John Musk:
Thank you for joining us today. This is the sixth session that we've hosted now in the Navigating the Energy Transition Series, hosted by RBC. Today we're going to focus on how we finance the renewable build-out that is needed as we move towards net zero. Obviously this is a very topical subject. I, for one, have had a lot of questions around the UK offshore leases that's happened very recently and how PPAs may help to deliver those alongside CFDs. So I'm sure we'll have a lot of topics to discuss. I'm hosting the session today with my colleague, Fernando Garcia, who works with me in the Utilities Research Team at RBC.
Fernando Garcia:
We have three speakers today who will each give their perspectives on how to finance the energy transition. We have Ken Gates, Director of Market Modeling at the Econ Study Consulting who has a long experience in forecasting long-term power prices. Unfortunately, Miguel Marroquin from Our New Energy is ill today and cannot attend as planned, but his colleague, Nikolaus Brost, who is a partner at Our New Energy, has kindly stepped up. Finally, we have Mark Saar, who has [inaudible 00:01:44] RBC project advisory on finance team.
John Musk:
Perhaps you can talk a little bit around your perspectives on how you see power prices developing over the longer term, especially with the potential for cannibalization from further renewables development.
Kim Keats:
So when I look at how it is that prices should evolve or what they should evolve towards, I'm always looking at the cost of new entry. So in the context of renewables, especially PV, and let's use that as an example, though it's also relevant for wind, the LCOE, the levelized cost of electricity. So in effect, if you think that the LCOE is really towards where we think the realized price for the different technologies should converge towards. Obviously there's a series of factors which influence that particular benchmark. So what is the capital cost? What are the financing parameters there too, which is where we get into the question of do you need PPAs and how do PPAs help you secure financing for those particular projects, debt to equity ratios, et cetera. O&M costs will also matter.
John Musk:
Maybe turning to you, Nicholas. Obviously when people are looking to sign PPAs, they're going to be factoring in long-term power prices, but what do developers need to have in place in order to secure the best PPAs?
Nikolaus Brost:
First of all, I think that the easy answer is there has to be a market in place. And we're fortunate that, let's say from a Spanish point of view, the market is very well developed. So if a certain counterparty wants a certain product, it can be sourced. We're seeing other European, and let's say European but not EU countries, in Europe, where we haven't seen that, such a level of advancement within the regulated power markets, so [inaudible 00:03:39] the market.
Nikolaus Brost:
Then, when people approach us, it's often because they just want to find an off-taker, and then they want us to close the PPA. But in actual fact, we generally have a three step approach, and that means that we actually start with a structuring phase because it's very different from investor to investor what exactly it is that really makes sense for them and why they're even signing a PPA, and in the end, should they sign a PPA? So it's only once we get to understand all the facets of the business case, can we even start coming up with the right PPA product. So I think that's the key message is that, to sign an attractive PPA, you need to know exactly what kind of PPA you're looking for.
Fernando Garcia:
How difficult is it to [inaudible 00:04:41] financing without a PPA? What are the key differences in project financings for all [inaudible 00:04:48] versus contracted assets?
Mark Saar:
Regarding the question of what other work needs to be done to achieve financing for projects, typically conditions to close and fund for renewables projects include having all permits and no appeals outstanding thereof. There have been a few cases of financings that have been challenged trying to close into appeal situations, and that can just be a nonstarter for some banks. Other aspects, having interconnection responsibilities and logistics between the project and the [inaudible 00:05:27] executed, having the EPC contract signed, and in the case of wind projects, it's typically two contracts, the turbine supply, and balance of plant for the site.
Mark Saar:
And then lastly, lenders will always require reports from a number of independent consultants. These would typically include the independent engineer, market consultants, an insurance consultant. If it's a bond deal, a model auditor. And I would say very recently with the October 2020 advents of Equator Principles 4, for some projects in sensitive environments or with indigenous community consultation requirements, lenders will require a supportive report from an independent environmental and social consultant.
