Flying home from the Netherlands, there are two obvious airport gifts you can buy for loved ones. One is a pair of clogs. These look fun but, in practice, tend to fester at the back of shoe cupboards without being worn – for years, if not decades.
The other is a packet of tulip bulbs. These appeal to the gardener instinct. You plant them, and then you look forward to the result. However, it can be a surprisingly long wait before anything is visible above ground – even though the soil is fertile and the tulips have every reason to want to grow.
PROJECT FINANCE
The tulip story might be a metaphor for what has been happening in clean energy project finance. When the 2008 financial crisis forced developed country central banks to cut interest rates to record lows, institutional investors found themselves searching for assets that were stable and low-risk, but that yielded appreciably more than government bonds.
For a time, corporate bonds fitted the bill. But voracious appetites among buyers, and the actions of central banks, forced yields on these down towards those on government bonds. So investors turned to emerging market bonds, with the result that at one point this year Rwanda sold $400m of 10-year paper at 6.9% and Bolivian 10-year bonds were trading on a yield of just 4.6%.
There was always another, less hair-raising alternative – infrastructure investment, and specifically clean energy assets. The latter offer predictable cash flows, often backed by governments, with an element of inflation-proofing, and yields more like 6% than the 1-4% range that has been available on 10-year German bunds, British gilts and US Treasury notes for the past few years.
Given this comparison, the idea of investment by pension funds, insurance companies and wealth managers in operating-stage renewable power assets looked promising for them. It also looked like a lifeline for clean energy, at a time when established sources of finance were under pressure. Of these sources, utilities were trying to cut back on capital outlays to conserve their balance sheets; and banks were struggling to offer project finance with long (15-year) tenors because of their own post-2008 wounds and new Basel III regulations.
But, like my tulip bulbs, the seed of institutional investment seemed to sit in the fertile soil – and sit, and sit – without much happening. There has always been some institutional exposure to renewable energy projects via diversified infrastructure funds run by the likes of Macquarie or via private equity vehicles, but more directly targeted investment by institutions in clean energy has been modest over the years.
One bulb that did sprout was PensionDanmark. Its managing director, Torben Moger Pedersen, wowed delegates at the 2012 Bloomberg New Energy Finance Summit in New York by revealing that he aimed to allocate 10% of total assets to renewables – a mile above the 1% that is the more typical pension fund allocation to all infrastructure investment. Since then PensionDanmark has been putting its money where its mouth is: in June last year for instance pledging more than $40m for the 216MW Northwind offshore wind project off the coast of Belgium, and in August this year GBP 128m to the Brigg biomass plant in the UK.
Impressive though PensionDanmark’s EUR 2bn commitment to renewables is, it must be noted that some it is directly linked to support for Danish technology – in the Northwind case, Vestas wind turbines – via risk cover from Eksport Kredit Fonden, the export credit agency. For other institutions, risk mitigation is equally important but they may well not have such strong national partners at hand.
And so, through 2009 and 2010 and 2011 and into 2012, utilities and banks, and the ever-important development banks, remained the dominant providers of finance for projects on both sides of the Atlantic.
Last year, green fronds started to appear a little more widely in the financing garden. In the US, Warren Buffett’s MidAmerican Energy got a warm reception for an $850m bond issued to part-finance the 550MW Topaz PV project in California. In summer 2012, Munich Re bought nine wind farms in the UK and Germany, taking its renewable energy investments in a year beyond EUR 600m.
OLD CHALLENGES
Despite this and other glimpses of green last year, however, the old challenges appeared still to be holding back any major flowering of institutional investor activity in clean energy. One of these has been a size issue – many institutions, especially pension funds, just do not have the resources to be able to deploy teams that understand the subtleties of investing in wind and solar projects. The flip side of the same coin is that the deals in renewables are often too small (a few tens of millions of euros or dollars) to make it worthwhile for institutions to spend time on due diligence.
A second issue has been an unfriendly regulatory regime. Bloomberg New Energy Finance chief executive Michael Liebreich and I published a white paper early this year, Financial regulation – biased against clean energy and green infrastructure? Our argument was that rules such as Solvency II for insurance companies, and those on pension fund asset and liability matching, tended to prompt institutions to hold liquid and supposedly low-risk instruments such as government bonds, corporate bonds and public equities – rather than infrastructure projects. In Sweden, pension funds are limited to investing no more than 5% in unquoted instruments, which dramatically curtails their ability to invest in infrastructure. In many countries, there are no fiduciary rules forcing pension funds to take climate change or other environmental risks into account when deciding on asset allocation.
