Silvio Berlusconi is no stranger to controversy. So when the Italian prime minister recently said that if elected for another term he would consider commissioning a nuclear generation programme, most dismissed it as grandstanding, a way to boost his reputation for bold initiatives. Yet his statement has its merits. As he pointed out, with around 17% of its energy needs imported mainly from France, Italy already uses nuclear power without any of the upside ? Italian electricity prices are about 25% higher than the EU average.

The cost per unit of generation in Italy is about three times higher than the cost of importing from France.This is the background against which new conventional plants are being developed. And it is a promising background: the high electricity price ? combined with historically high bank liquidity ? means that there has rarely been a better time for a sponsor to raise finance for a power plant. This is no better demonstrated than with the merchant financing of the Energia-sponsored Termoli plant.

Termoli, not turmoil

Energia managed to secure excellent terms, closing a Eu325 million financing from Banca Monte dei Paschi di Siena (MPS) for the 760MW Termoli combined-cycle gas turbine (CCGT) plant in January 2004. The financing comprised a 10-year Eu260 million main tranche and a Eu65 million VAT tranche with a 5-year maximum tenor.

The deal was widely derided by the Italian banking community because the risks were weighted too much on the lenders, for too little reward. Most had thought that to be digested by the market a debt to equity split of 50-50 would be necessary, but Termoli weighs in with a short-term split of 80-20 and a long-term split of 65-35. And the pricing is fairly thin, at 220bp over Euribor during the three-year construction, ratcheting down in intervals to 200bp, 190bp and 180bp.

That MPS was the sole underwriter for the first and sizeable single asset merchant plant in Italy was either a reckless gamble or a calculated risk. MPS's conviction paid dividends: whilst the murmurings by the wider market continued through 2004, local legal challenges regarding permitting brought by the municipality had to be heard before the debt was successfully sold down to a club of 10 banks, including MPS. The lead arranger, advised by Allen & Overy, was vindicated by the oversubscription to the deal (see Termoli, EMEA power deal of the year, for more details).

As a merchant plant, Termoli's credit risks are mitigated less by the structure of the deal and more by electricity pool price projections. UK-based power analysts, ILEX, ran a complex model for the plant's dispatch into the market. MPS and the joining banks also took a view that the technology risks were low and that there were tangible benefits from first-mover advantage, insofar as Termoli will be the first CCGT constructed and on-line of a batch of upcoming plants, when the gap between demand and supply will be at its greatest and therefore the price at its highest.

The Molise region, where Termoli will be built, is one of low generating capacity, stuck behind bottlenecks caused by a distribution network in need of investment. In such a transmission-constrained region project sponsors benefit from the support of the regional authorities, and thus the permitting process is faster and less susceptible to local-political risk. But while this process is capable of stemming opposition at the regional level, it cannot not necessarily stem municipal criticism.

Split market

That Termoli successfully syndicated does not alter many Italian bankers' opinions about the deal. Termoli is divisive. Many bankers say that although they would not have lent to Termoli, but they would consider lending to a merchant plant differently structured and priced. Others say they will not lend to merchant deals, and others still do neither mainstream tolling nor merchant deals in the current market.

?Banks are currently cash rich, so there's plenty of liquidity around and everyone's keen to book assets,? says Andrea Tiana, head of project finance Italy, BNP Paribas. ?This has an evident impact on pricing and structures, which in this market sometimes appear driven more by lenders' appetite for assets than an assessment of the fundamentals. It's a phase in the cycle seen in the past and not just in this market.?

BNP Paribas has carved out a niche in putting together financings such as the acquisition of Elettra assets from Italian steel group Lukini and RWE by a private equity consortium which closed in November 2004. Elettra's portfolio comprises a combination of 228MW in existing and planned capacity under CIP6 contract and 42MW of renewable capacity. However Tiana stresses that BNP still actively examines newbuild CCGT assets.

Whereas some banks are waiting on the sidelines, expecting margins to bounce back on a default, others such as Unicredit believe that there will be a gradual reversion after a period of frenzy. Sergio Alcini, head of energy, oil and gas, Unicredit, says: ?The market is splitting into two segments: the merchant plants, where the tenor is shorter at around 7 years, there's a bullet payment on debt, and the risks and margin are higher; and the tolling plants where finance is usually over 15 years, and the margin is lower depending on the creditworthiness of the sponsor and toller.
This is the first wave on the market, so we would expect the pricing to be tight. It is our strategy to participate in the first plants and stay in when, hopefully, the pricing eases.?

Two new contenders, and one old face

The market eagerly anticipated financial close for the two tolling plants currently close to financing: the 400MW Voghera Energia plant in the Pavia province of Lombardy, and the 800MW Sparanise plant, sponsored by Swiss utility EGL and HERA in the Caserta province of Campania. These plants look like setting a tight benchmark for toll-backed project debt of between 100bp to 150bp over Euribor.

The Eu242 million 20-year financing for Vogerha is lead arranged by HSBC and MCC, and underwriting closed 7 December. Seven to 10 banks are likely to join a club that was scheduled to close February, but is likely to slip by a couple of months. The sponsors, AceaElectrabel and ASM Voghera, financed construction on balance sheet and are taking out the equity post construction. In contrast to most toll-backed financings before now, the debt does not incorporate a tail beyond the 20-year tolling contract with AceaElectrabel. The DSCR is anticipated to be about 1.25x, and the debt should pay a margin over Euribor of at most 135bp.

With sponsors of lesser credit strength, the Eu400 million financing for EGL and HERA's project company, Calenia Energia will come in outside Vogerha Energia's terms, with a top level margin of about 150bp and an DSCR of roughly 1.3x. Tenor is likely to match the 15-20-year tolling agreement with EGL. Like Vogerha, negotiations are ongoing and close is anticipated in the first half of 2005. The banks arranging this deal are: RBS, SG, Fortis, Unicredit, WestLB, BoTM, Bayerische, HVB, Mediocredito and BNL.

