PwC Offshore Wind

7/31/2019 PwC Offshore Wind

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Energy, utilities and mining

Meeting the 2020 renewable energy targets:Filling the oshore wind fnancing gap


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Meeting the 2020 renewable energy targets: Filling the oshore wind fnancing gap

PricewaterhouseCoopers Energy, utilities and mining 1

Introduction 2

Executive summary 3

1. The UK renewable energy targets 5

What are the targets?

What are the implications or power generation?

2. The make or break role o oshore wind 6

How much needs to be built and how ast?

The pre-construction fnancing gap

3. Resolving the pre-construction fnancing issue 10

Who could invest?

What would make them invest?

Attracting pension and lie und investment

4. Moving orward: solutions to boost pre-construction fnancing 12

Solutions to reduce construction phase risk

Solutions to improve short-term returns

Contents


4/20PricewaterhouseCoopers Energy, utilities and mining


The UKs power utilities sector aces immense investmentchallenges over the coming decade. The main challenge is the partthe sector needs to play in responding to climate change andprotecting security o supply, whilst keeping energy aordable tothe consumer.

Oshore wind generation is a key component o the renewable energy strategy, and

will be critical to achieving the target to deliver over 30% o electricity generationrom renewable sources by 2020. While there are a number o challenges to deliver

signifcant volumes o oshore wind, the most signifcant is likely to be the

availability o fnance to support the construction phase o oshore wind projects.

In this report, PricewaterhouseCoopers1 (PwC) looks at the role that oshore wind

needs to play in delivering the renewable energy strategy, the investment levels

required, and the constraints on securing that investment. A quantum leap in

oshore wind capacity is needed and, with it, an equal leap in investment i we are

to avoid a situation later in the decade where time runs out on the UKs ability to

achieve the 2020 renewable energy target.

At a time when the new government will be considering the best way to respond to

the considerable energy challenges acing the UK, our report outlines our solutions

that could resolve the pre-construction fnancing constraint acing oshore wind.

The solutions seek to specifcally address the barrier to investment by creating

mechanisms to either limit the risk associated with the construction phase or to

improve short-term returns, without unduly pushing excess costs on to the consumer.

These are starting points rather than fnal answers and we hope they will help

stimulate debate on how best to attract greater oshore wind arm investment.

Michael Hurley

Partner, Global energy, utilities

and mining advisory leader

Ronan ORegan

Director, energy and utilities

PricewaterhouseCoopers LLP

July 2010

Introduction

1 PricewaterhouseCoopers reers to PricewaterhouseCoopers LLP (a limited liability partnership in the Un ited Kingdom) or, as the context requires,

the PricewaterhouseCoopers global network or other member frms o the network, each o which is a separate legal entity.


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The UK Renewable EnergyStrategy relies on investmentin renewable power generationto deliver around hal (49%) oits target o 15% o gross fnalenergy consumption comingrom renewable sources by2020. Oshore wind plays amake or break role. It will

need to deliver some 12GW,or 45%, o the additional circa27GW renewable generationneeded to reach the 2020renewable energy target.

To reach the target will require a rapid

increase in the oshore wind construction

rate. In 2009, 0.3GW o oshore wind

capacity was completed in the UK.

In an optimistic scenario we could still

achieve the required average roll-out

rate to reach the 2020 target. However,

there are a number o constraints which

threaten this. These include supply

chain bottle necks (including people with

the right skills mix), issues o obtainingconsents, and access to the grid, but

perhaps the most signifcant barrier is the

difculty that developers ace in securing

fnancing pre-construction. I this

fnancing issue can be resolved on a

large scale it would not only enable

sufcient investments, but would drive

confdence within the supply chain and

help ease other constraints. It would also

provide a strong signal to the market

that the oshore wind deployment

target is achievable and realistic. The

danger is that, unless these limiting

constraints are eased soon, we will be

signifcantly short o the required roll-out

path and targets will not be met.

The problem is that the balance o risk

and returns needs to be sufcient to

attract investors. Projects ace

considerable construction, technology,

operations and maintenance (O&M),

price and volume risks with many o

these ront-loaded with returns back-

ended. Historically the large utilities have

dominated the development o oshore

wind. However these companies have

many competing pressures or capital

which may limit their ability to und all

the required oshore wind projects. A

key reason why the fnancial constraint is

an issue is that project fnance to support

the development phase o oshore wind

projects has not been available to UK

projects to date. The challenge or banks

and other fnancial investors is to take

construction risk in the absence o an

engineering procurement contract(EPC) wrap rom the sponsors. Even i

some project developers can overcome

this challenge, there are doubts as to

whether this can be resolved or all

projects requiring project fnance.

We believe that current incentive

mechanisms, in the orm o Renewable

Obligation Certifcates (ROCs) and

the carbon price (even with a oor),

while important are unlikely to address

the specifc challenges o oshore

pre-construction fnancing. Usingthese incentives on their own to

boost investment would run the risk

o pushing excessive cost onto the

consumer. Instead, this report outlines

ways in which the incentives could

be supplemented with solutions that

specifcally address the risk associated

with the construction phase and

solutions that stimulate investment

by improving short-term returns.

