Participants:

PS: Paul Smith, News Editor, Project Finance Magazine
SL: Simon Luby, Due Diligence Team Leader, Sgurr Energy
MBen: Martin Benatar, Partner, JLT Specialty
CJ: Charles July, Partner, Watson, Farley & Williams
KJ: Karl John, Business Development Director, Areva Renewables
TMee: Dr Thomas Meerpohl, Managing Director, Global Tech1 Offshore Wind/ Stadtwerke Munchen
MBec: Dr Marcus M. Bechtel, Partner, Watson, Farley & Williams
AR: Andy Robinson, Managing Director, Global Head of Origination, Nord/LB
TMar: Tomas Marutz, COO, SIAG
HL: Heiko Ludwig, MD Head of Energy Origination Europe, Nord/LB

PS: How do you assess liquidity among project finance banks for offshore wind assets?

AR: The availability of liquidity for project finance is a topic of much debate at the moment. I think the offshore market is going to attract a significant portion of what liquidity there is because of the future pipeline and the size of the individual projects. I think it was interesting in Global Tech that we attracted 16 banks, which is certainly an indication of liquidity but I think there is still going to be an issue on size of commitments from the banking market. What is coming with Basel III especially will make project financing more difficult. So, I think that whilst there is liquidity, it is restricted and individual banks will continue to be restricted by the size of their final hold tickets. Undoubtedly however the offshore market is going to be one of the more attractive sectors for bank financing.

PS: Thomas [Meerpohl], given your experience with Global Tech, what’s your view on the bank market? And also as a corollary to that, are 16 banks ideal from a sponsor point of view?

TMee: I think 16 banks is a very large group. We were told by the banks that there is very limited liquidity in the market and that it might become a big problem to raise sufficient funds. So we were positively surprised by the market when 16 banks joined, and the size of the tickets was at the upper range of our expectations. We think the market in general is ready to finance large offshore wind projects in Germany. And the KfW programme helps fill the liquidity gap.

PS: Do you get a sense that there are any project banks that aren’t involved in the offshore wind sector that are staying out because of some reason, because, say, they’re not willing to accept construction risk?

TMee: I think we addressed a little more than 20 banks and got a positive response from 16, which is I think a very convincing story, so I would expect that of you address more banks it would be possible to raise even more funds. However, the question is - and that has to be shown in the future - whether it is practicable to have a group of so many banks in a project that has to handle construction risk. We will get into situations where it is necessary to find decisions quite quickly and where it would become very costly to have lengthy discussions among a large group of banks. This is one point of concern I personally have. We might get to a point where we have to decide on which way to go and which way to proceed. A large group of banks might be slower in decision finding. This is one challenge we will have during the construction phase.

AR: Up to two years ago it would have been even more difficult as all16 banks would have wanted to sit round the same negotiating table. In the structure here with four lead banks, at least negotiation could be made more efficient, so that’s a sign that something has shifted. Whether we’ll get back any time soon to full underwriting in the hands of a few banks, time will tell, but it’s too early at the moment.

PS: And where do you see the limit of take-and-hold ticket sizes at the moment?

AR: The market seems to be developing a final hold level of around Eu50 million. Whilst I believe final hold levels will remain around this level, an increase in ticket size will come about as the perception of depth in the syndications market improves. As confidence returns, which despite the challenges it will do, then ticket sizes will increase.

HL: With regard to liquidity, I think there are basically two main components, two variables which we have to look at to gain some idea about the short to mid-term future and one is, that the number of large scale project financings in the energy sector in Europe is relatively limited and there is a strong view in the market that offshore wind power will supply a steady number of large project financing opportunities over time. This is also the result of the strong and growing political will to have offshore wind capacity installed.
But the second point to be considered is the current return of fear and uncertainty in the overall financial markets. This is hard to predict and one will have to leave it as an external factor independent from the offshore sector. With regard to the pipeline of offshore deals and bank appetite, a lot a will depend directly from how the so-called early offshore projects will perform in their construction and early operational phase and currently we all know there is not a lot of experience about this first phase within the banking community. The current offshore project financings are structured in such a way that they can withstand most known risks. However, should a project financing suffer badly from unexpected events especially during construction or early operation than the current positive view of liquidity might very quickly deteriorate. That is why need good news and positive reports on those early projects.
In the long run the interesting question is whether the overall project financing capacity is going to increase or will it stay flat or decrease because of regulation such as Basel III. If regulation does limit project lending and a material portion of the offshore wind capacity will be financed on a non-recourse basis than the sector needs to successfully attract this limited capacity and compete with other sectors for it.

CJ: What is the impact of KfW on German deals, and the EIB on some of the Belgian transactions? Does their participation have a positive impact on liquidity?

