Financing Wind 2017: Merchant risk raises offshore concerns

We are all aware of the huge steps made in offshore wind in the last 18 months. Falling costs resulted in record-low strike prices in the UK's Contracts for Difference auction in September, and zero-subsidy bids in Germany’s offshore wind auction in April.

But these astonishing results will make developers and investors more reliant on volatile and unpredictable market energy prices to get their returns, and increases the risks for banks and financial institutions when they finance new offshore projects.

So how will financing structures in offshore wind have to change following the falls? This is a question that panellists grappled with in the second session of our Financing Wind 2017 conference in London last week, with the UK proving an interesting case study.

This low-subsidy world is causing some concerns. Michael van der Heijden, managing director at Amsterdam Capital Partners, said bidders should “calm down” as the market might be close to a point where low strike prices hurt the sector rather than help it.

He said: “This risks growing out of control… The worst thing that can happen right now is that someone puts in a number and then he can’t get it done.”

Van der Heijden added that “saying banks need to take on board all the merchant risk is not going to be the answer”, and argued that the system needed a newer and more balanced approach in order to bring deals to successful financial close.

Carol Gould, head of power and renewables for the EMEA region at Japanese group MUFG agreed. She said higher exposure to merchant risk was the biggest risk that offshore wind is facing, and could push commercial banks into “wait and see” mode.

If this was to happen, Gould said there would be room for export credit agencies (ECAs) to get involved in financing new offshore projects. This is because ECA-backed funding would be better placed to adapt to the current changing financial environment – and is particularly useful in the UK with the spectre of Brexit.

Specifically, the UK offshore wind sector faces a loss of funding from the European Investment Bank.

The UK was the fifth-largest recipient of EIB loans in 2016, with most funding going to infrastructure projects. The largest portion of EIB’s funds - around 30% - went to energy projects, and the EIB has been important in backing UK offshore wind.

For example, the EIB provided a £525m loan for the construction of the 588MW Beatrice wind farm in waters off Scotland, and participated in the funding of the 353MW Galloper offshore wind farm with a £225m loan agreement. But the EIB’s aim is to invest in projects in the EU which, after Brexit, will not include the UK.

In September, UK Brexit secretary David Davis said he wanted the relationship with the EIB to continue after Brexit, we don’t see on what basis this would happen.

Gould said that “the UK should give some consideration to the support of the ECAs” to replace the missing support from the EIB.

We expect the UK offshore wind sector to grow strongly after Brexit, but this adds extra challenges for sure. The record-low strike prices in the last Contracts for Difference tender are a big step in the industry’s maturation, but they mean more merchant risk for commercial banks. Developers are already reducing risks so they can keep their investors happy, but they should also look at how ECAs could provide support.

Denmark’s EKF and Germany’s KfW are among the most active ECAs in the wind sector, and might be a solution for the Danish and German manufacturers that plan to export to the UK. Even with Brexit and low strike prices, we are positive that UK offshore wind offers plenty of opportunities for overseas companies.