In particular, we consider ways in which

oshore wind arm development could

be opened up to pension and lie und

investments. The energy sector,

including oshore wind, can in principle

provide long term stable cash ows

which are the requirement or the like o

pension unds. However this will require

a new way o looking at the allocation

o risks amongst all the stake holders

involved in developing this new industry.

We have considered our potential

solutions to the issue designed to

either reduce risk or improve returns

or investors in oshore wind projects.

These are:

Reducing risk

Solution 1 underwriting risk by a

consumer levy

Solution 2 a regulated asset scheme

Improving returns

Solution 3 additional ROCs or a

limited period

Solution 4 ISA bonds or an equity und

Executive summary




Solutions 1 and 2 address the specifc

risks associated with the construction

phase o oshore wind projects with a

view to attract investors with a low risk

appetite, such as pension and insurance

unds, but also potentially open up

access to project fnance. We outline the

type o wind arm capital structure these

solutions would make possible and

show how fnance rom the proposed

Green Investment Bank could playa role alongside much larger private

investments. Solutions 3 and 4 are

ocused on increasing the return o

investments in the short term (the frst

ew years o operation) to attract private

investors who would seek a higher

return in order to accept the risks

associated with the construction phase,

such as private equity houses, hedge

unds and individuals. A summary o

each proposal is given in Figure 1 and

they are discussed in more detail in

chapter 6.

Each has its advantages and

disadvantages. We put them orward to

stimulate discussion on how best to

tackle the scarcity o pre-constructionfnance and increase oshore wind arm

development to put the achievement o

the 2020 renewable energy targets on a

more certain ooting.

Figure 1: Summary o potential solutions

Source: PwC analysis.

Increased number ofROCs over the firstfew years to provideincreased returns forthe investor taking theconstruction risk

Underwritten by a

consumer levy

ISA Bonds or an

equity fund

Additional Rocs for

a limited period

Regulated Asset

scheme

Risk sharing ofconstruction and

technology risks (overa limited time period)

Developer can sell atRAB value includingreturn

Risk sharing withconsumer

Stable long-termrevenues

Suppliers and indirectlyconsumers through alevy in the event of arevenue short fall for theongoing revenue stream

Consumers directlythrough a levy but

recouped through lowerROC level when theproject is operational

Suppliers and indirectlyconsumers throughincreased ROCpayments

The taxpayers in the

form of reduced incometax

Make investments in

off-shore wind tax freefor the public

Risk profile reducedand returns more

certain (insuranceagainst uncontrollablerisks)

Reduced risks for thedeveloper and a clearexit path

Long-term operatorhas price and volumeprotection

Variable but potentiallyhigh returns in the shortterm

Risk that supply chaincaptures higher marginsinstead of increasedreturns

Increased net return

since free tax gains

Levy based system isnot easy to implement

Complex to implementgiven that the RABscheme would requirea completely newregulatory regime

Relatively easy toimplement since it isan amendment to theexisting regulatorystructure

Process to allocate

funds to individualprojects

Clear communicationto the public that itrepresents a potentiallysignificant risk

1

2

3

4

Reduces construction

technology and

price/volume risks

Reduces construction

and technology risks

Increases return

Increases return

Solution DescriptionWho bears

the cost?Impact on returns Barriers to delivery

A solution toaddress thespecifc risksassociated with

the constructionphase ooshore windprojects isrequired toattract investors

with a lowrisk appetite


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Oshore wind plays a make or break

role as the largest single contributor to

the UKs expansion in renewable power

generation. As discussed in the previous

section, oshore wind would need to

deliver some 12GW o the additional

circa 27GW renewable generation

needed to reach the 30% target.

How much needs to be built

and how ast?The amount o oshore generation

needed is a quantum leap above the

1GW o total capacity that had been

reached by April 2010. It will require a

rapid increase in the rate o oshore

wind construction. The oshore wind

pipeline is healthy at close to 50GW,

but the bulk o the projects are in a very

early stage o the development cycle.

O the total pipeline some 32GW is

attributable to the recently awarded

Round 3 projects and a urther circa6GW to early stage projects in Scottish

territorial waters. Nevertheless i projects

could move steadily through the pipeline

there are a sufcient number o projects

to be able to meet the 2020 target o

12GW additional oshore wind capacity.

The problem is not the potential pipeline

o projects but the roll-out rate. In 2009

0.3GW o oshore wind capacity was

completed in the UK. However, the

12GW target implies an average annual

roll-out rate o 1.1GW, which is

signifcantly above the historical build

rate (see Figure 5).

RenewableUK (ormerly the British Wind

Energy Association) has developed a

number o orecast scenarios or UK

oshore wind based on potential delays

and barriers aecting economic viability,

connections to the grid, ability to get

consents etc. Figure 6 shows the high

and low scenarios respectively compared

to the average required roll-out rate to

meet the 30% renewable target by 2020.

These orecasts exclude Round 3 as well

as the recently approved extension o

existing wind arm sites, potentially

adding 2GW o capacity, which will not

start to have an impact until 2014.

