Memo to policy-makers: re-charge the development banks
Could one answer to the clean energy financing shortage in Europe be hiding right under the noses of the region’s policy-makers?
The question is pressing because blockages in the supply of loans from European Union banks are posing one of the biggest threats to clean energy investment this year – particularly in Europe but also to some extent elsewhere, given the large role that EU banks have traditionally played in renewable energy on the other side of the Atlantic.
The problem is partly economic – banks endured a sharp rise in their own costs of funding as a result of the euro area sovereign debt crisis late last year – and partly regulatory.
It is unfortunate timing, because the low-carbon transition of the energy sector will require unprecedented amounts of capital. European Union countries, alone, will need to invest some EUR 462bn in new renewable energy capacity in the 2011-20 period, according to Bloomberg New Energy Finance estimates, plus hundreds of billions more on grid, in order to fulfill their National Renewable Energy Action Plans, and meet their official target of 20% energy from renewable sources.
The latest figures on that score are not reassuring. Asset finance of utility-scale clean energy projects in Europe in the first quarter of 2012 was just $4.3bn, according to Bloomberg New Energy Finance data published this month, down from $7.5bn in the final quarter of last year and $7.2bn in Q1 2011.
A financing shortage is admittedly not the only problem. In several important EU countries, government support programmes for renewable energy have been in a state of flux. Developers, investors and lenders have been confused and concerned about policy twists from Madrid to Warsaw, and London to Rome.
However the deterioration in the financing environment has been important in its own right. Since the euro area crisis of last autumn, it has become more expensive for banks to borrow. Many of them are also positioning themselves for the imposition of Basel III rules later in the decade, by restricting 15-year lending unless it is matched by long-term funding.
Utilities have been less affected than specialist project developers because most of them tend to finance the construction of their renewable energy projects on-balance-sheet rather than via non-recourse project debt. However they have not escaped unscathed from the economic storms.Some of them have faced pressure to bolster balance sheets and limit borrowing, in order to protect their credit ratings, particularly if their sovereign governments have themselves had ratings downgrades. German utilities, meanwhile, have had to cope with a financial blow from the early closure of nuclear plants under the country’s energy turnaround plan.
Nevertheless, utilities are ploughing on with renewable investment – Eon for instance planning to put in EUR 7bn over the next five years, and RWE some EUR 4bn between 2012 and 2014. The main problem therefore lies with banks’ ability to provide project finance, rather than with the utilities.
Jim Barry, chief investment officer in the renewable power team at BlackRock, said at the Bloomberg New Energy Finance Summit in New York in late March that there was a “general balance sheet issue with respect to European banks” and that major players were “cutting back on capacity and capability”.
The finance squeeze is not going to ease quickly – not with Europe in such a deep economic bind. So where could answers lie? As many of us know from trying to find a lost set of keys or pair of spectacles, the hardest place to find something is often right in front of us. Perhaps one part of the answer to Europe’s project financing problem lies with the banks that policy-makers can most easily influence – the development banks.
The multilateral development banks, particularly the European Investment Banks and the European Bank for Reconstruction and Development, performed a crucial service to clean energy – and the wider European economy – in the period after the financial crisis, popping up as lead lenders to big projects at a time when the commercial banks were repairing their balance sheets.
The EIB’s own figures show it raising its lending to “renewable energy sources” from EUR 1.7bn in 2008 to EUR 5.5bn in 2010. One of the biggest deals in that year was EUR 450m for the second and third phases of the Thornton Bank offshore wind farm in Belgian waters. However in 2011, renewable energy project lending slipped to EUR 4.6bn, and with overall EIB lending to all sectors projected to decline over coming years, it will be hard to avoid further slippage in its support – assuming that the institution stays on its current course.
Its statement in February announcing the overall 2011 lending figures defined the outlook as follows: “Under the bank’s strategy to maintain its financial strength through a gradual return to pre-2008 lending levels, lending for new operations in 2012 is planned to decrease to EUR 50bn.” The equivalent figure was EUR 61bn in 2011.
There is another aspect to the EIB’s lending that deserves note. In France, the EIB provided EUR 200m via local banks for the “roll-out” of regional PV capacity but it also lent EUR 165m for the “construction and operation of a gas turbine power plant”. In Italy, it lent EUR 200m via local banks for the “financing of small and medium-scale renewable energy and energy efficiency projects” but it also provided EUR 185m for the construction of an “oil processing unit at Sannazzaro refinery” and EUR 240m for an LNG import terminal off the coast of Tuscany. Overall, in 2011, the EIB lent EUR 790m to gas-fired power stations, EUR 33m to coal-fired, EUR 175m to nuclear fuel processing, and EUR 1.1bn to natural gas grids.
