The UK wind sector is experiencing a spike in activity, as the country's government, eyeing ambitious 2020 targets, unravels a range of schemes set to boost investment in onshore and offshore projects. The UK pledged in 2008 to meet 15% of its energy needs from renewable sources by 2020, seven times more than its level of 2.25% in 2008.

New EIB funding is heading the onshore sector's way, whilst green certificate banding should encourage offshore financings. Sources say a large club of banks is poised to sign on Centrica's Boreas group asset financing and as debt pricing stabilises, UK wind looks set to accelerate out of the downturn.

The government wants UK wind projects, and in particular offshore wind, to power the country towards its targets, but when it announced its targets last year there was already much industry scepticism over whether the UK could get the turbines spinning in time.

Then financial markets froze and much of the project financing needed to bulk up the wind sector dried up. Just when the UK government wanted offshore projects to capture the attention of banks, the projects suffered from crunch-heightened risk aversion.

In common with other industries, due diligence took longer than for pre-crunch deals, and few projects were closed. Many smaller developers struggled, and some projects were sold to utilities, and other players with larger balance sheets. Even midsized onshore projects, generally smaller than offshore farms, found it harder to close financing.

There are, however, encouraging signs. Utilities have continued to develop projects, many offshore, and the Boreas financing, expected to include 14 commercial banks, is set to highlight the gathering interest in UK offshore and consolidate gathering market confidence.

The UK government has put in place measures to encourage financing in onshore and offshore projects – it has brokered a new EIB fund for onshore and made changes to Renewable Obligation Certificate (ROC) legislation, to spur the closing of offshore wind deals.

Tackling offshore risk

Offshore equipment still suffers from the perception in lender circles that it is much less tried and tested than in the onshore sector. There is no shortage of offshore prospects, but they ask lenders to spend considerable time and effort mitigating additional risks. Sea conditions can vary hugely from one site to another, and there is limited, if increasing, feedback on the performance of operational farms, because many operational projects were funded on a corporate basis.

The gap between turbine makers beloved of lenders and those that present concerns to banks is even greater than it is for onshore machines. Turbines with a solid performance history are much more attractive than newer models. According to one banker: "The primary selection criteria is the choice of turbine ... the impact of a failure is much greater [than for onshore] – it's not easy to fix it once its offshore ... the consequences are more penalising."

The harsher conditions for offshore projects mean that they need more care once they are up and running. Offshore projects tend to have longer turbine warranty and operations and maintenance contracts built into the structure, says Jamieson Thrower, a director in Royal Bank of Scotland's structured finance power group focusing on renewables. "Typically with offshore you will see a 5- to 10-year warranty period, whereas with onshore you might only see 2 to 3 years," he says.

Whilst onshore projects may tie in a turbine supplier to O&M duties for two or three years after startup and then re-negotiate the O&M contract, for offshore projects "you want the turbine supplier to be providing that protection for longer," Thrower says. Lenders to offshore projects are also less willing to take construction risk. "That's the bit that is the challenge to the bank market," Thrower adds.

If lenders do take construction risk, there will be usually be protection built into the deal. These might include lower leverage, or guarantees or contingent equity in place to cover cost overruns, even if these are due to force majeure events such as bad weather during construction, Thrower says.

The higher risks involved with lending to offshore farms means that pricing on the debt tends to be around 50-100bp higher than for onshore projects, banking sources say. Debt markets have somewhat stabilised since the crunch and the market price for UK offshore project debt currently starts at around 300bp above Libor, sources say.

ROC band on the up

In a bid to encourage the development of less established renewable technologies, the UK government published in April new rules for the banding of Renewable Obligation Certificates, a key revenue stream for renewable energy projects in the UK.

The ROCs are a form of subsidy for green power, an alternative to the feed-in tariffs used in most other European countries. The government said the new legislation would mean offshore projects would get a higher level of 1.5 ROCs per MWh, compared with 1 ROC per MWh for onshore.