The roll-out rate orecast is set toincrease signifcantly compared to 2009

and will be helped by the increase in the

average size o oshore wind arms. In an

optimistic scenario the oshore wind

roll-out rate could reach the required

average to meet the 2020 target beore

the middle o the decade. However, there

is a signifcant risk that constraints such

as fnancing, supply chain limitations

and delays in accessing the grid will

result in a roll-out rate that is well below

the required average. In this scenario a

signifcant increase would have to takeplace in the second hal o the decade

i the UK is to meet the 2020 target.

Our view is that it is highly risky to plan

or a signifcant increase towards the

second hal o the decade to reach the

target, particularly i it emerges that the

power sector needs to deliver in excess

o 30% rom renewable sources. It is

desirable to attain a roll-out rate in

line with the high scenario outlined by

RenewableUK and maintain it, since it

is close to the required average and willallow or a smoother scaling up o the

supply chain. To do this, it will be critical

to take active steps to resolve the

barriers that hamper the deployment

rate. It is not a long-term issue that can

wait but, rather, must be addressed now

given the long lead times involved. A

greater sense o urgency is needed.

The pre-constructionfnancing gap

There are a range o constraints on the

expansion o oshore wind. They include

supply chain capacity limitations,

planning delays and restricted access to

grid connections. However, the most

signifcant barrier is the difculty that

developers ace in securing pre-

construction unding. I this could be

resolved it would not only enable

sufcient investment, but would drive

confdence within the supply chain and

help ease other constraints. It would also

provide a strong signal to the marketthat the oshore wind deployment target

is achievable and realistic.

2. The make or break role o oshore wind

Figure 5: Required oshore average annual

build rate compared to historical data

Source: PwC analysis based on RenewableUK (ormerly the

British Wind Energy Association) data.

0.0

0.2

0.4

0.6

0.8

1.0

1.2

GW

2003 2004 2005 2006 2007 2008 2009

0.06 0.060.09 0.09 0.10

0.00

0.28

1.11

2010-

2020Actual Average

Figure 6: Oshore wind roll-out orecast

Source: RenewableUK (ormerly the British Wind Energy

Association), PwC analysis.

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Annual completed capacity (GW)

2010 2011 2012 2013 2014 2015

Low scenario (based on delays and delivery constraints)High scenario (based on delays and delivery constraints)

Required average to meet the 30% target


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The total investment needed is

substantial. An estimated 33bn or so

would be needed between now and

2020 to develop 12GW o oshore

generation and a urther circa 7bn

is needed or the associated oshore

transmission connections. The actual net

unding requirement rom the developer

point o view would be less because

completed projects would provide

operating revenues during this periodand expect it will be possible to

refnance projects once they are

operational. This cash can be reused

in new projects and thus reduce net

unding requirement.

What level o net unding is required to

accelerate the expansion o oshore wind

and avoid the high risk o leaving much o

the roll-out until later in the decade? Our

analysis shows that a rapid increase to a

cumulative net unding requirement rom

a developer point o view o around10bn would be needed or generation

capacity alone to achieve the 1.1GW

average annual roll-out rate we identifed

in the previous section. A key assumption

to limit the capital requirement is that

wind arms can be project fnanced at

70% one year ater they have become

operational and that the capital released

can be reinvested into the pre-

construction phase o new projects.

Competition or unding

Oshore wind aces immense competition

or unding. Ogem has estimated that the

combined power and heat sector needs

to make investments approaching

200bn over the coming decade. This

is based on a lower economic growth

scenario and includes investment areas,

such as renewable and conventional

power generation, renewable heat,

transmission, but also investments in

energy efciency measures and smart

meters. It is estimated that meeting

the renewable targets will require an

additional circa 100bn in investment

in comparison to a business as usual

scenario whereby the ocus remain

on conventional power generation

technologies like gas turbines.

The 200bn or so required is an average

o about 17bn per annum. This is

double the annual capital expenditure

programmes o the big utilities combined

which, taking the biggest six and

National Grid together, totalled 8.6bn in

2009. Independent developers will also

play a role in oshore wind development

but the lions share o development will

need to come rom the big utility

companies in the absence o project

fnance or new sources o equity.

Figure 7: Hypothetical build scenario and

peak unding requirement


0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

0

2

4

6

8

10

12

14

GW bn

2010 20202012 20182014 2016

Annual build rate

Peak funding requirement (cumulative)

Required averageroll-out rate (30% target)

Rapid ramp-up offunding requirementto c.10bn

Figure 8: Total UK Capex by the Big 6 utilities

and National Grid

Source: Company annual reports and presentations,

PwC analysis.

0

2

4

6

8

10

bn

2008 2009

7.7

8.6




The big utility companies have a

signifcant international ootprint.

Our analysis o the our utilities with

a predominant ocus outside the UK

shows that their UK capital spending

accounted or just 14% o their total

capital expenditure (see Figure 9). Thus,

UK oshore wind investment not only

has to compete with a range o other

pressing power industry investment

demands, such as nuclear and gasstorage, but also has to make its case

in an international corporate investment

context in which geopolitical actors

have to be considered alongside

fnancial returns.