Mark Saar:
Regarding debt pricing, this would've been a more interesting discussion, I think, anytime in the last 12 months of pandemic, but I would say at this point now the credit spreads for project bonds and bank deals in the North American renewable space have finally really come back to pre-pandemic norms. And I would say for bank deals in the renewable space, and probably only this space, have even pierced the pre-pandemic lows.
John Musk:
What is the cost of project financing between the sort of number of smaller renewables companies for the larger integrated names, but HOW would you see the cost differential there, or is it down to the assets of the parent doesn't matter as much? And then also, what's the difference between project financing on a renewable asset versus a regular asset? Is there a discount for being green now?
Mark Saar:
Yeah, I would say there's not much difference in structures or pricing in the different scales of project, given that there's significant bank and private placement market appetite in the renewable sector, with the caveat that there is a floor, I would say, in the scale where developers of all kinds of assets just find non-recourse debt finance not worth it. The required debt arranger fees, the lender's independent consultant fees, legal and loan costs, they're all pretty insensitive to financing scale. So at too small a project, they become an aggregate, pretty daunting when expressed as a percentage of project costs, and the developers just choose not to pursue that route.
Mark Saar:
So the threshold can obviously vary depending on sponsor bank relationships, but it might be 75 to a hundred million of financing side. But there is definitely benefits to financing a diversified asset portfolio of renewables versus single assets. For example, we took a portfolio that was a mix of wind and solar projects to two rating agencies, and as I talked about earlier, often, on a single asset, P99, 1 times the SCR might be your debt constraining factor, but having different assets allowed us to put forth the view of a non-concurrence of the P90 resource from asset to asset and led to a material formulaic leverage bump in terms of how rating agencies looked at it. A question comes up invariably for developers, do I use bank or bond or private placement debt financing.
Fernando Garcia:
So Kim, I would like to move for now to the role of technology in the energy transition. Obviously, we have a lot of moving parts here. What do you think will be the role of batteries, demand side response, or even hydrogen in long-term power prices?
Kim Keats:
Go back to a view that in the middle of the day, we have this solar generation, especially in somewhere like Iberia. So the sun is shining and it happens to be the summer, demand's a little bit depressed, do we bother with the fact that the spot market prices are likely to be extremely low, if not negative? As an anecdote, by the way, the Spanish market still operates under a cap and a floor of 180 Euro per megawatt hour and zero, so you can't technically get negative prices. You can get negative prices in ancillary services, but not yet in the spot market. That will change. We need more flexibility. Because we're capping the flexibility with respect to where prices in the day ahead market can go, it sort of affects the valuation for things such as batteries, for example.
Fernando Garcia:
So Nikolaus, we're probably moving from this [inaudible 00:10:08] solution flexibility to something that maybe available in the shorter term. What is your view of [inaudible 00:10:15] already commenting that in the [inaudible 00:10:18] be interested to join PPAs or for solar plus, maybe wind, or even including batteries as well. Do you think it might be interesting at this point, when this might happen?
Nikolaus Brost:
So maybe starting with the final question, when this could be happening. It is already happening. We're working on a PPA in Denmark at the moment where there's a PV plant, a wind farm, and a hydrogen plant, behind the same metering plant. So I think it is something that very much is happening, and it's something we will see happening. And I think it's important to, let's say, follow on what Kim said, that these are driven by different things. The need for introducing, just combining PV and wind will probably be less important unless you're factoring in [inaudible 00:11:23] grid costs and lowering your LCOE for the entire plant, whilst the storage aspect brings in a different type of product and [inaudible 00:11:32]. It becomes a completely different product, and it's something that maybe as a standalone isn't as valuable a component to add if you're doubling the price of your plant.
Nikolaus Brost:
But what it does do, it does buy you protection against hours where power prices are very, very low. And as Kim said, it's only a question of time before prices can also go negative. So I think in general, we have to say that, yes, we are going to see, and we are seeing, but in reality, it's more going to be driven by the markets, and people are going to be forced into making these kinds of choices because as more and more PPAs are signed, there's going to be less interest in profile products, meaning that the closer you can come to selling what is essentially a base [inaudible 00:12:30], where wind and PV might be, let's say, fitting together very well.