20bn. The UK too has reduced its support for solar installations.
The crash in the price of carbon credits has also stymied investment in renewable projects, though critics downplay the role of these credits in getting projects out of the starting bloc. “Green credits are important and a good source of revenue but they rarely make a dog of a project a good one,” says Kirsti Massie, a partner in law firm White & Case’s energy, infrastructure and project finance team.
ECAs take centre stage
ECAs have also grown weary of regulatory uncertainty, argues Enrico Lucciola, senior underwriter in Italian ECA Sace’s utilities infrastructure division. “Experiencing regulatory changes when projects are ongoing is not appreciated by lenders or ECAs when the economics of transactions rely on subsidies,” he says. He believes the continuing economic situation will confine most power projects to northern Europe where he sees greater renewable investment in offshore wind in the UK and northern Germany, forming opportunities around the transmission infrastructure for Italian cable exporters particularly. “Italy had her El Dorado of renewable projects between 2008 and 2013. We expect some greenfield projects particularly in geothermal and biomass fields, but the Italian pipeline’s not as huge going forward in this sector as it used to be in the past.”
Despite commercial banks’ increased liquidity, Lucciola believes any northern European projects might still seek ECA cover. Banks have to build larger capital buffers to absorb potential losses on loans that are long-dated, making debt expensive to hold. “ECAs are backed by governments so the capital requirements from the banks might be lower. This could put ECAs again at the centre of the scene, even in geographies perceived as low-risk such as EU countries” he explains.
In riskier European economies ECAs have proven crucial players in big power projects. “Banks struggle in riskier markets and it is here that ECAs really give the additional firepower,” says Calvin Walker, a partner at law firm Baker & McKenzie. In 2013, German ECA Euler Hermes provided guarantees on a syndicated loan to Greece’s Public Power Corporation to build a lignite power plant in northern Greece. And Turkey saw its biggest investment for years when a syndicate of banks, multilaterals and ECAs backed Saudi-owned ACWA Power’s US$1bn combined cycle gas turbine Kirikkale project last year. In fact, Turkey is so flush with local bank liquidity, development finance institution (DFI) and ECA support that international banks complain they have been pushed out of participating in the fast-growing market, with demand predicted to grow at 5% a year between now and 2030 and a swathe of projects in the pipeline.
One area where Turkey may struggle to attract future ECA or DFI support is its plans for new coal-fired generation, as OECD discussions now centre on cutting support for these projects, and member-nations (two-thirds of which are European) have already started to exit or reduce their support for coal on the ECA side.
Data shows OECD members have provided almost five times as much in export subsidies for fossil-fuel technology than for renewable energy in the last decade. OECD preferential loans and state-backed guarantees for fossil fuel technology exports are valued at US$36.8bn between 2003 and 2013, including almost US$14bn for coal. The figures will certainly fuel the debate on how to better target funding to reduce climate change, ahead of United Nations talks in Paris due to take place at the end of the year.
In another development the European Bank for Reconstruction and Development (EBRD) has said it will now scrap most assistance for coal-fired power plants. “Given emission restrictions, coal-fired projects in Europe are unlikely to get many new builds that don’t incorporate carbon capture and storage,” predicts White & Case lawyer Mark Castillo-Bernaus.
Some ECAs are also under pressure to step away from nuclear. NGOs are lobbying for Italy’s Sace to stop any financial guarantee of up to €500mn in favour of the Enel-sponsored Mochovce 3 and 4 nuclear power plant project in Slovakia. Germany has stopped issuing Euler Hermes guarantees for nuclear power plants in line with the decision to phase out nuclear by 2021. In the UK, lenders are cautious about financing new nuclear plants, citing the high level of construction risk, including cost overruns and any deterioration in the economics of a project. “Many will line up but it remains to be seen what the funding mix will be,” says Baker & McKenzie’s Walker. For now, the UK general election and a possible change of energy strategy are stalling any real lender enthusiasm, making policy uncertainty the spoke in the wheel again.
Despite forecast growth in energy demand, the lack of projects in Europe’s power sector is holding back the market’s potential.
Policy uncertainty has knocked investor confidence, and as long as growth remains muted in key economies, demand for new power plants will be low.