Constraints on unding

The issue o competition or undsoutlined in the previous section is

compounded by the risks associated

with oshore wind power and the

continuing sub-optimal banking and

investment climate. So ar there has

been no availability in the UK o project

fnance to support the development

phase o oshore wind projects pre-

construction. This is in contrast to

onshore wind projects where project

fnance is available i the project is

o sufcient scale.

Oshore wind developers have only

been able to fnance new projects once

an existing arm has an operational track

record. An example o this is Centricas

re-fnancing o the Lynn and Inner

Dowsing and Glens o Foudland wind

arms. However, this model creates an

inherent time lag and as described

above will not be able to support the

required development rate to meet the

30% renewable power target.The tight unding and banking climate

has been o little help, but the main

reason or the inability to project fnance

oshore wind arms pre-construction is

that the risk is deemed to be too high

(see panel opposite) or the banks to

take onboard. The project sponsors

would need to provide some orm o

guarantee to cover construction risks

beore banks will consider lending

pre-construction. Even i some project

developers can overcome this challenge,there are doubts as to whether this can

be resolved or all projects requiring

project fnance.

The result is that oshore wind

developers must fnance oshore wind

projects largely rom their balance

sheets or wait to roll over fnancing once

projects become operational which,

as discussed above, has its limitations.

However, even the large utility

companies are not in a position to

countenance unding to the scale o therequired oshore wind investment rom

their balance sheets and, as we have

seen in the previous section, the level

o investment implies a doubling o

current capital expenditure.

UK oshorewind investmentnot only hasto compete

with a range oother pressingpower industryinvestmentdemands, butalso has to

make its case inan internationalcorporateinvestmentcontext

Figure 9: 2009 capital expenditure

by company and territory

Source: Company annual reports and presentations,

PwC analysis.

0

5

10

15

20

25

30

35

Euro bn

TotalIberdrolaEONRWEEDF

2.2

12.4

10.2

RoW UK

18%

0.9

5.9

5.1

14%

0.9

8.4

7.5

10%

0.7

6.4

5.7

11%

4.6

33.0

28.4

14%

% Proportion invested in the UK


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Oshore wind risks

Construction risk

Untested construction techniques, unpredictable weather

conditions, and the potentially severe consequences o

accidents all create a high level o construction risk or

oshore wind projects. The projects that are currently being

developed are relatively close to shore and in relatively

shallow waters. Much o the oshore wind expansion will be

in deeper waters and as ar as 200km out at sea.

Technology risk

The current technology platorm, based on 3.6MW turbines

(and to a lesser extent 5MW), is starting to develop an

operational track-record, reducing the technology risk or

projects based on the same technology. However the next

generation turbines will have an increased capacity greater

than 5MW, which is untested and will heighten the

technology risk.

Operations and Maintenance (O&M) risk

There is uncertainty about the required operations and

maintenance costs over the lie time o an oshore windarm project. This cost is related to the technology risk since

the reliability determines the required O&M costs, but it also

depends on the impact o adverse weather conditions and

the availability o required equipment and vessels. Operators

are starting to get a better understanding or the O&M costs

through their early oshore projects, but as the technology

evolves and arms are deployed urther out at sea, the risk

will increase.

Volume risk

The volume risk relates to the unpredictability o the load

actor that a particular wind arm will be able to achieve.The average load actor is dependent on the prevailing

conditions applicable to a site, but also on annual variations

due to weather patterns. This risk can be better understood,

but not eliminated, by surveying the wind patterns at a site

prior to commencing construction.

Price Volatility risk

The revenues that a wind arm operator is able to secure

on a per MWh basis have three components the MWh

output, the wholesale power price and the value o

Renewable Obligation Certifcates (ROCs). As depicted in

Figure 10 the electricity price in the wholesale spot market is

highly volatile. It is possible that the volatility will increase

over time since a higher proportion o variable output wind

generation could result in very low or even negative

wholesale prices when the wind output is high and high

prices when there is limited wind generation.

Based on the experience rom project fnance-backed

onshore wind arms, independent operators typically do not

sell output on the spot market, but through a Power

Purchase Agreement (PPA) with an o-taker. However such

agreements typically have the power price linked to the

market price, or at best only locked or a shorter time period,

and the developer thereore will have an exposure to the

market price.

The ROC component o the revenue stream is currently

based on two ROCs per MWh produced and split out into

two parts:

A fxed amount that is RPI indexed over time(buy-out price)

A variable component that is dependent on the overall

number o ROCs that are presented to Ogem by the UK

suppliers compared to the target (recycled beneft)

The introduction o a ROC headroom mechanism will lead

to the buy-out price being viewed as a oor price.

A cap and collar mechanism or a eed in tari are ways to

mitigate the price risk and were discussed as potential

options by the previous government.

Figure 10: UK wholesale power spot price (weekly rolling average)

Source: Elexon, PwC analysis.

0

20

40

60

80

100

120

Price (/MWh)

01/01/

2004

01/01/

2005

01/01/

2006

01/01/

2007

01/01/

2008

01/01/

2009

01/01/

2010


12/200 PricewaterhouseCoopers Energy, utilities and mining


In the previous chapter we saw that a

much aster acceleration in oshore

wind development is needed to avoid

a situation where time runs out on the

achievement o the 2020 renewable

energy target. But pre-construction

unding is unlikely to come orward

quickly enough to deliver the scale o

roll-out needed to put oshore wind on

course to deliver its 45% share o the

renewable power generation target.In this section we look at solutions to

address the problem o the scarcity o

pre-construction fnancing.

