The £326.5 million ($480 million) Fred Olsen wind portfolio financing has just signed – and while any European wind deal closing in the current lending climate is good news, the terms of the deal are much harsher than wind developers have been used to.

The key changes are not just on debt pricing – margin ratchets from 150bp to 195bp and fees have been upped to 130bp. More significant is that any bank on the 18.5 year loan has an option to call for full repayment in year 12 and although the structure is intended to be added to with new projects in the future, the banks can opt out of funding new assets or sharing security with those assets.

As the credit crunch ups the cost of project finance debt by as much as 125%, many small wind developers are struggling to finance projects, prompting some to cancel or delay them. And things are set to worsen in 2009 when and estimated 10%-20% of the sector's planned capacity expansion could be derailed.

As cash-strapped developers scramble to fund projects, they are expected to sell wind-farm stakes to the major utilities – this is not new, but more of them may start selling up pre-operation: For example, troubled Babcock & Brown is looking to sell its undeveloped 102MW Arganil wind farm (part of the Enersis portfolio) to Caixa Capital having failed to get a debt financing via Dexia, BBVA and BPI off the ground.

The funding squeeze is also likely to mean the development focus returning to onshore projects, which are much cheaper to finance than offshore and proffer better asset security.

2012 targets?

The EU may bolster subsidies to meet its 2020 renewable power targets which call for the installation of 180GW of wind farms. Europe has so far plugged 57GW of onshore and offshore generation capacity, according to the European Wind Energy Association (EWEA). By 2012, output should rise to 80GW, with Spain, Germany, the UK and France driving that expansion.

EWEA hopes Europe will install 8.2GW of wind power capacity annually by 2012. However, analysts say that target is untenable in the current funding climate and the divergence of opinion between development and lending industries is widening.

Many bankers expect a slew of projects will be delayed as funding evaporates and the generous terms that were once available disappear. Conversely, EWEA's chief executive Christian Kjaer says it's too early to assess the crisis' impact. While acknowledging that some projects are suffering, he expects most to proceed on schedule.

"As any other sector, the crisis will affect us but we don't know to what degree," he says. "We are a capital-intensive sector so you would expect us to be hard hit. However, there are many investors that can take over struggling projects including utilities that have a lot of cash and strong balance sheets."

Kjaer has a point. Babcock & Brown has managed to find a buyer for its operational Enersis assets. A consortium led by Portuguese buy-out firm Magnum Industrial Partners is buying the operational portfolio (named the Pavel assets which include Martel I and II) and is expected to reach financial close on the Eu1.2 billion acquisition very soon. BBVA, BCP BES and CaixaBI are keeping their original Eu740 million debt position in the portfolio and, other than BBVA, all are also providing a bridge loan to develop the 156MW Martell III assets.

However, the Babcock & Brown sale is further down the line than many deals – Babcock was one of the first to feel the full fall-out from over-leverage – and in the current climate even names like Centrica and Generg are struggling to get debt facilities in place.

Centrica, despite having the advantage of being a vertically integrated supplier, has postponed its wind portfolio until next year in the hope of better liquidity, and Generg's 442MW portfolio financing, although nearing close after months of negotiation, is designed to incentivise the sponsor to refinance fairly quickly (the margin jumps from 140bp to 180bp in year three and 220bp in year seven).

The one thing all agree on is that utility-sponsored projects are more likely to get done than those without that kind of credit clout. "The large utilities that can do this on balance sheet will be okay – but those that rely on debt, such as the smaller, undercapitalised developers and IPPs could very well see delays," says Tom Murley, head of renewables at HG Capital, which operates a Eu300 million renewables private equity fund.

Capacity down 10%-20%

According to Murley, cash-rich utilities have financed half of Europe's wind expansion. They are expected to continue doing so and will bolster their market share as they snap up stakes in small developers.

"They have a whole bunch of cash [boosted by high energy prices] and a range of borrowing options including the loan and bond markets which are still open to them" Murley points out. "They don't need to take on bank debt."

Consequently, market leaders such as E.ON, RWE, EDP and Iberdrola are unlikely to cancel their ventures as they have enough money to deploy them. And while lenders have temporarily shut the door in the face of independent developers, they are still willing to back utilities, which can borrow on a full-recourse basis (providing more repayment guarantees), giving jittery banks more peace of mind.

The same can't be said about IPPs and other entrepreneurial firms. Debt margins for wind have soared to 180bp-225bp from 80bp-100bp a year ago while loan covenants have toughened up, making it very difficult for these players to raise cash. "Half of the market is struggling," Murley says. Kjaer disagrees, saying that IPPs – especially those with secure wind-turbine contracts – will be able to obtain cash from utilities and other alternative investors.

