The gauntlet has been thrown down: 22% of Europe's electricity needs must be met with renewable energy by 2010. The Renewables Directive 2001/77/EC, which entered into force on 27 October 2001, aims to increase the share of electricity from renewable sources to 337 TWh. Member states have been set indicative targets as to their share of electricity; though these targets must correspond to the overall purpose of the EU Directive. According to the British Wind Energy Association, wind power could meet up to 50% of the target.

In 2003, EU wind power capacity increased by 23% to 28,401MW, with Germany (2,645MW) and Spain (1,377MW) dominating the market. Moreover, by the end of last year, Germany, Spain and Denmark accounted for 84% of the total wind power capacity installed in EU-15. These figures indicate that wind power is in effect concentrated within the three Member States that face maturing markets.

For the Directive to succeed, wind power will need to be harnessed in other European states on a scale similar to that of the three leading countries. "The future direction of the European market depends on how fast other markets can replicate their build rate, and the speed of offshore developments," states Corin Millais, chief executive, European Wind Energy Association (EWEA).

With a target of 10,000MW expected from offshore projects by 2010, European utilities and banks have their work cut out. High investment expenditure and poor infrastructure mean that the costs involved in an offshore wind project may be 20 to 30% higher than on land. Thus, it comes as no surprise that a handful of offshore projects are currently being scrutinized in order to see whether they can be templated for future deals.

At present there are some 84 wind power schemes in the UK, the majority of which are onshore. Nevertheless, the UK government is looking to further offshore projects, even though questions have been raised as to planning requirements, transmission infrastructure and grid access in the North Sea.

Offshore deals may be thin on the ground, but they are starting to emerge. Most recently, Offshore Wind Power Limited (a joint venture between Renewable Energy Systems and nuclear generator British Energy) has been given the go ahead for a 30-turbine 60MW-120MW wind farm near Skegness. The project is just one of 18 offshore wind schemes around the UK coast granted seabed leases in 2001 in the government's first round of offshore development. Currently 1.2GW of offshore projects have been consented to.

The most significant offshore deal to date was closed in the UK last year. RWE Innogy's Beaufort Wind/Zephyr Project for an offshore wind farm - the 60MW North Hoyle on the Welsh coast - proved that a structure could incorporate a removal of UK Renewable Obligations Certificate (ROC) risk while taking the financing off-balance sheet. "The Zephyr deal will hopefully be a benchmark in creating on-going offshore deals," says John Pickett, head of the Green Energy Group at Linklaters.

UK commits

The UK government has shown its commitment to renewables by imposing a 10% target by 2010. Initially, industry experts were concerned that the renewable obligation scheme - imposed in April 2002 - did little to further non-recourse development. The scheme, which requires electricity suppliers to buy quotas of power from renewable sources with the receipt of a ROC worth around £47 ($85) per MW/h, only ran until 2010. Moreover, for every MW/h the supplier fails to meet its renewable obligation, it is liable to a £30 buy-out escalated at inflation. This short time frame gave bankers cause for concern. Fortunately the scheme has now been extended until 2015. Under the new ROC plan renewable obligations increase from 10.4% of generated output to 11.4% in 2011 and incrementally to 15.4% in 2015.

The financing entails £300 million of project debt and £112 million in equity for UK wind farm holding company Beaufort Wind, which in turn will buy Innogy's wind farms post-construction. The project financing comprises three tranches: 'A' will finance the existing farms; 'B' will finance subsequent acquisitions; and 'C' finances the offshore wind farm acquisition. The loan tenor is 18 years and margins are dependent on the asset: 110bp-140bp for the existing plants and 125bp-155bp for new acquisitions.

Although the deal overcame both intellectual property and insurance issues relevant to future projects, industry experts have been impressed by the circumvention of the UK's ROC regime. The structure allows banks in future wind projects to take no construction or price risk: a position they will feel comfortable with in the untested waters of a UK offshore market.

Nevertheless, certain industry experts believe that while the offshore UK market is attractive, onshore options have not as yet been exhausted. While this may be true, the UK has some of the best natural resources in Europe to accommodate offshore wind project - a large coastline and shallow waters.

According to Ernst & Young's Renewable Energy Attractiveness Index, published last month, the UK has become 'the most attractive market for wind energy'. The index scores 15 countries 'based on their national renewable energy markets, renewable energy infrastructures and their suitability for individual technologies.' Nevertheless, the UK's surprisingly high score - having beaten off Germany, Spain and the US - seems to be founded on the UK's potential. Though the UK may have a large amount of unexploited wind resource and Scotland, in particular, may be Europe's windiest region, it does not follow that these resources will be fully tapped.

Certainly protection from the deregulated market by ROCs, changes in the planning environment, together with decent capital allowances and grants will mollify any doubters as to the potential of the market. In addition, there is bank appetite for renewable deals: there are many bankers with the IPP skill-set, who don't have a lot on at the moment and could transfer their skills.

A number of utilities are beginning to look at the possibilities of offshore development, which is proving a boon to project financiers. Given the nascent status of the offshore market, financiers tend only attach themselves to those with longer pursues and larger balance sheets. Smaller companies may be pushed aside, unable to secure the large amounts of equity needed to finance these projects.

In the past three years Shell has built up a sizeable presence in the wind power market. Although the multinational has approximately 650MW capacity (550MW in the U.S. and 100MW in Europe) onshore, it has currently only one project offshore, at Blyth. In December 2003, a consortium consisting of Powergen Renewables, Shell WindEnergy Limited and CORE Limited was awarded the opportunity to lease an offshore wind farm site in the outer Thames Estuary from the Crown Estate. Technical and environmental studies will take place this year, while a four-phase plan is expected to be effected in 2007. The first phase would be a 300MW wind farm, followed by three subsequent phases of a smaller size commissioned in 2008, 2009 and 2010. The subsequent phases are all subject to the success of the first. The full development is expected to generate around 1,000MW.