Who could invest?

Figure 11 reviews the various potential

sources o unds available and their

attitude to the risks inherent in oshore

wind generation. Banks, although

they have some availability o capital,

are unwilling to provide project fnance

pre-construction due to the associatedconstruction and technology risks

unless as a minimum there is a

clearly articulated contingency plan

to manage risks or at best there are

parent guarantees rom the sponsors.

However, the sponsors are not keen to

provide the EPC wrap which makes

project fnancing by banks difcult.

Other investors, such as pension and

insurance unds, potentially have ample

capital available, but also are not willing

to assume the associated risks.Private investors, or example private

equity houses, hedge unds and

individuals, would potentially be willing

to accept the risk provided that the

returns available are commensurate with

the risk profle. However, at the moment

there is a mismatch the risk is high but

the returns available are only in line with

a utility-type return.

3. Resolving the pre-construction fnancing issue

A Green Investment Bank

The new coalition government has decided to proceed with the plan to create

a Green Investment Bank (GIB), although no detailed proposals have yet been

published. The GIB outlined by the previous Labour government assumed

a capitalisation o around 2bn which potentially could be more signifcant

i gearing is possible. However, it would not be sufcient to plug the pre-

construction unding gap, nor is it clear under what premises a GIB will seek

to invest. I the investment criteria are not vastly dierent to those used by

commercial banks, it would restrict the ability to und oshore wind projects

pre-construction, although smaller stakes in individual projects may be possible

to spread the risk through a portolio approach.

Figure 11: Availability o unds and attitude to risk by source o unds


Source

of funds

Availability

of funds

Investment

profile Construction Technical Price Volume

Attitude to specific risk currently present for offshore wind

Infrastructure

funds

Low to medium risk depending on

fund profiles (risk spreading key)M UA UA PP

Private investorsCan accept a range of risks provided

that the return is appropriateM PPPP

Project finance

(banks)Risk adverseM UA UA UA P

P PDeveloper equityWilling to invest as long as return in

line with risk (has control of projects) UAPAL

Pension funds Requires lower but certain returms UA UA UA PH

Insurance funds Requires lower but certain returms UA UA UA PH

M Medium H HighL Limited P Possible A AcceptableUA Unacceptable


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Issues with the existing supportmechanisms.

What would make them invest?

To attract investments, the risk and

reward profle between type o unds

available and the investment must be

aligned. Current market mechanisms,

including ROCs and the carbon price, all

short o an eective solution because theydo not address the dierent risk profles

over the project lie cycle. They increase

the return available over the project lie,

which is attractive to utilities but not to

more risk-averse investors or investors

with shorter investment horizons.

The beneft o ROCs and the carbon

price are only realised once a project is

operational leaving investors exposed

during the construction phase. I the

number o ROCs and the carbon oor

were raised to higher levels, privateinvestors would at some point fnd the

prospect o these uture returns

attractive enough to accept the risk and

inject pre-construction phase fnancing.

However, the cost to the consumer

would be substantial.

In short, ROCs and the carbon price

are too blunt an instrument. Instead,

solutions are needed that specifcally

address the risk associated with the

construction phase or which improve

short-term returns without undulypushing excess costs on to the

consumer. We look at possible options

in the next chapter.

Attracting pension andlie und investment

The stable and predictable annual

cashows o inrastructure investments

are attractive to pension and lie

companies. Demographic trends

heighten the need or this type o

investment. With an ageing population,

more pension assets have to move

rom accumulation stage into an annuity

or payment stage and there is an

accompanying need to shit rom

long-term investments like equities,

to investments with regular and certain

returns. The energy sector, including

oshore wind, is a good match to the

investment needs o such unds

provided that the construction risk is

understood and steps taken to either

insure or transer it.

The historical model

Previously, low risk investors such

as pension unds and lie companies

invested in inrastructure or asset-

backed securities through investment

grade rated bonds or securities. Some

higher ratings were achieved by

wrapping (in eect insuring) the unrated

or lower rated securities through

monoline insurers. With the higher AAA

ratings guaranteed, investors did notneed to assess the risks associated with

the underlying asset.

The sub-prime crisis and ensuing credit

crunch, led to a downgrade o the

monoline sector. It is no longer viable

to insure inrastructure asset-backed

securities to achieve a AAA rating. The

balance sheets o monoline companies

are weak and they are not in a position

to write policies. Historically, the

insurance was mispriced based on too

optimistic a view o the risk and, eveni monoline insurance was to be oered

today, it would be much more expensive.

What is needed in the uture?

Given that the asset cannot be insured

at acceptable cost, the pension or lie

company must now take a more direct

interest in the underlying asset and

understand the associated risk. Some

pension unds have already started to

think about building teams with

inrastructure and energy expertise to be

able to assess the risk but it represents a

signifcant investment and, thereore, will

not happen in the short term. Even i

they develop their own internal expertise,

the specifc construction and technical

risks in oshore wind are too high or

them to consider investing unless they

were underwritten or transerred.