That last point means not only that funds are not much invested in clean energy, but that it is easier for them to go on holding stakes in fossil-fuel, mining and emission-intensive companies without worrying about the possibility that some of those assets might become “stranded” as a result of tightening regulations or changes in consumer behaviour in the future.
There is a third, and more specific, reason that institutions have shied away from wind and solar, and that is fear of retroactive policy change. At a recent appearance in front of the House of Commons Environmental Audit Committee, David Russell, co-head of responsible investment for the Universities Superannuation Scheme, one of the UK’s largest pension funds, spoke of his alarm at Spain’s decision in 2010-11 to cut retroactively its support for existing solar projects.
Russell said: “It really does not happen very often that you make an investment decision, based on what you are told you will earn from that investment, and then they say, ‘We are going to change the rules’. The knock-on implications for that is not only for the investors who were invested in the Spanish PV sector, where we did lose money, but it raises the risk level for investment in renewable energies across Europe, if not globally, because investors now consider the additional risk that someone else might change their tariffs retrospectively has gone up. If it can happen in a developed market, like Spain, it can happen almost anywhere.”
Happily, institutions in 2013 have swallowed some of their trepidation about policy risk, and increased the pace of their investment in clean energy projects. Germany’s Munich Re and Allianz have continued to acquire assets, the latter only last month buying two construction-stage wind projects in France and an operating project in Italy. In February, Danish pension funds PKA and Industriens Pensionsforsikring provided some of the finance for the 288MW Butendiek offshore wind farm in German waters. Also in February, Australian pension provider AMP invested $100m in North American project developer Capistrano Wind Partners.
POOLED APPROACH
The biggest shift, however, has been via the pooled approach. In the US in July, a unit of utility NRG Energy raised $431m in an initial public offering priced above its target range, with a business plan to own wind, solar and natural gas-fired plants. In Canada, in August, TransAlta Corporation raised CAD 200m via the sale of its renewables offshoot, a “yieldco” entirely made up of operating projects backed by power purchase agreements, in order to lure institutions. London has seen a rush of fundraisings aimed at institutions, Greencoat UK Wind harnessing GBP 260m in March in an IPO, then Bluefield Solar Income Fund raising GBP 130m in July, and The Renewables Infrastructure Group, or TRIG, closed on GBP 300m the same month. In the latest move, Foresight Group is seeking to raise GBP 200m in an IPO in October for a fund to own UK and French solar projects.
In the first three of these UK IPOs, blue chip institutions without an established profile in clean energy emerged as large holders after the flotation – CCLA Invest¬m¬ent Management in the case of Bluefield, Investec Wealth & Investment in the case of Greencoat and Prudential and Henderson Global Investors in the case of TRIG.
Back to my tulips. The stems and even the leaves of institutional interest in renewables now seem to be emerging from the ground at last. Will flowers follow those shoots? Will blue chip investors take over as holders of wind and solar assets from banks, private equity firms and utilities, thereby lowering the cost of capital and improving the cost-effectiveness of those projects? It looks just about possible.
Much depends on interest rates. The case for long-term institutions becoming major providers of debt and equity for renewable power projects strengthened after the financial crisis because of the big gap that opened up between the yields on government bonds and those available on infrastructure. If the cost of money, short-term and long-term, were to rise sharply in the coming years, as developed economies accelerated back to 3%-plus GDP growth per year, then that gap would shrink and the case for green infrastructure holdings would be weakened. Either that, or the cost of finance would rise so much that fewer projects were economically viable. For now, that is not the case. To return to my original metaphor, the soil seems sufficiently moist, and the sun seems bright enough, for those tulips to flourish.
We plan to address the continuing risks, challenges and barriers to increased institutional investment in clean energy at our forthcoming Finance Leadership Forum, taking place in the countryside outside London on 21-22 November. The event will bring together some 60 senior executives from the different players in clean energy asset finance. I look forward to reporting back on the conclusions. For details of the event, please contact David Foster on dfoster31@bloomberg.net.