2020 and the future beyond
After another strong and innovative year of Australian renewables activity, Allens project finance specialists Michael Ryan and Lisa Zhou reflect on the key trends in 2017 and provide their insights on what happens after the 2020 finish line.
The year opened with a number of interesting trends, which may be here to stay, at least until 2020.
* The stretching of debt tenors– We saw the first quarter open with the landmark Edify Energy and Wirsol-sponsored solar portfolio financing. Distinguished by unique features of a cross-collateralised portfolio structure of three greenfield projects and the mix of long-term contracted retailer and government-funded offtake revenue and uncontracted revenue, the transaction achieved debt tenors of 15 and 18 years with Commonwealth Bank of Australia, Clean Energy Finance Corporation and Norddeutsche Landesbank Girozentrale.
The Edify Energy and Wirsol financing was a ground-breaking example of how the common challenge for sponsors around debt tenors could be overcome for a greenfield renewable energy asset financing in Australia.
Further examples of longer debt tenors followed, with Willogoleche Wind Farm achieving financial close with a long-term debt solution and Edify Energy demonstrating the success of its model with the completion of a second portfolio financing of the Daydream and Hayman Solar Farms, achieving a 13-year debt tenor.
The support of governmental schemes from state and territory governments and funding programmes provided by ARENA and the Clean Energy Finance Corporation have continued to accelerate these changing market dynamics.
The preparedness of European and Asian banks to offer longer tenors is also having an impact. This has facilitated growth in diversification of funding sources by sponsors (including by reducing capital needs with ARENA funding grants) and their ability to procure revenue streams supported by government credit. With new large-scale renewable energy auctions continuing to be unveiled, such as the Victorian government’s 650MW wind and solar auction, this can only encourage participation of traditional project finance lenders in longer-dated debt for a greater number of projects.
* Continued strength of solar activity and a mix of investor types– Solar energy continued to be a hot commodity in 2017, proving that with the technology, significant cost reductions in PV panels and shorter construction periods, solar is here to stay as a viable investment.
Governmental policy continued to be an integral contributor to the solar boom, with large-scale solar development initiatives being implemented in 2017 by multiple state and territory governments predominantly through offtake contract schemes, ARENA with its grants programme and the activities of the Clean Energy Finance Corporation.
With the publication of the Finkel Review and the focus on energy stability, the attraction of solar energy may have been further increased given the potential for a more stable power supply during daylight hours when wind is far more intermittent.
This was supported by the popularity of solar projects among financial and offshore investors in what is becoming an increasingly mature solar energy development market.
We saw Goldman Sachs join fund manager Palisade Investment Partners as an investor in the Palisade Renewable Energy Fund. This followed the establishment of the existing fund with Clean Energy Finance Corporation which included management of the Ross River solar project asset. Lyon Group continue to make headlines through projects such as their A$660m combined solar and storage project in Sunraysia, Victoria.
The greater diversification of equity capital pools willing to support solar power development in Australia has truly grown. As costs continue to decrease and environmentally responsible investments continue to move up in importance for the global business community, the level of demand from financial investors and alternative capital providers in renewables projects can only be expected to increase.
Despite the highly politicised Finkel Review and Clean Energy Target proposal, Australia remains as a destination that is viewed as having relatively greater political stability due to the Turnbull government’s Renewable Energy Target and funding incentives or contract auctions announced by different levels of government. The reduction in infrastructure privatisation opportunities in Australia in the short term, when compared with recent years, will only increase the size of capital pools looking at renewables investment opportunities.
A change in direction and beyond 2020
While the race to 2020 showed no signs of fatigue during 2017, the momentum in the renewables sector did in some ways change direction as the year progressed.
The commissioning and release of the Finkel Review sparked a heightened level of conversation around energy security and reliability. Connected to the Finkel Review was the highly politicised proposal to replace the Renewable Energy Target with the Clean Energy Target and the eventual abandonment of the Clean Energy Target in October with the Australian government’s announcement of the National Energy Guarantee policy (NEG).
While the NEG is not fully enacted and the market is keenly seeking more detail, the policy involves imposing two new obligations on electricity retailers that may be particularly relevant to shaping the renewables market once the Renewable Energy Target runs out.
First, the Emissions Guarantee, which aims to reduce the electricity sector’s greenhouse emissions by requiring electricity retailers to buy or generate electricity with a set level of emissions intensity each year.
Second, the Reliability Guarantee, which aims to ensure that there is sufficient electricity generation available to meet consumer needs by requiring electricity retailers to contract or own a certain amount of “dispatchable generation”. While not formally defined, some likely examples of what dispatchable generation would cover are coal and gas-fired generation, pumped hydro and battery installations.
* Diversified energy sources– The potential shift in momentum arising from the Finkel Review and the NEG is yet to play out in full. However, investment patterns from 2017 may anticipate some of the structures that may ultimately be adopted broadly in the market place.
