Despite the recent dramatic fall-off in project finance for renewables, Janet Wood finds there is still an appetite for new projects among investors.

There have been some startling falls in investment in renewable energy projects in the past few years. Alex Desberres, senior renewables analyst at Datamonitor, put some numbers on the decline at a recent conference on funding renewables. He said that in the last quarter of 2008, investment was down 50 per cent from its peak a year earlier. In 2009, venture capital and private equity investment dropped 44 per cent.

Maria McCaffrey, chief executive of Renewable UK, supported Desbarre's figures. She said that although deals had been finalised, many were part of a European Investment Bank "wind initiative". She said this "masks the true picture". That true picture is one of slow deals that are costly to put together, because the cost of credit has risen and so has the cost and pace of deal-making. The latter problem is because now syndicates of investors have to be put in place. The more people involved, the more a deal costs.

*Rising project costs*

McCaffrey pointed out that the UK has been badly hit on project costs, because the value of the pound against the euro has fallen by nearly one-third and most of the supply chain for renewables projects is in the eurozone, especially Germany and Denmark.

According to Desbarres, the cost of setting up deals has fallen, but he said that did not outweigh the much higher financing costs.

So, what are the implications for the large volume of deals that will be required to reach the UK's renewable targets over the coming decade?

Richard Nourse, managing partner at Novus Modus, said the challenge was big, but also Europe-wide. "We have an adequate power sector already but we need to reinvent it," he said. "That is going to cost about £200 billion for each of the large countries in Europe. For them, the key challenge is that governments are interfering in the market. Do utilities have money to spend, and if not, will other companies come in?

"It's a big number, and when you compare it with the combined capital expenditure of the major utilities over the next five years, it's really on the edge [of what they can invest]."

*The investment community is key*

That means the investment community will be key. But if it is clear that there are still procedural difficulties in financing energy projects, participants do see grounds for "cautious optimism".

Johannes Schmidt is chief executive in the Equity Investments & Project Finance department of Siemens Financial Services. The organisation is Siemens internal adviser for project finance. Schmidt said it places "financing of €2-6 billion a year for Siemens infrastructure". Schmidt's view was that investors were ready for the challenge.

He said: "As regards capital investment, there are some huge numbers being talked about, like the 32GW of offshore wind in the UK. That means €100 billion of investment, but it is over 10-12 years so it is well stretched out. We are in the market talking to banks and we find no scarcity of funding. There is enough financing from banks, and enough balance sheet financing from utilities, for the next five years."

*Tangible assets*

Schmidt said this was partly because of the nature of investment in power projects. "They want to invest in something tangible," he said. "That's the beauty of infrastructure investment, and there is scarcely any substitute. It's not only Siemens but banks and pension funds that are interested and ready to invest."

Andrew Buglass, head of power at RBS, also thought that the industry was seeing the beginning of an uplift. "Power will be a huge user of project finance debt, and recent experience in this has been far from encouraging. But the situation is improving and there are grounds for cautious optimism," he said.

He admitted: "The past couple of years have been dire for funding renewables projects. The financial community was undergoing its own restructuring, bank balance sheets were resized. It was back to national markets and fewer clients. They effectively rationed funding to companies with repeat business, which disadvantaged the single, smaller developers.

"There was a strong appetite for utility debt, which was seen as defensive. Funders got lower gearing, shorter maturity, tighter covenants. With such limited liquidity, underwriting also dried up. All transactions were on a club basis, so there were more issues around the finance." Energy remained the largest sector in project finance, but there was a dramatic decline nonetheless.

*The demand is still there*

Buglass said that although the funding declined, the demand never entirely went away and "the demand for funding is still there because the EU targets are still there. Projects were delayed but they are still good. There is a huge requirement to replace existing plants, so we won't be short of deal flow. Banks have completed changes in their business models. Funding costs have fallen, although they are not back to old levels. The power sector is strong on credit quality. There is debt available now for the right projects and liquidity is coming back."

