Having decided to phase out its nuclear power plants, Germany is in the midst of a major construction programme of new coal-fired power plants as exemplified by Trianel's Lunen project which closed earlier this year.

However, project sponsors find themselves caught between a shortage of debt capacity from project lenders and fierce protests from environmental groups who oppose the building of new-coal fired plants because of their high CO2 emission levels.

At the same time, the big utilities are understandably conservative about their balance sheets, and may feel that now is not the right time to press ahead with new plants in a controversial segment of the electricity market.

The situation is further complicated by changing European Union rules which will see a reduction in free allowances under the Emissions Trading Scheme (ETS), meaning that increased CO2 prices will need to be factored into German power prices. Meanwhile there is also discussion within German political circles to prolong the phase-out of nuclear reactors, which would impact the future competitiveness of coal-fired plants.

Despite all these difficulties, bankers are still pressing ahead with preliminary work on project financings, hoping that the lending environment will improve in the first half of 2009. Tenors are likely to be shorter than the 25 years seen on past financings, and sponsors may be asked to up equity levels. But deals are still viewed as fundamentally bankable, and if even half the planned coal-fired plants manage to get past environmental objections, that will still leave a sizeable amount of business for project lenders over the next 24 months.

"At the moment if you go out to the market there is no underwriting capacity," comments one Frankfurt-based project lender: Even Trianel and Prokon Nord's 400MW Borkum West II offshore wind farm financing, a less politically contentious project than coal-fired generation, is being reassessed after banks told the sponsors Eu1 billion of debt could not be raised in the current lending climate.

"You need to do deals on a club basis, but at Eu1-Eu1.5 billion club deals are complicated," adds the lender. "In 2006 or 2007 banks were willing to do a final take of Eu100 million or Eu150 million, but today they are suggesting a final take of only Eu50 million, so if there is no underwriting you can see how many banks would need to come in on a club deal. There will need to be bigger underwriting groups put together next year."

In order to bring in these broader groups of lenders, project arrangers may also have to reassess debt-to-equity ratios, which have ranged between 10% and 25% equity on German power projects, depending on the structure used to determine the sale price of the electricity. Some banks may have a problem going below 15%, and 20% may be more realistic to make a large group of lenders comfortable.

Similarly, whereas very long tenors out to 25 years had been realistic in 2006 and early 2007 – dependent upon a small group of specialised project finance banks for underwriting commitments – these will have to be shortened in 2009. Nor can projects expect KfW IPEX to come to the rescue, since it is setting extremely tough environmental conditions for coal based power projects. "KfW are basically saying that total carbon emissions must be reduced, which means that if you have an existing 400MW location to shut down and want to build a new and more efficient 800MW plant they will say no," says a lender.

Trianel's Lunen

The only major German coal-fired plant to reach financial close this year is the 750MW project in Lunen – one of the world's most advanced hard coal fired power plants, with an efficiency rating of more than 45%.

The Lunen project is sponsored by Trianel Power-Projektgesellschaft Kohlekraftwerk, which is a subsidiary of Trianel European Energy Trading, an association of 28 regional and municipal utilities. These utilities are seeking to improve competition in the marketplace by building power plants, and reduce their dependence upon the major power companies.

The mandate to arrange Eu1.31 billion of 23-year debt for Lunen was won by WestLB. Given the nature of the sponsor, the target group for banks during syndication was mainly landesbanks and regional savings banks (sparkassen). This financing strategy had been developed on another Trianel plant back in 2006 – the Eu359 million Hamm-Uentrop CCGT facility.

The Lunen syndication got off to a slow start. With the help of market flex provisions pricing was widened, though rival bankers suggest that WestLB still has a sizeable chunk of the loan on its books. Margins were set at 95bp up until 2013, which includes the construction period, then drop to 92bp until 2018, and rise again to 105bp to 2023, 120bp to 2028 and 135bp to maturity.

Coal-fired pipeline

Trianel is unusual given that it is made up of municipalities, but all the major electricity utilities in Germany, plus others from around Europe, have been pressing ahead with hard coal generating plants.

Kraftwerke Mainz-Wiesbaden (KMW) looks set to mandate Deutsche Bank and Barclays to arrange debt for its Eu1.2 billion 823MW Ingelheimer Aue coal-fired plant in Mainz. And late last year Electrabel chose Wilmershafen (WHER) as the site for a new coal-fired power station, with the full support of ruling state government and Lower Saxony prime minister Christian Wulff. Coal supply logistics will be handled by Rhenus Midgard, and state government will upgrade a bridge in order to help supply.

