Trianel has just appointed RBS as financial advisor for two more 800MW plants, and around 20,000MW of power development is planned in Germany as nuclear is phased out, and a highly competitive debt pricing competition has broken out in the German power sector. Some banks are taking on very cheap debt for current deals in a bid for future market share.

The current focus of bank attention is the Eu820 million ($105 billion) Duisburg-Walsum coal-fired independent power project (IPP) financing, lead arranged by KfW IPEX-Bank, IKB Deutsche Industriebank AG and Helaba. The 750MW hard coal-fired power project is supported by a 20.5-year Eu615 million loan and the two project sponsors – STEAG (51%) and Austrian utility EVN (49%) – will provide guarantees during the construction phase, after which the deal becomes fully non-recourse.

Market rumour prices the debt at around 43bp over Euribor during construction with step-ups during operation – a margin so low that several Landesbanks are said to have walked away because the terms were so competitive.

Trianel's first IPP financing last year – a Eu360 million loan – also came in low at 60bp, later stepping up to 95bp. At the time the tight pricing surprised many banks: "The Trianel transaction was already quite surprising for the terms and conditions that could be achieved in the German market," confirms Michaela Pulkert, head of power and environment with HVB. Now, if market rumour is correct, it appears generous compared with Duisburg.

Fair pricing?

Syndication of Duisburg-Walsum is expected shortly and some bankers expect only a small part of the loan to come to market. Although, no-one expects any problems with the credit due to its high quality, some question whether the margin can be justified in terms of the lender's internal rate of return (IRR) – cited as one of the main reasons for none-participation by some bankers.

Conversely, Duisburg-Walsum has also been praised for its structure.
"Although the pricing is very tight, the deal does have its merits," says Nikolai Ulrich, head of project finance energy with HSH-Nordbank. "It is a very good risk, it has a fairly conservative tenor for a coal fired plant and is conservative in many respects and this to an extent justifies a tight pricing."

Furthermore the deal has been structured to be as vanilla as possible. For instance it is described as having a simpler structure than Trianel – a deliberate strategy, according to bankers, to achieve a lower margin.

Although exact details of the long-term PPA are sketchy, bankers privy to the deal claim more risk than is normal for such a transaction has been passed on to the off-taker. For example much of the operating risk has been transferred, along with other risks that would normally reside with the sponsors (although the sponsors are partially acting as the off-takers as well).

However, the real question is the identity of the ultimate off-takers, which remains under wraps, although they are understood to have a strong credit rating.

An equally strong under-current pushing margins down is the sheer volume of liquidity in the market. There are at least ten German banks capable of raising several hundred million Euros for project financing power stations. Add to this foreign banks – like RBS – establishing a presence in the German market, and competition looks intense.

In addition, "the reason for so much liquidity is that we have been through a long period with no project financing in the [German] power sector," explains Frank Beckers, co-head of project finance and capital advisory with Deutsche Bank. "So now that it is happening again people are extremely keen to play a major role in the early deals."

The thinking is that some banks are offering highly competitive terms to build their reputations. They are also looking to better position themselves in the market for future deals.

Duisburg-Walsum is now the third IPP deal and so far margins have been moving lower. "There's a keen appetite for good risk," says Juergen Frank, executive director in the global energy team with WestLB. So does it follow that the next batch of deals will be on similarly tight and maybe even lower margins? "I hope at some stage we will see an end to such tight pricing, because it is not justified," says Beckers.

In some respects Duisburg-Walsum may turn out to be a one-off. To achieve similar margins, future deals would have to be structured in a similar way. They would also have to be of similar quality to the Duisburg-Walsum sponsors and the off-taker would require a comparatively strong credit rating.

Also, WestLB's Frank reckons the current downward trend in margins shouldn't be taken for granted. "We have a number of projects coming up, not just in Germany but all over Europe for new capacity, at which point how liquid will the market be if demand for funding is very high?" he asks.

Many bankers estimate that 2007 should be busier than 2006 was. Names such as Electrabel and Stadtkraft come up regularly. There is no doubt that there is a lot of activity at the moment from companies looking to get a foothold in the German power generation market.