To catalyse offshore development, the rules stipulate that offshore projects that enter into a firm contract for turbine supply before 31 March 2010 would qualify for 2 ROCs/ MWh, or 1.75 ROCs/MWh the following year.

Ben Warren, a partner who heads up Ernst & Young's renewable energy team, advised the government on the business case for new regulations. "Pre-ROC banding the economics were difficult to say the least, and certainly did not justify the huge amount of investment required, aligned with the additional risk that offshore projects have in them," he says.

Projects that come online next year may qualify for 2 ROCs/MWh, but this will drop back to 1.75 ROCs and finally 1.5 ROCs/MWh, as projects are expected to benefit from economies of scale as more and more are rolled out, Warren says. "As risks are better understood, the pricing of those risks will fall and therefore the construction costs will fall," he says.

Before the credit crunch, turbine prices rose and UK projects continued to be hit by deteriorating UK to Euro exchange rates, he says. While onshore turbine prices have come off since the crunch, the costs associated with construction of offshore projects have remained comparatively high, largely a result of limited competition among offshore equipment manufacturers. Furthermore, the increased risks associated with offshore construction and operation still warrant the higher ROC allocation, Warren says.

Government thinking is that it will be possible to develop the UK's North Sea oil and gas industry expertise into the construction and delivery of offshore wind farms, at a time when job creation is rare. "The Government and Crown Estate have been trying hard to put in place a framework for the procurement and delivery of offshore wind farms. Government and [energy regulator] Ofgem have been working together to provide a framework for the delivery of connection capacity through an offshore transmission regime," he says.

This was illustrated by an Ofgem announcement on 23 September that 13 international bidders had been selected for the tender of nine new offshore transmission lines worth £1.15 billion ($1.8 billion), which could connect 2GW of power to the grid. The bidders include utilities and infrastructure funds. Ofgem launched the first round of competitive tenders for offshore electricity licences on 22 July 2009. In a subsequent process, investors will be invited to develop, finance and maintain new transmission lines.

Boreas sets a benchmark

Centrica's £325 million Boreas wind portfolio financing is likely to close in the first half of October, according to sources close the deal. The portfolio includes the recently operational 194MW Lynne and Inner Dowsing farms off the coast of Lincolnshire and the operational 26MW onshore Glens of Foudland facility in Aberdeenshire.
The 194MW Lynne and Inner Dowsing offshore farms reached their full capacity in March of this year, and debt negotiations had already begun by then.

There are 14 banks negotiating the debt deal, and Centrica is in negotiations to bring in a third-party equity investor, sources say. Centrica currently owns 100% of the project. Short-listed equity bidders are thought to have included RREEF, Hong Kong Electric and KKR. The banks are Bayerische Landesbank, BBVA, BTMU, Bank of Ireland, Calyon, Dexia, Fortis, Lloyds, HSBC, KfW-Ipex, NAB, NIBC Bank, Raiffeisen and Santander.

Bankers confirmed in late September that the tenor on the loan is to be around 15 years, debt pricing is likely to start at around 300bp over Libor and has changed little since the middle of the year, when pricing was said to be around 300bp over Libor to year five, 325bp to year eight and 375bp from year nine. Banks have taken a range of tickets up to £85 million, and fees range from 235bp to 260bp, depending on ticket size. The debt package is to consist of a 15-year term loan, a working capital facility, a debt service account, a maintenance service account and a letter of credit. Though the tenor is set at 15 years on the term sheet, there will be a 100% cash sweep at year nine.

The deal requires analysis of offshore risks, as well as the specific performance of recently-completed, though operational, assets. One banking source said the portfolio is to generate 1.5 ROCs per MWh for the offshore assets. The combination of assets at different stages has meant due diligence has taken some time, but most issues have been resolved, sources say.

The large number of banks interested in a deal which is to weave together operational and recently completed assets has boosted market confidence, and shows conditions may be improving. "If you go back six months you would not have had that breadth of institutions coming into a deal of that type," one banking source says, adding, "it's a precursor to significant offshore deals coming through ... it will establish a framework for how these deals might be done going forward, in terms of utilities financing construction on balance sheet and going out to banks with this type of structure."