For example, the diversification of energy sources as part of one project may be increased. With the closure of ageing coal-fired power stations, and as energy companies and banks increasingly decline to participate in new coal projects, a consistent theme surrounding the Finkel Review and the Reliability Guarantee is making up the base load power shortfall.
While gas-fired generation will inevitably play a role in meeting those objectives, the emergence of hybrid projects that combine a traditional renewable energy source such as solar or wind with a “dispatchable” generation source such as battery storage to ensure that the project can meet times of peak demand or where the sun or wind is not available, will assist.
We have seen the ground-breaking partnership between the South Australian Government, Tesla and Neoen to install the world’s largest lithium ion battery alongside a 315MW wind farm. Other good examples can be found in CWP Renewables, which is reported to be building a 600MW solar and battery storage project in New South Wales near their Sapphire Wind Farm Project, while Genex Power is building solar and pumped hydro projects at the former Kidston mine site in Queensland. The announcement by SolarReserve of a 150MW solar thermal project with a molten salt storage facility in South Australia also provides a possible window to the future of renewable projects.
Once the full parameters of the Reliability Guarantee under the NEG are rolled out, we can expect greater investment in similar hybrid projects that involve dispatchable generation sources combined with more traditional renewable energy sources such as solar and wind.
* Diversified revenue sources– The diversification of revenue sources by sponsors may also be influenced by the NEG. Only a short while ago, the feasibility of project financing a renewable energy project was dependent on the availability of a long-term offtake contract. Typically, what that meant was where the offtaker was a non-government entity, the provider of that offtake contract had to be at least investment grade – which meant procuring a contract from one of the three major electricity retailers in Australia (AGL, Origin or EnergyAustralia).
Given the abundance of renewable energy certificates (the demand from retailers for which was the driver of much of the first wave of long-term offtake contracts for renewable power projects in Australia), obtaining a long-term offtake contract has proved more difficult in recent times and continues to be challenging today. Among other reasons, this is due to the expiry of the RET in 2030, the policy uncertainty in Australia around carbon pricing, and the market’s views on how shortfall penalties will be enforced and whether the operation of those penalties will affect behaviour as intended.
We have already seen the trend of some sponsors responding to this by bundling projects on a portfolio basis to aggregate and diversify contracted and merchant revenue streams. As shown in the Edify/Wirsol transaction, the sponsors were able to obtain an attractive debt financing package by combining long-term contracted revenues with a strong credit and merchant based revenues. This has reflected a shift from what has traditionally been a single asset project financing approach to greenfield renewable energy projects.
The motivation that the NEG may provide to build hybrid projects involving battery and other forms of dispatchable energy may increase the feasibility of traditional renewable energy projects being financed on a merchant basis where they are bundled with contracted revenue streams and the increased stability of revenues that may come from having dispatchable sources in the portfolio.
* Corporate PPAs– A key feature, or lack thereof, of the NEG is that there is not an explicit subsidy scheme for solar and wind energy projects. The lack of an explicit subsidy may encourage the rise of corporate PPA activity, which is arguably less subsidy driven and more economics driven.
With longer tenors compared with traditional electricity retail contracts, less exposure to price movements and alignment with sustainable investment mandates, corporate PPAs are increasingly becoming a viable option for businesses that are looking to reduce their energy costs and implement sustainable investment initiatives.
In 2017, we saw Telstra directly contract for the long-term output from the Emerald Solar Farm, which is aligned with its reported broader energy strategy involving objectives of reducing energy costs, building network resilience and supporting a more stable energy system. Announced just before writing, the bundled PPA from a consortium of 14 universities, cultural institutions and councils as part of the Melbourne Renewable Energy Project in favour of Pacific Hydro’s Crowlands Wind Farm has captured much attention.
Whether corporate PPAs can become widely recognised as a bankable revenue stream in their own right as opposed to a hedging instrument for a merchant based financing will depend on the ability of sponsors to implement structures that reflect an adequate credit support level, tenor and risk allocation with the offtaker.
As we have seen from the past year’s activity, these structuring matters are not insurmountable and there are many market factors that motivate the growth of corporate PPAs. The technological improvements, lower costs and shorter build timeframes will continue to be attractive to corporates, especially in the current environment of rising wholesale electricity prices combined with the benefit of trading large-scale energy certificates at least until 2030.
From a developer perspective, corporate PPAs may be a welcome addition to a renewable asset portfolio as traditional offtakers that are willing to write long-term PPAs may decline as we approach 2030.
2017 saw the boundaries of renewable energy investment shifting, with longer debt tenors and portfolio based renewables financing becoming familiar features across a number of transactions. The developments surrounding the Finkel Review and the NEG are yet to play out in full. However, early signs have shown that the wave of renewable activity may continue for years to come, with some interesting shifts in structure and risk allocation that will play out in the coming years.