Are banks overtaking governments in subsidizing renewable energy?
Intense competition for assets means that risk is being mispriced.
The world’s governments have been withdrawing direct subsidies for renewable power projects in recent years, as the cost of production of wind and solar energy projects has fallen below that of traditional fossil-fuel power plants.
And as governments step back, banks have been rushing in.
Commercial banks, looking to decarbonize portfolios, are creating a surge in demand for renewables financing. Commitments to net zero are creating ESG-weighted demands on asset finance – with traditional power and infrastructure shunned in favour of projects that will tilt portfolios more deeply into the green.
A recent HSBC survey found that 75% of global investors – asset allocators and owners – are interested in investing in sustainable project finance deals and, of them, 23%, are already doing so.
While the growth in such projects has been rapid, demand is outstripping supply. Inevitably, the banks’ approach to risk pricing these renewables projects has come into question. Take one example: Vineyard Wind, in which Spanish utility Iberdrola has a 50% stake through Avangrid Renewables, which is developing a large wind farm off the coast of Massachusetts. It will be the first commercial-scale offshore wind farm in the US.
The company, in which Copenhagen Infrastructure Partners is joint venture partner, recently closed $2.3 billion debt financing led by Santander. Additional lenders include Bank of America, JPMorgan, BBVA, NatWest, Crédit Agricole, Natixis, BNP Paribas and MUFG Bank. The construction plus 10-year loan priced at 138 basis points over Libor – in line with offshore wind risk in the far more established European market.
As well as performance variability and operational risks, the growth of merchant risk in some projects also needs to be considered
Vineyard Wind will be constructed in two stages, with Vineyard Wind 1 built between now and 2023 and, when operational, will have a capacity of 800MW, which will be able to meet the energy needs of more than 400,000 homes.
The wind farm will be built 15 miles offshore and, given the cost of the necessary infrastructure to deliver power to the mainland’s grid, has a 20-year power purchase agreement (PPA) in place to limit merchant risk – though bankers say substantial operational and performance risk remains.
Vineyard Wind filed a 20-year PPA with Massachusetts electric distribution companies (EDCs) in 2018 with a first-year PPA price of $74/megawatt-hours (MWh) for facility 1 and $65/MWh ($2023) for facility 2. The first such 20-year offshore wind PPA in the US was signed in 2010 for the 30-MW Block Island Wind Farm with a starting price of $244/MWh. And while the Block Island agreement was signed with the National Grid, the Vineyard Wind agreement is with individual EDCs.
However, other fully commercial renewable power projects do not have long-term PPAs in place and therefore expose sponsors to wholesale prices. Long-term PPAs are becoming less popular with corporates and energy prices – while spiking right now – are trending down in the long term.
The offshore wind industry in the US is far less developed than that in Europe, so the market had been anticipating premium for these projects. Vineyard Wind shows that the sheer demand for such assets will wipe out any such distinction. This project certainly benefits from being large scale and banks want to be in on the first deal of its kind.
Broader set of risks
However, project finance bankers, who have focused almost exclusively on construction risks for fossil-fuel power plants, must now consider a broader set of risks as they scramble for green assets.
As well as performance variability and operational risks, the growth of merchant risk in some projects also needs to be considered. McKinsey estimates that this can be two to four times greater than the construction risk and can be as high as 20% to 40% of capital expenditure in value at risk.
In the rush to get to zero-carbon project exposure, banks risk mispricing renewable power assets. They are thereby in effect subsidizing the renewables energy industry, but taking on merchant and operating risk themselves that they may not be fully prepared for.