Smaller developers need big parents

Other recent signs of encouragement include the close in early September of financing of Ecowind's 43MW portfolio of Irish assets, and the appointment of three banks as joint MLAs on GreenPower/Statkraft's Carraig Gheal onshore wind farm project in the Argyll and Bute region of Scotland.

Viridian acquired Ecowind in April 2008 and the financing is for a portfolio of operational and construction wind assets. The deal has been structured in such a way that the lenders have an option to invest in the 110MW of construction assets that form part of Ecowind's expansion plans.

The lenders on the deal were Royal Bank of Scotland, Bank of Ireland and National Australia Bank, which each provided an equal amount of the Eu38 million ($56 million) in debt. The assets financed on day one were five operational assets and two construction assets. The banks were mandated at the beginning of 2008 and had to weather the financial storm since late last year.

The project has a flexible structure, which means it can benefit from potential downward swings in supply prices, but it also required frequent review of the structure during unstable debt markets, and this dragged on the schedule, says Linklaters' John Pickett, a partner who was legal adviser to the lenders. "It's a dynamic structure. It is designed to accommodate a range of projects that are coming through into the portfolio this year.... Lenders were not just doing due diligence on a static set of assets, they were doing due diligence on a moving set of assets," he says.

Amid further signs that market conditions are improving, Barclays, Lloyds and Royal Bank of Scotland have been brought in as joint MLAs on Carraig Gheal. "The intention is to close it this year and from where I sit today I don't see any reason why that won't happen," says one source close to the financing.

Total project cost is around £80 million, of which £60 million will come in as commercial debt, which will be split equally between the three banks. The tenor is to be around 15 years. The 60MW project, located south-east of Oban, will comprise 20 wind turbines. Construction is expected to start this year, and the plant is expected to be operational by the end of 2010.

Having three banks involved in a relatively small project has surprised some market participants, which have suggested that this may have been at the urging of the Scottish government. But sources close to the deal say having three lenders on board is a useful tactic to get the deal closed efficiently. It means, for instance, that if one lender leaves the group, the gap can be easily filled by the two remaining banks, as both would be able to achieve credit approval for the remaining debt.

EIB boost

Whilst the UK's offshore wind sector has been boosted by favourable ROC banding rules, sub-£100 million onshore projects are soon to receive EIB funding through a new scheme which could provide £600 million to UK onshore projects. The scheme is likely to be launched around the end of October, sources say.

It is hoped the "EIB Intermediated Lending Scheme" will fill a lending gap for the numerous onshore deals that have struggled to secure commercial debt as crunch-beaten banks prefer to fund core customers. The scheme is to be managed by BNP Fortis, Lloyds and RBS and is designed to provide competitive, long-dated funding that feeds through to the onshore sector.

The EIB has said it plans to supply around £600 million towards the fund. Under the scheme, the EIB funding is not to exceed 50% of project cost, with the rest made up from commercial capital and equity. The scheme would support up to £1.2 billion capital cost of onshore projects.

"In the first half of 2009 in onshore wind there was no project financing for deals of significant size. This scheme is key to getting back on track to where we want to be, moving towards reaching our long-term targets," says a spokesman for the UK's Department of Energy and Climate Change, which sponsored the scheme. Under the scheme, the EIB lends to each of the banks and the banks take project risk.

The price of the EIB lending is likely to be significantly lower than commercial rates, and the banks will be obliged to pass on the pricing benefits to the projects. The exact terms on which EIB would lend the capital to the banks, as well the size of the fund in its initial phase, is currently under discussion. sources say.

Historically EIB has lent on larger deals, and taken on project risk itself, but the multilateral only has finite resources with which to analyse projects. The fund would be designed to spur the quick deployment of EIB funding. "If the scheme proves a success, EIB has stated it would consider a repeat facility, again using commercial banks as intermediaries," the DECC spokesman adds.