Well established renewable energy technologies such as onshore wind, photovoltaic (PV) and even biogas have been able to attract non-recourse debt financing for some years. But bank lenders are facing a new set of challenges, as other sources of green energy grow in importance.

Last year saw the first ever non-recourse financing of a solar thermal power plant using parabolic trough technology. Tidal energy is under study in some countries. And over the next two years there will be a big move towards offshore wind projects in countries such as the UK, Netherlands and Germany.

Some sponsors will prefer to finance on-balance sheet, and avoid the complexities of putting project debt in place. But bank lenders are keen to move onto more difficult projects, where margins are better than onshore wind, and will be offering competitive non-recourse funding.

In any case, the trend in renewable energy is for projects to get bigger, which points towards more use of non-recourse debt financing. Projects costing upwards of Eu500 million ($650 million) will not be uncommon in the offshore wind sector – much larger than typical onshore wind farms.

New technology construction risk

The question is how banks will address construction risk, particularly where new technology is being used, or where sponsors are pushing the barriers with ever-larger wind turbines that have very limited historical performance data.

Two sizeable projects are already being built offshore from the Netherlands. One was financed on-balance sheet by Noordzeewind (a joint venture between Shell and Nuon), and comprises a Eu200 million facility near Egmond aan Zee involving thirty-six 3MW turbines. The first test power is already being used by Dutch households. This project has been supported with various tax incentives, as well as renewable energy tariffs set by the Ministry of Economic Affairs.

From a project arranger's point of view, more instructive is the Q7 project, which last October succeeded in putting in place non-recourse bank debt, with Rabobank and Dexia Credit Local as lead managers.

The 120MW Q7 wind farm is powered by 60 Vestas V-80 turbines, and is being developed by ENECO Holdings, Econcern and Energy Investment Holdings. It is being built by Vestas and Van Oord Dredging and Martime Contractors under two separate construction contracts. Total project cost is Eu383 million, with operation expected to start in March 2008.

"In offshore wind projects such as Q7 there is no single EPC contractor, but instead there are various contractors working closely together, so it is necessary to carefully manage the interface risk within the project," says Niels Jongste, senior manager, project finance, at Rabobank in Amsterdam.

"Construction risk, in terms of cost overruns or delays, is obviously a major risk in a new sector such as offshore wind, and on the Q7 project the sponsors and contractors were willing to work closely with the banks to find a finance-able solution, with debt being in place right from the start of construction," he adds.

The financing includes a Eu219 million 11-year non-recourse facility, fully underwritten by Rabobank, Dexia and the ECA Eksport Kredit Fonden, which is providing a guarantee on a Eu68 million portion of the debt in support of Danish turbine supplier Vestas.

There is also a Eu160 million short-term construction facility, provided by Dexia and Rabobank. The financing structure includes a contingent facility (together with contingent equity provided by ENECO) to cover any cost overruns or delays, a cash sweep mechanism, and availability guarantees from Vestas to cover any under-performance during the operational life of the project.

Jongste notes that the current MEP (environmentally friendly energy) subsidy that Q7 benefited from is no longer available. The Dutch government will now be looking at the Q7 and Egmond aan Zee projects to see how effective they are, and decide upon any future programme of subsidies for the offshore wind sector.

Offshore Europe

"The main focus for financing offshore wind in Europe is now on the UK, Germany and Belgium, where a number of new projects will start construction this year, and will be looking for non-recourse debt financing," Jongste says.

In Belgium the most high profile deal is the C-Power wind farm, which is starting off at 30MW but may be expanded from there. Dexia is arranging financing. And in the UK there are some ambitious new projects, against a background of a government target to produce 15% of UK energy from renewable sources by 2015.

The first round of offshore UK wind projects are already in operation, but Round 2 projects will be much bigger. Late last year Thanet Offshore Wind, which is controlled by Warwick Energy, got its various permits to begin work on a 300MW farm off the coast of eastern Kent.

Deutsche Bank has taken a 20% equity stake in the Thanet project, and is also arranging the £340 million of debt for the £480 million project, alongside Bank of Tokyo Mitsubishi UFJ. The wind farm should come on-stream in 2008.

In the outer Thames Estuary, an even bigger wind farm is being planned, known as London Array. This is being sponsored by Shell WindEnergy, E.ON UK Renewables and CORE Ltd, and will be a 1000MW project.

"The UK government has said that it intends to band the Renewables Obligation, and target the existing cost to the consumer more towards emerging technologies such as offshore wind, wave, and tidal, rather than well established technologies such as onshore wind and landfill gas, which now need less support," says Richard Tyler, partner, energy and projects team at Lovells in London.