Steven Fawkes, head of new energy and power at Matric Corporate Capital, agreed with that assessment. "Power utilities have become stronger during the crisis. They have mature technologies and there are lower levels of risk. Sovereign wealth funds have entered our markets. Utilities have won out because they have strong balance sheets, greater buying power, a portfolio of assets and low-risk projects."

*Defensive investments*

If utilities in general are seen as good "defensive" investments, are the types of projects coming through high on investors' wishlist? So far the evidence is that there is investor appetite. Perhaps the newest type of investment opportunity right now is in offshore transmission ownership (Oftos), part of the competitive connections regime for windfarms far offshore. It is a new regime in a new environment, but Buglass said: "Ofto sales have attracted a good level of interest, and that reflects strong credit fundamentals, their very long-term nature, and predictable cashflows".

Schmidt made the point that this was also partly a function of the UK's reputation as a place to do business. He said: "We have looked at two [offshore transmission] projects. There is not much experience of the tender process for these projects. But the trust we have because of the UK's experience of public private partnerships lead us to believe that there will be a regime that will satisfy investor needs. There is no reason why it should not work."

That pragmatic approach seems to be a common theme among investors, who do find energy projects attractive.

As Matric Corporate Capital's Fawkes pointed out, although the investment required for new energy projects looks huge, it is not so big in comparison to the broader market. "Total green investment volumes represent less than 1 per cent of the money managed in London every year," he said. "There is lots of money out there, and more of it is coming into the space." He added: "Venture capitalists are not short of capital, they are short of projects."

*Who will finance offshore wind?*

Financing will be pivotal to realising the UK's ambitious offshore wind plans. This will fall to large, well-financed companies and will prove very different from building a few megawatts of onshore wind capacity. So who has the money?

Global players. The truly global players have few problems raising substantial sums of money on attractive terms. GE has been a prominent investor in wind power through its extensive turbine manufacturing operations. Its commitment, like Siemens, to renewable energy - and indeed to nuclear power - is strong. Both Shell and BP are players among the oil majors, although BP's future involvement is uncertain, given its Deep Horizon rig disaster in the Gulf of Mexico. Large asset disposals are a near certainty, possibly including its renewable assets, which have waned in importance in recent years.

Major EU utilities. Few smaller companies are likely to be directly involved. The real challenge for the large companies will be justifying financial returns to their shareholders, especially if the generous Renewables Obligation subsidy scheme changes materially.

Vattenfall and Denmark's Dong Energy are in the vanguard. The former's interests include the 160MW Horns Rev and 90MW Kentish Flats schemes, while its Liligrund offshore windfarm also opened recently.

Eon is investing heavily in renewables plant in the UK and US. However, future investment will be constrained by its net debt of around £35 billion.

Financing new investment should not be unduly challenging for RWE, worth £24 billion.

In the UK. Centrica's finances remain enviably strong - last week it posted pre-tax profit up 65 per cent to £886 million - so funding its renewable investment programme should not be too difficult.

In Scotland, both the Iberdrola-owned Scottish Power and Scottish and Southern Energy have focused on wind generation projects, partly due to a more accommodating planning system. In the latter's case, it has successfully raised almost £4 billion since July 2008, including £400 million recently from the European Investment Bank for its renewables projects.

Irrespective of Ofgem's efforts to attract competition to National Grid, the latter's role in building electricity links between offshore wind plants and the nearest coastal facility will be crucial. It is sharply raising its investment programme and has recently raised around £3 billion through a surprise rights issue that attracted an impressive 94 per cent take-up.

Suppliers. The likes of turbine or gearbox manufacturers. These will need to raise funds for working capital purposes. To do so for any offshore wind projects that are anything but first-rate will be challenging.

Nigel Hawkins is a director of Nigel Hawkins Associates, which undertakes investment and policy research. Email: nigelhawkins1010@aol.com