In the case of the EBRD, partly owned by EU nations and focussed on lending to former Communist countries in Eastern Europe and the old Soviet Union, total lending and investments in 2011 amounted to a record EUR 9bn. Projects benefitting in 2012 have included EUR 30m of energy efficiency initiatives in Romania, and Mongolia’s first ever wind farm, a 50MW project at Salkhit. However, also last month, the EBRD said it was considering the financing of the construction of a 750MW lignite-fired power plant in Serbia “that would replace a number of obsolete power generation units in the country”. Overall, the EBRD says it invested EUR 500m in renewables last year, and EUR 700m in conventional energy. It does not lend to nuclear.
Make no mistake. The EIB and the EBRD cannot cure Europe’s shortage of clean energy finance. It is not sensible for public sector institutions to shoulder the whole burden, either. However, given the fact that project finance has become scarcer as a result of the late-2011 euro area crisis, it seems perverse for EU governments to be sanctioning a decline in EIB lending.
EU policy-makers should think again on EIB lending in the light of the economic circumstances. Robert Zoellick, president of the World Bank, argued in an article in the Financial Times in mid-April that EU governments should boost the capital of the EIB by EUR 10bn. That would enable the bank to increase its lending by several times that figure, and some of that would feed through to renewable energy and efficiency.
In addition, the boards of the EIB and EBRD should reconsider their energy-lending remits, to maximise outlays that assist the low-carbon transition and minimise those to conventional energy. They could for instance decide to stop lending to coal altogether and lend only to gas if those projects directly reduce emissions by a large percentage.
There is another species of development bank that will be important to the financing of clean energy in Europe in the years ahead – the national institutions. Germany’s KfW has been a thoroughbred in European clean energy, just as important in its way as the EIB, last year lending EUR 22.8bn to the widely-defined area of “environmental and climate protection”. It has been of particular value in providing low-cost refinancing to renewable energy projects in Germany, in the provision of loans on commercial terms via its KfW IPEX offshoot, and via its EUR 5bn special fund for financing German offshore wind (recently extended to cover offshore grid as well as the generation projects themselves).
However there are also new members of this species. The UK has a Green Investment Bank soon to start work – once it has completed inspection by the European Commission to make sure it is not breaching state aid rules. And the Netherlands, Finland, Ireland and the Czech Republic are among those other countries also reportedly thinking about spawning a national green bank.
The UK GIB starts off with a modest GBP 3bn of capital endowed by the UK Treasury, and will have borrowing powers to supplement this from the bond markets only from 2016. Sensibly, in our view, it has identified just three sectors as its priorities rather than trying to make a difference to financing right across the clean energy and environmental spectrum. Its chosen three are offshore wind, waste infrastructure, and energy efficiency.
Offshore wind is key to the UK’s National Renewable Energy Action Plan to achieve 2020 targets – our analysts have estimated that the whole plan will cost the country some EUR 72bn, of which offshore wind will account for more than EUR 40bn. But commercial banks do not have anywhere near the capacity needed to lend the debt portion of this – perhaps EUR 28bn over the next nine years, not to mention the associated grid works. Utilities will fund some of it via their balance sheets but there is a dire need for other sources of money.
The UK’s GIB planners believe that there is a specific problem with pre-construction debt, and are thinking at the moment of using part of the GIB’s firepower to provide pre-construction junior debt, or mezzanine finance, for offshore wind projects.
We are worried about this prospect. With its slim resources, and with public and political warmth so crucial to the continued support of renewable energy investment in the UK, the GIB would be jumping feet-first into the highest-risk portion of lending to a sector that is not completely mature and is moving steadily further offshore and into deeper water.
In fact, the commercial banks have shown themselves willing to finance offshore wind, in German, Belgian and UK waters and are about to do the same in French waters. They are warming to pre-construction debt too – its higher risk means the banks can charge more. The GIB would be better to leave pre-construction lending to those with more experience, notably the commercial banks, the EIB and the Danish and German export credit agencies.
Instead, it should concentrate its efforts on shepherding long-term institutional money – from pension and insurance funds – into energy efficiency and operating offshore wind projects, in the latter case enabling commercial banks to recycle their loans to new projects. This role might involve the commitment of some GIB cash for a period, but the central role would be as a designer and packager of pooled, investment-grade products for long-term investors.
The clean energy sector is lucky to have the development banks. It would be luckier still if European policy-makers thought afresh about how best to deploy development bank resources.