AR: Absolutely - if you look at the pure debt requirement for these projects we wouldn’t be talking 16 banks, we would be talking about 35. So, apart from advantages on the funding side in terms of price it actually plugs a gap that the banking market just isn’t filling at the moment.

PS: I’ve heard that EIB is unable to participate in some deals – for instance Lincs in the UK - that are too aggressively structured. Is the EIB being too conservative?

AR: I can’t speak for the EIB but they do have pretty set requirements, which is one of the very good things about working with them as they are very consistent. Perhaps the issue was more about structure rather than appetite, but that is just a guess.

MBec: And if I may add here, the good thing about EIB is that if you invite them early in the process they are absolutely willing to have a look and give you guidance which you can really rely on if the project proceeds, so it’s not that you are left somewhere and at the very end you apply for EIB and then EIB says, “No.” So if you structure it in the right way - I think that’s an experience not only from the project Thomas Meerpohl and I did together but also in other projects we did - you will get good guidance at an early stage about how it should look for the EIB to be considered for participation.

TMee: That is something I can confirm from the sponsors side. The EIB is a very reliable partner that clearly states its expectations and then delivers. I think it is worth mentioning that the EIB is from the funding side providing more than half the debt in the Global Tech I deal. I think without EIB and KfW, the financing of Global Tech would not have closed.

PS: In terms of the supply side, the competition for capital, how does Germany fare and rank against other European jurisdictions?

MBec: It’s a bit tricky to ask a German lawyer whether we have an appropriate regulatory framework (... of course we do!...), but I think it’s fair to say that, in terms of political will, throughout the years we’ve worked on such projects political support has grown stronger in Germany. That will was enhanced this year by the tragedy in Japan, which completely changed the German environment. You wouldn’t have thought that within virtually 3 or 4 months the entire regulatory framework for key issues of energy development in Germany would change, and we have a new scenario here, so I think for the industry that’s a very positive signal. Also the regulatory framework improved not only because of tariffs but also in dealing with potential deadlock situations or bottlenecks which could occur in a project finance situation. It’s not yet perfect and because of the speed of passing the recent legislation we will see a lot of issues which will be solved in practice and maybe by some additional acts coming later. In general, I think we have a positive, reliable framework in Germany.

PS: Karl, do you have any thoughts on this?

KJ: The UK regulatory framework holds itself well against the German one. However, I think there’s a real worry in the UK that post-Fukushima and Germany’s consequent planned closure of nuclear plants, Germany is going to overtake the UK. And that ties back to the first question about liquidity because there’s only so much in the market. Is it going to go to UK projects or German projects? Speaking as Areva we don’t really care whether it’s UK or Germany, but from a UK perspective there is a worry that there will be an increase in build rate in the German market. On paper today the UK is on a higher build rate to 2020. Whether that is maintained remains to be seen.

SL: Speaking as an engineer, we are working on most of the project finance deals in Germany and the UK for offshore wind and we see big differences: in the UK the longer term approach seems a little bit confused. Is this all a way to get nuclear in by the back door and renewables will be dumped because the current government’s never really been pro-wind? But the current build-out rate is by utilities and when they finish what they’re doing at the moment there will probably be quite a gap until Round 3 picks up. Permitting is much more straightforward in Germany. The people doing the projects more often need project finance more in the UK and elsewhere. I think within the next two years we’ll see a very visible shift to Germany in terms of build-out rate and the longevity of that market, that there will be a dip in the UK and then it may or may not start to pick up depending on what happens with Round 3. The German situation is much more long term, much more visible and much more consistent, we can see the projects coming through at different stages and there will be a certain build-out rate for the rest of this decade.

KL: One of the things that we struggle with is size, because deal size in the UK is enormous and the Global Tech size is a manageable deal. From a manufacturing perspective, 80 turbines and 80 build-out is a manageable number, and on the financing side, it’s smaller numbers, but when you start looking at trying to do 7.2 or 9 or 4.2 gigawatts, it suddenly becomes very frightening from the outside, until you look inside the project and realise that actually that project is made up of six 1.2 gigawatt projects.

SL: That’s certainly what we’ve seen of Round 3 is that you look under the skin they’re mini projects, they’ll build these out one after the other.

AR: And in fact in many projects the individual companies are being set up now.

SL: Yes, because even the utilities realise they don’t have enough cash, they’re bringing in investment funds and pension funds etc, and selling shares to each other in their projects, and that’s before we even get to Round 3.

CJ: Yes, well it’s interesting that round 3 will probably be structured differently from the beginning because of those constraints that you mention.

PS: Do you think Europe is just a case of UK versus Germany?