In the past, some investors shunned projects without these contracts because they were perceived as too risky. But now that turbine demand is slowing, smaller developers are having an easier time securing engines at very attractive prices, making their projects more attractive.

Other industry executives were also optimistic. Euribor rates are falling and lower turbine prices are boosting project economics, prompting some banks to reconsider the sector. In addition, some claim turbine prices are set to fall as much as 15% as manufacturers suffer from falling demand and work to stave off further declines in their share prices, which have been pounded recently.

As prices for turbines and other components fall, wind-farm construction costs could decline to Eu1 million per MW from 1.5 million per MW now, some observers say.

To woo banks, smaller developers are also providing additional guarantees such as higher up-front payments and other collateral to minimise project risks. Meanwhile, turbine suppliers are providing greater assurances of on-time deliveries and expanding their maintenance cover.
Ben Warren of Ernst & Young doesn't expect the financial meltdown to significantly derail wind projects, particularly onshore ventures. "Many project developers can afford more expensive senior debt and there is no shortage of appetite for financing wind, particularly well structured, robust on-shore facilities."

However, he acknowledges that costlier offshore projects could suffer. "Offshore projects have large capital requirements so they are less economically attractive," he says. "We have seen some large sponsors withdraw from offshore and there could be more as some utilities rationalise capex," Warren points out.

Consolidation

As banks avoid small developers, many are expected to sell project stakes to utilities, increasing their chances of survival. "Rather than being delayed, the lack of third-party funds might result in independent producers selling wind farms to utilities that don't require external financing," says Warren.

Murley agrees. "There is less debt available so some developers will sell stakes to utilities or other investors such as private equity or infrastructure funds," he says. "Others, however, may take the view that the credit crunch will be over in six months and will probably go out of business."
Apart from utilities, a growing number of investors are looking at the market but whether and how much they will invest hinges on sponsors' pricing expectations, which have been too greedy in recent years, Murley says.

"Too many of these developers have benefited from cheap equity and debt as well as an uninformed investor base who though renewables were going to go up an up and didn't understand the dynamics of the sector," he explains. "Project valuations are coming down to more reasonable levels so some investors may re-consider the sector."

This new cadre of financiers could include petro-rich investors from the Gulf as well as emerging and restructured infrastructure funds.

Masdar, a green-energy investment vehicle funded by the Abu Dhabi government, recently bought a 20% stake in the 1GW London Array offshore project, taking the place of Shell, which exited the venture amid spiralling costs.

In similar moves, Scottish Southern has sold its 50% stake in UK offshore scheme Greater Gabbard to Germany's RWE Innogy for £308 million to ensure that its £1.3 billion complex is finished by 2010. Meanwhile, Swedish utility Vattenfall recently rescued Eclipse Energy's Ormond wind park by acquiring the whole venture and has just bought the 300MW Thanet offshore project from Christofferson Robb.

More Gulf investors such as Masdar are expected to back European wind projects to profit from falling valuations and the industry's promising long-term prospects.

"This is a sound investment opportunity and many Middle East investors want to acquire the European know-how to set up their own wind industry at home," Lange says.

But what if the crisis worsens, prompting more investors to flee the market? The EU is unlikely to save wind through bank-style bailouts. "EU governments are not in the business of socialising energy infrastructure so I doubt they would step in to invest," Warren says, echoing other experts.

However, some say the EU could step up incentives to ensure it meets its renewable power targets, which call for 20% of energy to stem from environmentally friendly sources by 2020.

Stronger onshore

As the crunch makes project economics a top priority, many expect onshore schemes to make up a larger-than-expected contribution to Europe's wind portfolio by 2012. "It's difficult to say what will happen but there is a strong possibility that new onshore development will overtake offshore as these technologies have huge investment differentials," says Miroslav Durana, a renewables analyst at Credit Suisse.

Adds Murley: "Right now it's massively expensive to build offshore farms which cost at least double that of onshore facilities." In the UK, building an offshore park costs £2 million-£2.3 million per MW compared to £1.4 million-£1.7 million for an equivalent onshore complex. In Germany, it can cost as much as £3 million per MW. Sub-sea grid connections are hugely expensive while project logistics and maintenance requirements can be very cumbersome. "My view is that offshore is not going to have a material presence in the industry's future," Murley says.

Some investors have already walked away from the offshore market, most prominently Shell, which caused a stir when it pulled out of London Array, citing soaring costs. The scheme's costs have reportedly soared to £3 billion from initial estimates of £1 billion.