However, i the construction/technology

risks could be underwritten or

transerred, this would open up oshore

wind to pension and lie companyinvestors. Solutions 1 and 2 in the next

chapter outline two possible ways in

which this could be done. Having

pension or lie company investment

available rom the pre-construction

phase would be o enormous beneft

to oshore wind developers as it could

provide fnance or the 20 years+

duration o the project, providing an

end-to-end solution that avoids the

uncertainty and cost o having a bridging

fnance solution.

In turn, with the assurance o the

underwriting or transer o construction

stage risk, pension and lie companies

would be attracted by the regular and

low risk cashows post-development.

The attraction would be all the greater

because o the shortage o long dated

sterling assets o 20 or 30 years in

duration that can provide the kind o

stable and predictable annual cash ows

they are looking or. In the next chapter,

we look at solutions that could open upthis opportunity or pension and lie

companies and the kind o oshore wind

project capital structure that could be

made possible.




4. Moving orward solutions to boostpre-construction fnancing

Solutions to reduce constructionphase risk

Solution 1: Underwriting construction

and technology risks by a

consumer levy

The principle o this solution is that

construction and technology/O&M risks

are shared between the developer and

the consumer. The consumer is

represented through a government bodythat acts as the scheme administrator.

Prior to commencing construction the

developer would need to register the

project with the administrator. As a

prerequisite the administrator must

approve the ollowing:

The general ability and fnancial

strength o the developer

Key supplier and sub-contractor

agreements (assuring appropriate

transer o risk)

Agreements with the fnanciers

Availability o unding in the event o

additional capital required

Only the generation component o the

project would be included in the

scheme. The oshore transmission

would be handled through the Oshore

Transmission Network Owners (OFTO)

scheme.

Underwriting o project risk

I unoreseen construction or technology

issues aect the project during the

construction phase leading to cost

overruns, the developer would be

compensated. There would be an

element o risk sharing between the

administrator and the developer. A fxed

cap would limit the level o overrun costs

that would be covered. For example, the

fxed cap might be set to 10% o the

total project cost.

An absolute cap at the appropriate level

would be necessary to provide the

required comort or lower risk investors

who need to understand what the worst

case scenario could be. Similarly during

the initial operating phase, or interim

operating phase, the administrator will

cover under the same cap any

unoreseen costs and revenue losses

due to operational issues.

Within a defned period o interim

operation the wind arm should have

demonstrated its operational stability

and the arm will enter its ull ongoingoperating phase. At this point the

administrator would no longer cover or

unoreseen costs and revenue losses.

The lower risk investor that invested in

the pre-construction phase could either

exit or stay on, given that the risk profle

is signifcantly reduced once the project

is ully proven and operational.

Project lie-cycle risk

Figure 12 outlines who will bear the

various risk elements through the lie

cycle o the project.

Scheme fnancing

The scheme would be fnanced through

a levy on all electricity consumers on a

usage basis, but potentially recouped

through a reduced number o ROCs

available to developers who elect to

participate in the scheme. I projects

participating in the scheme suered

overruns o 20% on average and the

developer exposure is capped at 10%,

the number o ROCs could be reducedproportionally or the consumer to

recoup the cost.

In eect, part o the beneft o ROCs

is brought orward and transerred

into the risk-underwriting scheme in

the event that overruns have to be

unded. The overall return to a

developer should, on average, be the

same but the developer is able to go

ahead with the project knowing they

ace a much lower level o construction

and commissioning risk.

Figure 12: Underwriting through consumer levy: Risk taker through the project lie cycle


Decision point whether to enter the scheme or not

Consenting risk N/A N/AN/ADeveloper

Price risk N/A N/A OperatorDeveloper

Volume risk N/A N/A OperatorDeveloper

Construction risk N/A N/A N/AShared between

Developer & Consumer

Technology/

O&M riskN/A Operator

Shared between


Shared between


1

1

2

2

The underwriting scheme ends after c.1 year of operations and the Operator continues to receives a reduced number of

ROCs as a trade-off to have had the construction risk and technology risks underwritten through the duration of the project

Pre-construction Interim operations Ongoing operationsConstruction


15/20



Implementation considerations

We would envisage that such a scheme

would be in place or a limited time up

until a point where the market has been

sufciently derisked to be able to

sel-sustain the required pre-

construction fnancing. To speed up the

overall derisking o the market,

participants in the scheme could be

required to share project development

knowledge on certain pre-agreed topicswith other developers participating in the

same scheme.

This type o levy-based scheme is not

unique. Carbon capture and storage

demonstration plants are, or example,

intended to be fnanced in a similar way.

However, the challenge o implementing

this scheme in a timely ashion and

managing it in an efcient manner

should not be underestimated. A

signifcant advantage o this scheme is

that the cost impact to the consumer willpotentially be neutral compared to the

current market mechanisms in place.

Oshore wind project capital structure

Solutions 1 and 2, by underwriting or transerring construction phase risk,

potentially open up oshore wind arm development to low risk investors, such

as pension unds. We illustrate below the capital structure this might create.