Construction on the 800MW plant at Ruestersieler began in 2008. It is expected to come onstream in 2012, with total capital costs of Eu1 billion. Electrabel is also preparing the construction of a second 800MW power station in Brunsbuettel, which will start operations in 2012.

RWE has a new coal-fired programme underway. At the existing power plant location in Hamm, and also at Eemshaven in The Netherlands, RWE is building hard coal based units at a cost of around Eu2 billion each. These new units will be the most modern plants of their kind, and reach an optimum efficiency of 45%. The two plants can also be retrofitted with CO2 flue gas scrubbing equipment that can be used to capture and store CO2 after combustion.

Meanwhile Energie Baden Wuerttemberg (EnBW) is also pressing ahead with new projects. In September the foundation stone was laid for the new RDK 8 hard coal power station at Karlsruhe Rheinhafen. This Eu1 billion plant, which is on the site of an existing power station, is scheduled to come onstream in 2011.

E.ON, Essen based Evonik Steag (formerly STEAG), and Swedish utility group Vattenfall also have hard coal power plants coming onstream in the coming years. The 800MW coal fired cogen plant at Duisburg Walsum is being built by Evonik Steag and infrastructure company EVN, with EnBW buying the electricity. It is scheduled to come onstream in autumn 2009.

Banking strategy

The strategy on the part of banks and sponsors alike is to press ahead with working out the details of financing plans, while hoping that market conditions will improve to make way for syndication sometime in 2009. During the second half of 2008 banks have not stepped up with underwriting commitments, but have simply been doing structuring work.

"We are working on a number of coal projects, and moving ahead with structuring and preparing things for our clients," says a banker. "But we still don't know when the debt markets will re-open, and what pricing will be like."

Meanwhile more plants are expected to be blocked. In November 2007 plans for a big 1600MW coal fired plant at Ensdorf in Saarland were scrapped after a citizens vote in which 70% said no to the coal project. This was despite the full support of Bundeskanzler Angela Merkel and Environment Minister Sigmar Gabriel.

Sponsor RWE, which is the largest power generator in Germany with 33.5GW of capacity, said that it was without a Plan B at Ensdorf, and announced that it would not fight the decision but would simply scrap the project.

However RWE remains committed to a very large investment programme, although the associated increase in leverage has already resulted in a downgrade of its corporate rating in 2008, with Standard & Poor's moving it from A plus to A flat.

S&P noted that RWE's generation capacity is highly carbon intensive, as it is skewed towards lignite (24% of owned capacity in Germany and neighbouring markets), and hard coal (32%). "The group's ambitious targets to reduce its carbon emissions are contingent on life extensions for its nuclear plants, strong growth in renewables (an area where the group has only recently started to expand in earnest) and the sourcing of significant clean development mechanism (CDM) and joint implementation (JI) credits from outside the EU.

An extension to the life of nuclear plants is a hot topic in Germany at present. Federal elections are scheduled for September 2009, so there could yet be a change of political direction next year.

The resolution of the nuclear power question will be important, since higher CO2 prices within the EU will mean that coal fired plants will probably remain marginal generators behind nuclear and gas fired plants, though this depends on the development of oil and gas prices, which given recent volatility are very hard to forecast.

Germany is the biggest electricity market in Europe, and under the current programme needs to replace 40,000MW of generating facilities by 2020 in order to keep up with the phase-out programme for nuclear and other older power plants.

A sizeable number of gas-fired plants are being built, and gas pipelines from Russia form part of the overall energy infrastructure programme. But energy security is high on the agenda right across the European Union, and the heavy reliance upon Russian gas is now viewed as problematic, which could tilt things in favour of coal.

Using new clean technology to burn domestic German coal, or coal from neighbouring Poland is an attractive proposition. And even using imported coal from countries such as South Africa is seen as a more secure long term source of electricity than Russian gas.

EPC costs

Clearly the higher cost of debt financing is going to impact the economics of new projects, but on a more positive note there may at last be some let up in the continuous upward movement in EPC costs.

As many global economies enter a period of recession, a range of goods such as steel and turbines may see a fall in price, especially if the extremely heavy demand from China begins to ease. Coal fired plants are particularly expensive, because of the need to clean up emissions, and industry estimates suggest that cost has now risen to Eu1,700 per KW.

Any drop in that figure over the next few years will come as welcome relief to project sponsors, who have had to cope with relentlessly rising costs for the past five years.