"Some big Round 2 projects have already gone ahead with getting planning consents, and the sponsors clearly believe that when the Renewables Obligation system is changed the economics of offshore wind will improve," says Tyler.

Bank arrangers will draw on the structure of the Q7 financing to come up with ways to make bank lenders comfortable with construction and operating risk. As one comments, "Q7 has pushed the market forward to the next level."

But not everyone is convinced. "You have to be sure that, even with guarantees in place, if the windfarm is not performing as expected, that you can identify which contractor is responsible," comments one banker. "We are still not happy taking offshore wind construction risk ourselves, and a number of issues need to be worked out before we would lend into these deals."

Previously there had been some offshore wind risk included in the Beaufort Wind portfolio, but the offshore assets (North Hoyle) were already operational, and were a small part of a mainly onshore wind portfolio.

Just as in the UK, offshore wind energy has been slow to develop in Germany, where a few test sites are operating. But 17 projects have been approved, and another 22 are in the process of public authoritisation.

The legal approval for the erecting and operation of wind farms is issued by the coastal states such as Lower Saxony, Schleswig-Holstein and Mecklenburg-Vorpommern within a 12 mile nautical limit, and by the Federal Maritime and Hydrographic Agency outside this zone, in the so-called Exclusive Economic Zone.

Germany has a simple feed-in tariff system, which makes it easier to put in place financing compared to the green energy certificates plus tariff system in the UK. German operators are paid Eu0.0619 per kWh, though this will decrease by 2% each year beginning in 2008. An additional Eu0.0291 per kWh is granted for a twelve year period if the wind farm is commissioned before 31 December 2010.

A major obstacle to making the economics of offshore wind work has been the cost of offshore connection to the grid, and this has held up many projects. But since the end of 2006, the German Energy Act states that the grid operator will have to bear all the costs for cable connections, for wind farms built before the end of 2011.

This window of opportunity is expected to be taken advantage of by many German sponsors, who will typically start off with an 80MW first stage before building out to anywhere between 250MW and 500MW.

"Now that the grid companies have to pay for the connection of offshore windfarms, that takes out a considerable amount of the construction budget, and if you assume that the tariff remains the same that obviously substantially improves the economics of an offshore windfarm," says Nikolai Ulrich, head of project and export finance at HSH-Nordbank in Kiel. "The cost will be amortised over the long term via the grid usage fees paid by all power consumers."

"Banks in Germany have become used to taking construction risk on good projects in the onshore wind, photovoltaic and biogas sectors, so this is not a major issue for lenders, but offshore wind will be more challenging," comments Joerg Fischer, vice-president at Bremer Landesbank.

Thus far there are only a few offshore test sites operating in Germany, but some sizeable commercial deals are at the planning stage, and have received a boost from recent regulatory changes.

"The grid operators will now be obliged to connect offshore wind farms to the grid, which will shift 25% to 30% of total Capex to the grid operators," says Fischer. That makes a lot of projects more feasible, especially ones that are located further out into the North Sea, and we are expecting a number of projects to begin construction in 2008."

"There is also quite a lot of biogas activity in Germany, such as plants that run on manure supplied by farmers," he adds. "These tend to be rather small, perhaps 500KW, but equity investors are putting together portfolios of these plants and getting them project financed."

Solar picks up

In the solar sector, photovoltaic plants are also getting larger, and can count on banks to put in place non-recourse debt at the construction stage. Newer technologies such as solar thermal can be more problematic for lenders, though last year there were major financings closed for AndaSol1 and AndaSol2 in Andalucia, Spain. Both are 49.9MW power plants using solar parabolic trough technology.

The Eu253 million non-recourse debt financing for AndaSol2 was arranged by Dexia Sabadell Banco Local, Banco Sabadell, BNP Paribas and WestLB.

The project is being developed by Cobra Sistemas y Redes (part of the Spanish ACS construction group), and Solar Millennium Verwaltungs, a German company which is a leader in solar parabolic trough technology.

EPC contractors are Cobra Insersa, the parent company of Cobra Sistemas y Redes, and Sener.
The projects can sell electricity to the grid under Real Decreto 436/2004 which sets out tariff regulations for 'special regime power producers'.

Other solar plants in Spain are looking at non-recourse financing, though some big sponsors, including players such as GE, BP and Shell, remain happy to fund on balance sheet.

GE is actively buying European renewable energy portfolios as well as building its own wind and solar projects. In June 2006 GE Energy Financial Services, PowerLight Corporation and Catavento broke ground on a photovoltaic power project at Serpa in southern Portugal. The 2,000 modules have a 11MW capacity.