Low risk investors, such as pension unds, could invest in the highergrade tranche but possibly also the lower grade tranche which would have

a higher yield.

On a case by case basis the capital structure could be split into multiple

tranches that represent dierent levels o risk.

For example, the higher grade tranche could be backed by the buy-out

ROC component that is indexed at P90 output levels.

Higher risk levels would be based on wholesale revenues (excluding ROCs),

the recycled beneft proportion o ROCs and higher load actors.

The role o the proposed GIB could be to provide a mezzanine or high yield

loan acility, representing a small proportion o the total capital requirement.In this way, the available GIB und o 2bn would be sufcient to fnance the

unding requirement or oshore wind.

The developer would raise more fnance than required in the project plan,

providing an upside incentive i the plan is achieved.

Figure 13:


Guaranteed by consumer

Capped developer risk

Target cost 900M

Above

developer cap

Developer downside

Higher grade tranche

Lower grade tranche

GIB loan

Developer equity

Developer upside

Capital requirement

and risk

900

100

100

Finance raised

pre-construction

200

100

300

400




Solution 2: Regulated asset regime

The second solution is based on

bringing oshore wind arms into a

regulated asset scheme. The risk sharing

principle would be in line with that

described or the levy-unded

underwriting scheme. It would also be

on a voluntary basis and regulated by a

scheme administrator. Participation in

the scheme would be subject to the

same prerequisites outlined undersolution 1 above and, like that solution,

the transmission element o the project

would continue to be managed through

the OFTO regime.

The developer would share construction

and commissioning risk with the

administrator and indirectly with

consumers. Once the wind arm has

demonstrated operational stability ater

an agreed period o operation it would

be auctioned o. The price would be

set to the regulated asset base (RAB)value and the winning bidder would be

the one oering the lowest required

return on the capital. This ongoing

capital return might be reviewed every

fve years by the administrator, similar to

other regulated assets.

The administrator would assume

responsibility or the o-take and any

potential short-all in selling to the

market would be covered through a

consumer levy.

Determining the regulated asset

base (RAB)

The RAB would include fve cost

elements, each reviewed and approved

by the administrator:

1. Pre-construction costs

benchmarked and adjusted or

specifc circumstances.

2. Construction costs based on plan.

3. Overruns based on a risk sharing

mechanism (the developer liabilitywould be capped at perhaps 10%

o the total cost as or the levy-based

underwriting solution).

4. Capital costs based on agreed

return rates or allowed costs.

5. Interim operating phase overruns.

Auction and ongoing revenue

determination

The winner o the auction at the end o

the interim operating phase would pay

the RAB value and receive an ongoing

return on the capital to manage the

asset. I the operator ails to maintain the

agreed availability, fnancial penalties

would be imposed. At a regular interval,

perhaps fve years, the administrator

would re-adjust the ongoing revenue

stream based on a determination

process. The logic or this review would

be that the costs were highly uncertain

at the start o the scheme but, over time,

actual costs and the potential or

efciency gains would become known.

Project liecycle risk

Figure 14 below demonstrates who is

assuming the various risk elements or

the duration o the project liecycle.

Scheme fnancing

The administrator would control all

output rom the wind arm and sell it

primarily through the wholesale market

on a bilateral basis and, to some extent,

on the spot market. The revenue stream

would include a reduced number o

ROCs, to compensate the consumer

or the risks assumed during the

construction risk in very much the

same way as under solution one.The market price risk is transerred to

the consumer and any potential shortall

in the required revenue streams to the

wind arm operators would be covered

through a levy on all consumers on

a per MWh basis. Any surplus would

either be retained in a und to cover

or other potential shortalls, be given

to the Treasury or transerred back to

the consumer.

I the auction is competitive, and on

the basis that the operator could expect

to become more efcient over time in

managing the asset, the net result could

be cost neutral compared to the two

ROCs currently received.

Figure 14: Regulated asset model: Risk taker through the project lie cycle


Decision point whether the asset should be managed as a regulated asset

Consenting risk N/A N/AN/ADeveloper

Price risk N/A N/A ConsumerConsumer

Volume risk N/A N/A Consumer

Construction risk N/A N/A N/AShared between


Technology/

O&M riskN/A

Shared between


Shared between


Shared between


Shared between


1

1

2

2 3

The asset is auctioned off to a operator who pays the RAB value and bids required revenues p.a.

3 The scheme Administrator determines the level of ongoing revenues p.a. for example every five years

P re- co ns tr uct io n Co ns tr uc ti on I nt er im o pe rat io ns O ng oi ng o per at io ns


17/20



A low risk investor, or example a

pension und, could participate as

fnancier in the pre-construction phase

o the project and remain as such or the

duration o the asset lie. Once the arm

is operational and it is auctioned o the

fnance arrangement would roll over to

the operator acquiring the asset.

Eectively the operator would pay the

developers equity proportion and

potentially chose to refnance some othe lower grade tranches o the capital

structure.