Banks come to a decision as to leverage, tenor and pricing based on a combination of the strength and creditworthiness of tolling counterparties and the underlying dynamics of the electricity market. The terms now being seen reflect the high quality of tolling counterparties, the fact that Italy is massively short of power and the liquidity in the banking market. To compare these deals, with say the 800MW Amorebieta deal in Spain [a comparable tolling deal with a top-level of 170bp] has little useful benefit. Amorebieta was closed in the fallout of the difficulties in the power market during 2002, and the European bank market has moved on considerably since then. If Amorebieta was refinanced now it would come in a lot tighter.

The tightening of margins has spread into projects from corporate deals, and sponsors are keen to take advantage. Many of the project financings are close cousins to corporate deals in that although the debt is not consolidated on balance sheet, a power plant, especially for a utility, will be of such strategic importance that the sponsor will assist if the project company struggles; and thus effectively the debt is assumed to be recourse. Moreover, a parental toll will add almost as great an obligation as recourse debt to a sponsor's credit profile.

Illustrative of banks' demand for assets and approaching the market relatively quietly, the anticipated Eu2.3 billion Edipower refinancing should close in February. A sizeable portfolio, with an anticipated margin of around 80bp, the deal has a set of covenants more suited to a corporate loan.

The original deal refinanced Eu3.8 billion in acquisition bridge debt. The financing was a complex hybrid of recourse and non-recourse tranches, comprising a Eu1.6 billion non-recourse loan, a Eu600 million loan guaranteed by the sponsors, Edison, Aem Milano, Aem Torino and Atel, and a Eu100 million revolver. Tolling agreements initially cover 6,000MW of capacity, rising to 8,000MW over an eight-year period as new plants come on line.

The lead-arranging group is thought to comprise 11 of the 13 lenders on the original refinancing, which were BancaIntesa, RBS, Barclays Capital, BNP Paribas, Commerzbank, Calyon, HSBC, Interbanca, MCC, Mediobanca, SG, Unicredit and WestLB. The deal reduces the cost of borrowing by tapping the market at the prevailing cheaper terms and taking out the junior tranches.

Respite ahead?

Despite the slim lending returns, banks on the tolling deals can take some heart from the Energia experience. Although Termoli set an aggressive benchmark, the structure for Modugno CCGT will follow it only in terms of gearing and is otherwise completely different. Whereas Termoli has a gradual amortisation schedule over 10 years, the seven-year bullet financing for Modugno will make the annual DSCRs much higher. This would appear to fit in with Energia's plan to IPO within four or five years. Financing for the 760MW plant, located in Bari, is lead arranged by MPS, BNL, Efibanca and WestLB. Close is expected in the first quarter of 2005.

Beyond Modugno, the next CCGT project financing could be for the 800MW Scandale plant in Calabria, sponsored by Eurosviluppo Elettrica, ASM Brescia and Endesa.

The plant will be a cogeneration facility, supplying heat to industries in an adjacent business park, giving its output priority dispatch as well as such other advantages as an exemption from green certificate obligations.

So far the three sponsors' investment has been on balance sheet. The plant will be completed in 2007 and require an investment of Eu400 million.

How long will the sweet spot last?

Tightening power prices are symptomatic of the evaporating market uncertainty: the gencos have been successfully refinanced and are repowering; and the electricity pool is up and running ? save for two investigations for price spikes by the regulator, the operation of the market has attracted few complaints.

How long will conditions favourable to sponsors last? Bank liquidity is difficult to define, but appetite seems strong, regardless of the Edipower refinancing. But electricity market conditions are unlikely to move further in the sponsors' direction. Even though demand continues to rise, there are first signs that the generation gap is beginning to fill. As well as the genco repowerings and the plants in construction, by the end of 2005 the interconnection capacity between France and Switzerland will increase from 6500MW to 7200MW.

?There is a danger of a number of years of oversupply if all the proposed power plants are commissioned, in conjunction with the increase in interconnector capacity and lower than expected demand growth ? although this is unlikely, as not all projects will go ahead,? says Steven Pedder, principal consultant, ILEX Energy Consulting. ?However given the nature of the Italain market and the dominance of Enel, we believe the levels of wholesale electricity prices in such a downside scenario would still be sufficient for banks to cover the debt ? at a DSCR of about 2 ? although the developers would not meet their return expectations.?

If all the authorised plants were built there would actually be a glut in supply of electricity. Therefore present financings, particularly merchant deals, to a lesser or greater extent depend on the inefficiency of the permitting process for their well being. As one commentator put it, despite the Marzano Law, permitting ?is still a numbers game. A good sponsor like Atel, which was behind Novel, had ten prospective plants. As yet none have been developed. If you have ten planned plants, perhaps if you're fortunate three may get built over a space of about four years.?

The Elettra acquisition
The Elettra acquisition by private equity houses Hutton Collins (70%) and Oxenbridge & Co (30%) is believed to be one of the first continental European project financings of power assets involving private equity. The acquisition was financed by a Eu119 million non-recourse facility solely underwritten by BNP Paribas and Eu41.5 million equity.

The debt financing comprises an 11.5-year Eu109 million senior facility and a five-year Eu10 million junior loan. The senior facility benefits from a front-ended amortization profile and a cash sweep in year eight. As well as benefiting from the cross-collateralisation from a portfolio, there is a cash reserve mechanism to allow for the refinancing of the largest plant, Servola, and cash traps to protect both from a fall in power prices relating to the non-contracted plant and regulatory risks. The average debt service coverage ratio is 1.6x.