Shell is also involved in a Dutch project, which could set a template for future deals in the jurisdiction. Construction of NoordzeeWind - a joint venture between Shell and Nuon - is expected to begin this year. The 36-turbine wind farm will generate up to 99MW from its position 10km offshore from Egmond aan Zee. Although Shell would not comment on the structure, the financing has been completed and is around the Eu200 million mark with a 20-year concession. Subject to any final approvals, it is expected that the wind farm come on stream in late 2005.

Under the new MEP scheme (a grant scheme concerning the environmental quality of power generation), which entered on 1 July 2003, the project will be subsidised for ten years and will also qualify for an investment grant under the CO2 reduction plan.

It makes sense for the Dutch and the Belgians to go offshore - they are densely populated. Other countries such as Spain do not have the problem.

Germany goes offshore

Germany may be the largest developed wind farm market in the world with 13,407 installed capacity, but its deals have been small. "What we understand by project finance is different from what you might understand," muses a German banker. The fact remains that Germany does not have a project finance market for either on- or offshore wind projects.

Onshore deals to date have been small - rarely breaking the Eu10 million mark - and mostly financed through limited partnerships (the Kommanditgesellschaft or KG). These 'dentist structures', as they have become known, have become very competitive and have allowed high net worth individuals to offset their income tax. Moreover, the market has been sustained by a renewables regime that guarantees off-take for 20 years at various rates, i.e. the higher the wind expectancy the lower the rate. Consequently local state banks and KGs are eager to invest in secure structures that allow an average 10-year claw-back on investment.

On-balance sheet financing, an oligopolised market place and a refusal by German utilities to write long-term PPAs has not tempted many project financiers. In addition, few utilities have entered the German wind market. According to a European industry source, "German KG structures work extremely well: they are competitive and give a large tax advantage. But the utilities are too dominant, so there is not a lot of opportunity. It is not an interesting market for us."

Yet this attitude - though not uncommon - may yet change. With the onshore market close to reaching maturity, the German government is keen to get offshore projects going. The German government has estimated a wind power potential of 20,000 to 25,000MW by 2030. Therefore, an extension has been given for the cut-off date for the highest KW/h subsidy from 2006 to 2010, after which - as is the case with the onshore sector - rates will drop annually by 1.5%.

And attitudes towards financing may also change. "Butendiek could well be the test case. The financing is not yet in place, but it could be anything including non-recourse project finance. We just don't know," adds a German source. A decision as to the financing should be reached by the middle of the year. Under the current proposals Butendiek will consist of 80 turbines spread over 35 square kilometres off the coast of Eastern Germany.

Strictly onshore

While northern Europeans are setting out to sea, their Mediterranean counterparts have their sights firmly on land.

Italy has seen a spate deals over the past year, which shows no sign of abating. In December 2003, the 176MW IVPC2000 financing for five wind farm sites signed and became the market test case for Italy's new green certificates regime. The Eu170 million club deal consisted of six banks taking a slice as mandated lead arrangers: Royal Bank of Scotland with Eu35 million; BNL, Dexia Crediop, MCC and San Paolo IMI at Eu30 million each; and Banca Verde with Eu15 million. The sponsor, Italian Vento Power Corporation, is already well known in the market for a number of wind deals closed under the old CIP6 regime.

The key issue in the deal was how the green certificates regime would perform. The green certificates scheme is not unlike the UK ROC system. Renewables generators receive the pool price for their power and then receive a premium by selling certificates matching that amount of power to utilities that lack the renewable capacity to meet their government targets - currently 2% of output rising to 12% over time.

According to industry sources in Italy, there will be a steady deal flow of 150 to 200MW per annum. The next deal expected to sign is another 70MW farm - Andretta in Campania - which is expected to close shortly. Nevertheless, there is a dearth of offshore deals at present, and this is likely to be the case for the foreseeable future.

Spain similarly has a steady onshore deal-flow. In late December 2003, Spain saw its Eu361.5 million 14.5-year Biovent Energia phase 1 wind financing close. The financing may be the second largest in Spain, but its combined phases could exceed the Eu913 million EEE deal. The Iberdrola-led project funds build-out of a 496MW Eu400 million portfolio of 15 wind farms in Castile y Leon and is expected to be followed by a further deal of similar scale. The deal was lead arranged by BBVA, Credit Agricole, SCH and Caja Duero; while Banesto, Banco Sabadell, BNP Paribas, Caja Madrid ICO, Commerzbank and RBS acted as arrangers.

With transactions such as these, where deal size allows for project financings, there is little rationale for Spain to go offshore. Moreover, Spain has forsaken the one-off SPV deal and replaced it with corporate structures and refinancings for consolidated renewables' companies.

Although offshore developments will be instrumental in fulfilling the requirements of the Renewables Directive, onshore projects will continue to dominate the market in the medium-term. Each European jurisdiction will evolve very much at its own pace, testing the market on a deal by deal basis. The trend for offshore projects in the UK and Germany will be mirrored in Spain or Italy.

The growth of the European offshore sector will depend on a number of important factors. Planning, consents, grid access, infrastructure and time frame between licence and development will all have their part to play in whether or not a project gets off the ground. But the most important factor to get any turbine turning is cost. As an industry banker states, "You have to remember that at the moment onshore makes more money. Few want to take on the risks of offshore projects. No one likes to lose millions in development money."