As with solution one, the RAB scheme

could be put in place or a limited period

o time until the market or oshore wind

development has been derisked

sufciently to attract the required

investments. Alternatively, it could be

viewed as a more permanent solution

more in line with the already established

Oshore Transmission Network Owners(OFTO) regime. A RAB scheme as a

concept is not something new. The

OFTO regime and that o similar

arrangements in other sectors could

provide a useul guide to how to

structure the oshore wind scheme.

A potential downside o the regulated

asset regime would be that the

implementation time rame could be

lengthy. It might require thorough

consultation processes and is

administratively complex to implement.Another downside that may aect the

willingness to invest is the risk that

insufcient investors would be willing to

participate in the auctioning o a project

given that, potentially, a large number o

projects would be coming to the market

at the same time.

Solutions to increase returnin the short-term

Solution 3: Additional ROCs

or a limited period

This solution boosts the short-term

return by increasing the number o

ROCs available or oshore wind arms

in the frst couple o years o operation.

An investor who invests under this

scheme would assume the ullconstruction and technology/O&M

risks. However, the increased return is

intended to compensate or the

additional risk. The main principles o

this scheme are illustrated in Figure 15.

Investments and returns

The required capital to commence

construction would be invested on an

equity basis, split 50:50 between the

developer and the private fnancial

investor. For private individuals this type

o investment would have to be managedthrough an intermediary such as an

equity und managed by a commercial

bank. The construction phase would be

expected to last or two to three years.

Under this scheme the wind arm would

be entitled to, or example, our ROCs

rather than two during the frst two years

or so o the operational phase. The

entire dividend payable during this

period is paid to the private investor.

At the end o the initial two year period

the project can be refnanced and the

private investor is repaid the initial

equity stake. Any potential equity

upside is retained by the developer in

compensation or not receiving any

dividend in the frst couple o years o

commercial operation.

Depending on the precise confguration

o the scheme private investors couldachieve an IRR o up to 20% i the

project is delivered on time and budget.

However, developers may fnd it difcult

to invest hal o the required capital.

I this is the case, the proposed Green

Investment Bank (GIB) could support

the developer to fnance its part o the

investment. In this way, this scheme

could help the GIB leverage private

unds and, thus, make a substantial

contribution.


The additional ROCs scheme would

be relatively easy to implement given

that it would build on the existing ROC

scheme and not require a substantial

restructuring o the market. As a

consequence the scheme could make

an impact in the short-term and put

the UK on track to achieve the 2020

renewable target.

Figure 15: Illustrative: Model to attract a private investor with an attractive return and exit

within 5 years


1 4

Year 1Year 0 Year 2 Year 3 Year 4 Year 5 Year 6

Additional RoCs

Standard RoCs

Wholesale revenues less opex

Developer equity

Private investor equity

Developer and private

investor splits the required

equity investment 50:50

The ongoing c.2 RoCs will provide

sufficient return for both the developer

and the new low risk investor

Initial private investor achieves

c.15%-20% IRR through the benefit

of additional RoCs (all available

dividends to private investor)

New low risk equity

investor any upside

to initial investment

to developer

2 3




A potential downside o the scheme is

that the supply chain might absorb a

signifcant proportion o the incremental

revenues generated by the additional

ROCs. This is because there are

constraints in the supply chain and

suppliers might be able to push through

higher prices i they know that additional

revenues are available. The result would

be reduced returns to the private

investors and, with it, the danger o lack

o interest rom the private investors in

anticipation that this supply chain

squeeze could happen. Another

downside is that the cost o enabling the

increased investor returns would need tobe absorbed in ull by consumers

through increased electricity prices.

Solution 4: ISA bonds or equity und

To attract investments rom private

individuals to und the construction

phase o projects, investments in the

oshore wind sector could be made tax

ree through an extension o current ISA

allowances or individuals. This could

either be in the orm o a fve year

renewable ISA bond or a renewable

equity und. The capital raised through

such schemes would be unnelled to

appropriate projects by the commercial

bank managing the investment or

through the GIB. These schemes would

require the capital to be tied up or a

minimum period covering construction

and commissioning o the asset and

would only oer returns ater thisminimum period. Cost and timing

overruns would continue to be borne

by the developer.

Developers would either seek an

equity investment rom the renewable

equity und or raise the required

fnance through bond fnancing.

The bank managing the und would

screen and select projects and the

scheme would be monitored by a

regulator. The return or private investors

would need to be commensurate withalternative investments products.

It should be noted that the scheme

would not suit all private investors,

or example private equity houses

who would fnd that the risk associated

with the investment would prevent

them being able to get the leverage

on their investment that they need.


This scheme would be relatively

straightorward to implement. It would,

however, be important to inorm thepublic about the level o risk o investing

in the scheme. The management and

marketing o the bond/equity unds

would be managed by commercial

banks and their expenses would need to

be paid rom investment returns. The

ultimate cost o providing the additional

return to attract the investment would be

borne by the taxpayer in the orm o

reduced tax revenues or the treasury.


19/20

Michael HurleyPartner, Global energy, utilities

and mining advisory leader

Email: [email protected]

Tel: 020 7804 4465

Ronan OReganDirector, energy and utilities

Email: [email protected]

Tel: 020 7804 4259

Contact details

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