AR: Ultimately banks are competing – even departments within banks - as to where they’re going to apply their liquidity and their capital. In the European context, in my view, Germany has an edge as there is more certainty in the offshore agenda. I would agree with Karl that there is little in it but on balance, I would say I think that Germany edges it in terms of consistency and transparency. It is an issue that if you have uncertainty in your regulatory framework or lack of clarity about what you’re trying to achieve at a political level, then you are going to struggle to attract liquidity and capital in. From Nord/LB’s point of view, being a public sector German bank based in the north of Germany and with a specific focus on renewable energy, obviously the clarity of the German agenda is manna from heaven for us as this is exactly what we would hope to see from the German authorities.

HL: It has taken a long time and  many lobbying efforts by this young industry to create a support environment which grants a comparable high amount of certainty for large investments. I think the secondary questions about how the regimes compare are interesting: how much does a support system address the needs to push investments such as price certainty under a feed-in-tariff versus certificates? Is there additional support like the KfW programme helping the debt side? How are sub-suppliers being helped and attracted? Is there grid-connection support? And so on.
The support system in Germany has evolved over time and with the final adjustments will in my opinion mark the most comprehensive and transparent system in Europe. If the non-recourse model is used to finance a material portion of the offshore wind capacity then the offshore sector has to attract this capital from other project finance sectors because the overall bank debt capacity will most likely not double but largely stay flat. And then the support system will play a major role when these national markets potentially have to compete for a limited capacity of debt. (Third party funding sources may be an alternative but that is another topic.) On top of this investors and project sponsors will have to form an opinion on the stability of these support systems. What has been learnt over the last 2 years is that support systems can change quickly and the worst case scenario is a retroactive change, if we take the Spanish or Czech examples for a second. What markets or banks don’t like is any level of uncertainty and regulatory risk. As a stable system with grandfathering as a key principle I expect there is a good chance that Germany will stack up and probably produce offshore wind capacity which is comparable to those markets who are leading, like the UK.

PS: So you think it’s realistic for renewables to step into the space left by the nuclear base load?

MBec: In theory it is possible. Offshore wind is a huge resource and can very much contribute to substituting nuclear. However, to me, the big issues are grid capacity and grid management. Again, offshore wind is an important factor here because there is a constant flow of energy if you look at offshore wind compared to what we see onshore. But there are other issues which need to be overcome. Namely transmission capacity, and all the issues associated with that, and the others are smartgrid and grid management in general.

MBen: Is there no concern at all with the pricing of offshore wind and the way that you procure things, could actually raise a regulatory risk issue? When the European taxpayer is being faced with uncertainties over the security of supply and yet are being told, “For offshore wind you’re going to pay X but nuclear you pay a lot less,” in a context where a combined cycle gas turbine power station can be up and generating within 36 months, with generation on open cycle within 12 to 14 months, whilst you have a massive deficit in power. It’ll take at least 4 or 5 years to get an offshore wind farm up that will give you a few hundred megawatts when you can build several thousand megawatts of gas open cycle within 12/14 months.

CJ: Isn’t it going to be all of the above?

MBec: Yes, but Martin is right in one way. People are saying: “OK, it’s feasible, we can do it, you just need combined gas turbine power plants in addition to renewable energy plants which can step in when needed”. I think that’s great, but then you also rely on the fact that, to some extent, if things go awfully wrong, you can still cross the border, go to France and have nuclear energy delivered to Germany. This is what you hear from time to time, so this kind of fall-back scenario is still available. But regarding pricing, from what people are saying in Germany, they are aware that it doesn’t come for free. The expectation is that we will see an increase in power prices, and the argument you hear is that, in the long run, people need to be aware that nuclear is not free either; it hasn’t been free in the past and it won’t be in the future, but costs are allocated differently. It’s nothing you would feel directly in your pocket but on a national-economic scale, there are costs which are borne by the taxpayer and not by each consumer, that’s the difference.

PS: Are you confident of the long term political will behind offshore wind? Especially as prices for end-users start to rise?

MBec: If you look at the political scene in Germany in the past, the one party which now mostly promotes this shift is actually the one which was most likely to promote nuclear rather than renewables. I don’t think that the actual government could turn around again, like they did a couple of months ago, to start over. I think that’s impossible because they would lose all credibility by doing that. Now, the alternative scenario is: They lose the next election – and I’m not going to comment on that – but if that happened then we have, I think, a government which is even more in favour of proceeding with that shift, so at least in the mid-term, I can’t see there being another turnaround.

PS: Moving on from political willingness, in terms of realising the offshore wind pipeline where are the biggest obstacles? Tomas, do you see any bottlenecks in your business?

