‘Mexican stand-off’ blocks new renewables projects from coming on-stream
By David G Rose
A fundamental misunderstanding between buyers of renewable energy, new projects and their investors is blocking new plants from unleashing terawatts of clean, green energy into grids worldwide.
Something not widely appreciated about the renewables transition is that it is comprised of thousands of individual projects across wind, solar, waste-to-energy, nuclear and other technologies worldwide. The majority of these projects are ready to go, right now, but held back from moving forward because grids and other buyers of their output refuse to sign, or even produce, their PPA’s until financing is proven to be available.
Even now, investors are being asked by energy off-takers for proof of funds. This can no longer be done as today’s investors are overwhelmingly hedge, private equity/debt, alternative investment and other funds along with family offices, private capital and asset managers and similar private capital allocators. They assemble and aggregate funds and deploy them into individual projects not from a fixed capital pool, but from private investors whose identity no private capital fund manager would ever disclose.
Research by the Project Finance Exchange (PFX) has identified a global market of over 120,000 private capital funds with an aggregate investment capacity of c$9.5tn. However, with energy industry groupthink mostly grounded in now obsolete 20th century investment structures, countless projects cannot move forward because of widespread unfamiliarity with the new financing structures. Consequently, there is a hugely destructive and needless ‘Mexican stand-off’ between energy buyers, the projects and their investors which is blocking terawatts of clean, green energy from being unleashed into grids worldwide.
Project Finance
The crux of the problem is that ‘project finance’ is still widely regarded by CFO’s, the global financial establishment and, shamefully, university curricula as being unchanged since it was first developed in the 1950’s to fund large-scale infrastructure projects. But, after seven decades of evolution, it has emerged as the primary means of financing projects across many sectors worldwide, funding deal values from sub-$10m to $10bn+.
Critically, and uniquely out of all investment structures, the track record and financial stability of whoever is contracted to buy the output from the built project overrides the balance sheet and assets of the borrower.
With renewable energy projects, fund managers therefore invest (predominantly private debt) against the PPA with the regional or national grid or other party contracted to buy the plant’s output when it is built. These are usually stable entities, which is why bringing proven renewable technologies on-stream are the overwhelmingly preferred investment vehicles for private capital funds and their underwriters.
Ultimately, project finance investment is lending against revenues from a yet-to-be-built asset, from which mainstream banks are precluded by their own regulations. Only private capital funds have the flexibility to lend on this basis. But, for a transaction to work, the investor must have a PPA from a credible party with track record and financial stability against which they can secure their underwriting.
When a project team submits their opportunity to an investor, they need to show that they have ownership or control of the land, access, permits, permissions, connectivity, a seasoned team, a contracted EPC (Engineering, Procurement and Construction) contractor that can demonstrate, along with all other contractors and counterparties to the project, track record and financial stability and many other things besides. Above all, they have to show a Power Purchase Agreement with a credible off-taker, signed or ready to sign, without which no investment will be forthcoming. But, when the PPA is provided, along with all the other essential information, there are mostly happy endings.
The solution? Produce the PPA but add a paragraph stating: ‘This Power Purchase Agreement is subject to investment in [the project] by a credible party’ (or something similar). And then we can all move on.
It is interesting to note that within the past few years the global insurance markets have taken a distinct interest in the project finance structure which, by its very nature, delivers the long-term returns and risk-mitigation that private investors demand. Insurance wraps are now available with interlinked policies underwriting every aspect of the project, backed by Lloyds-of-London and other leading insurance markets. The A+ rating that come with this underwriting elevate project finance transactions to equivalence with any mainstream fixed-income asset, and makes them available to pension and other regulated funds.
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