European Banks: developers must structure new power projects to mitigate risk in order to successfully obtain finance.
With banks facing ever-tighter regulatory and reserve requirements, project developers in the electricity sector, including state-owned utilities, must structure their schemes most carefully to minimise risk if they are to obtain effective finance in coming years, according to a report by KPMG, published today.
The report - Power Sector Development in Europe – Lenders’ Perspectives 2011 – notes that the European electricity industry will need an estimated EUR 1,900bn investment over the next twenty-five years if it is to meet both increasing electricity demand and ever-tightening environmental standards.
Based on interviews with a selection of top European banks, the report concludes that the financial sector is confident that the capital will be available for the numerous, complex projects that need to be undertaken in the coming decades, but only if the project developers address and minimise risks appropriately.
“Regardless of whether we are talking about wind farms, new gas-fired plants or the latest ‘smart’ transmission grids, senior bankers made it quite clear; if projects are well prepared, with transparent, manageable conditions, then money will be available – but only under those terms,” says Darryl Murphy, Partner at KPMG in Global Infrastructure.
The report indicates that according to best estimations, some EUR 1,000bn will be needed to fund the creation of over 600GW of new generation capacity across Europe in the next 15 years. Of this money, roughly 24% will be required for wind turbine schemes, and a further 18% for solar energy, though substantial new capacity in more traditional forms of generation, including coal, gas, hydro and nuclear, will also be required.
While western Europe will absorb the greater proportion of this new capacity, due to the expected higher growth in demand in central and eastern Europe (an annual 2.1% growth, versus an expected 1.3% in the more mature western Europe) – the region will also need proportionally more investment in new capacity to replace its aging power infrastructure assets.
In view of the expected competition for capital, project developers will need to take a long hard look at the risks and other various barriers to funding that are of paramount concern to potential lenders. According to the respondent banks, the list begins with an aversion for merchant power plant projects lacking long-term Power Purchase Agreements (PPAs).
“Lenders generally avoid high exposure to merchant risks, [yet] securing the desired long-term off-take is increasingly difficult for project developers to achieve,” the report notes.
Other primary concerns include construction risk (most particularly with new nuclear plant, but also with specialised generation schemes, such as off-shore wind farms), covenants in place, return/cash cover ratios and, most critically, a stable regulatory environment.
“Without exception, all banks stressed the fundamental importance of a stable and supportive regulatory regime for the success of any project finance deal. It is vital for lenders that governments create trust, and provide clear guidance and robust legislation in support of a specific project or technology,” says Peter Kiss, KPMG`s Global Head of Power & Utilities.
In particular, banks voiced the strongest concerns over retroactive legislation, as this practice totally undermines business models that have been painstakingly constructed, causing both wasted effort and creating deep frustration.
“Legally binding assurances that there will be no retroactive legislation affecting schemes once deals are signed will significantly add to the bankability of projects,” Darryl Murphy adds.
The report also highlights the increasing importance of environmental and social aspects of projects. The vast majority of respondents said that their institutions had adopted the Equator Principles as their benchmark for assessing and managing social and environmental risk associated with project financing. Projects that fail to comply with these principles will thus struggle to win financial backing.
“Without doubt, to be successful new, capital intensive power projects must pass through an increasing number of stringent hoops if they are to pass the financial muster. Developers who pay close attention at the planning stage and get the basics right will get the finance - and at an appropriate cost - for much needed future investment into the electricity sector. Those that do not, will struggle, and could ultimately pay a high final cost,” says Peter Kiss.
Power Sector Development in Europe - Lenders' Perspectives 2011
Lead arrangers active in the Europe, Middle East and Africa (EMEA) region were interviewed using a structured questionnaire prepared by KPMG’s Power & Utilities Knowledge and Resource Center, regarding lenders’ views on the main aspects and perceived/actual risks of financing power and utility projects in Europe.