More solid prospects include another project from STEAG and another from Trianel. Bankers also mention the possibility of a couple of deals from regional and municipal utilities keen to develop their own independent capacity.
There is also the possibility of two or three waste-to-energy plants and other corporate-sponsored deals.

A tender is out for the financing of a power plant for copper refiner Norddeutsche Affinerie. The project may require Eu200 million-Eu300 million in financing. With few other details available, it is too early to give an opinion on the likely margins, say bankers. However, one thought is that the mandate will be strongly contested, implying a tight spread.

A statement from Norddeutsche Affinerie says that it feels it is being over-charged by the big utilities and therefore wants its own independent source of electricity. Apparently, other large corporates feel the same, so more deals are clearly on the way.

According to Beckers, coal-fired plants need to have large enough economies of scale to justify commissioning them. He reckons about 800MW is a good size. "You then have to find others off-takers to take on that volume of power," says Beckers. Finding other parties can prove challenging, say bankers.

Waste-to-energy plants continue to be an attractive proposition for funding. Depending on the project, the quality of the off-takers and sponsors, margins can range from 80bp to 150bp. They were given a boost with the 2005 ban on putting various types of waste into landfill sites. Burning the refuse derived fuel (RDF) can generate 50-60% of the plant's overall income.

On the downside, "at some point there is a risk of not enough pre-treated waste," says Ulrich. "I would think there are indeed more projects under development than the market can sustain or the fuel cycle will have to grow as well."

Nuclear extension

Looking further ahead, there are a number of issues creating uncertainty for the market. Firstly, there is the status of Germany's nuclear power plants.

They were originally set to be fully decommissioned by around 2020. Currently, they provide about quarter of the nation's electricity needs. However, Germany's Chancellor, Angela Merkel, has raised the prospect of extending the life of some of the newer plants. She argues that it makes commercial sense to do so and gives more time to develop alternative energy sources. There is also the question of reducing carbon emissions and security of energy supply.

Some of the newer plants could run for another five to seven years. This would influence the timing on the country's need for new thermal plants.

"Irrespective of when nuclear is shut down, there is still demand for new capacity," says Beckers, "There are plenty of older coal and gas fired plants, which need replacing." Pulkert basically agrees. "Because of the need to replace old thermal plants, extending nuclear probably won't have much impact on building new thermal capacity in the short- to medium-term," she explains. Nonetheless, it is an issue that is being followed closely.

According to bankers, one of the biggest concerns raised by sponsors is the prospect of the EU internal electricity market being fully liberalised. They fear that Germany could be flooded with cheap French and East European nuclear-generated electricity. Such an outcome would inevitably stall the construction of new thermal plants. However, it is unlikely to affect existing plants, as they are tied into long-term PPAs.

Carbon squeeze

Another concern potentially clouding the long-term outlook for new thermal plants is the issue of carbon credits. The European Commission recently reduced Germany's carbon emissions cap to 453.1 million tonnes from 482 million for the trading period 2008-2012. One banker suggests that sponsors may rush to try and get any new coal-fired plants operational before 2011. He says there is considerable uncertainty as to how the next European Emission Trading System (ETS) plan is likely to shape up after 2012. Recently, the European Commission has become much more zealous about enforcing lower carbon emissions.

It has also challenged German plans to exempt coal-fired plants until after 2020. Under its national allocation plan, the federal government guarantees new coal plants the carbon allowances they need to operate viably.
This is, however, a double-edged sword. On the one hand more expensive carbon credits favour renewables at the expense of hydrocarbons. On the other, the new generation of coal- and gas-fired plants are much cleaner and more efficient than their predecessors. If anything, more expensive carbon credits may encourage more clean thermal capacity and may favour gas over coal.

However, this is counter-balanced by recent rise in gas prices, which make coal appear more competitive.
Barring any major upsets, 2007 looks set to be a busy year for German project bankers. No doubt margins will continue to be tight for the foreseeable future, especially for the more desirable credits. This is not just the result of Germany being over-banked, but also the result of a huge amount of global liquidity desperately seeking yield.