TMar: Yes, from the supplier side we see firsthand the demands of the banks when the client says, “Okay, we have some restrictions from the bank side, we have to fulfil this, and if you want to get the job you have to accept these risks.” As a small sub-supplier we have to figure out how we can deal with these financial risks and technical risks. That is one of our biggest concerns overall.

PS: And Karl, do you have any bottlenecks or do you perceive any?

KJ: Yes - lots of bottlenecks. I think the biggest problem we see with bottlenecks is in our supply base. Now it’s not saying that our supply base can’t supply the right quantity/quality, but they need enough upfront warning to supply the quantity/quality. We’ve already had discussions with our German supply base, and know what they can supply and we know where we can go up to, but to go beyond that ceiling for a single supplier is going to require a step change in the supply chain. There’s going to have to be greater investment in the supply chain and it’s putting possibly greater risk on suppliers because we’re saying, “Right, we want to go from 200 a year to 400 a year, can you come with us on that journey?” Maybe it’s getting a second source, or third source in. I think one of the things that we always try and warn against is that if you look at this on a total ‘what we need to do’ you can scare yourself silly: there’s not enough concrete, there’s not enough steel, there’s not enough installation vessels, there’s not enough finance, nothing, none of it’s going to work, we might as well all pack in and go home basically.
My take on it is that we’ve just got to get this going, we just need to get it going, we need to be able to push on people like Tomas and say, “we need to be able to go plus 50 this year, and plus 100 next year,” but not say, “Right, we’ve analysed this and we need to go plus 500 units in 5 years” And I think that there is just a case of, “Just let us start it going and I think you’ll find that the supply chain will come up to the challenge...” There’ll always be misalignment in the supply chain at times but through cooperation we should be able to minimise the knock on effects.

PS: So how is supply at the moment?

KJ: I think right now I’d say there is a slight supply difficulty in that it’s at capacity but the difficulty is also the breadth of suppliers, in that there are only certain suppliers that can fulfil our orders. Part of it’s down to new technology that there are only certain suppliers in this technology area, but we see a number of new suppliers entering the market which will ease these difficulties.
In the area of installation vessels we have clearly seen this – an existing fleet that is capacity limited in numbers and capabilities. New vessels are currently been built in shipyards around the world to predominantly service the German and UK markets. In the next years these are all coming online, however we also know that there is a great risk that there could be clashes for example from the French, US and Asian markets for these vessels. So we maybe back to square one again!

PS: Is that the biggest pinch point at the moment, the installation vessels? Just booking the slots for that?

SL: It’s still a point of concern for project companies, their engineers and the banks and their engineers that by the time the banks get involved they’ve got vessels in place - some awkward banker will always ask, “What happens if the vessel goes away? Somebody gives them a better offer; they’ll pay independently and take them off to some big rich oil or gas job, or hits a wave or sinks?” There was a job in the UK where the vessel selected wasn’t suitable for the site but was chosen because it was available; the project suffered significant delays because the vessel obviously kept breaking down, and it never really got going until they got a bigger, better boat going, so unfortunately there’s examples where things go wrong with vessels, and that’s when the crunch point comes in. If you lose your vessel for whatever reason you have a serious headache, you can’t just go out and hire another one like you’re hiring a car.

KL: I heard a particularly good analogy –  "it’s two o'clock at night in London and you try to get hold of a taxi. They’re rare, too few and all booked. What we need is to hit the sweet spot at six o'clock when choice and supply are plentiful."

CJ: But isn’t that also an example of how Germany is pushing ahead? The contractor and vessel operator coming together in a joint venture and providing a solution, there’s been a lot of talk of that. Is that happening in the UK sector to the same degree?

KL: It is. There are various alliances going on behind the scenes to start doing that. At Areva we got involved because we needed to secure a boat to ensure we could offer our customers access to a state of the art vessel (Innovation from Hochtief and GeoSea). These alliances are not only in the area of vessels but more generally across the supply chain. It is difficult for example to ask Tomas of SAIG, “Make 500 today and we will call off when necessary,” we need to be able to put a piece of paper on the table, and for me to put a piece of paper on the table I need a piece of paper from our customer.

TMar: Yes. I think Karl pointed out that everybody is waiting and then asking for a solution, “Can we figure out what we will do next and how we will come together?” We need a clear picture, we need a partner, and in the end we need money. We need money to start and we need a contract to start, so I think we are able to grow our productivity and our capacities, but for what, in which time, in which steps? In the beginning we started small, we produced and we built the area to step into this big market, but in the end we talk about huge projects and we need the next clear picture and the contract to go ahead. We can’t go ahead without a contract, with only the idea, we are not in this money situation to do the next step first before we have a contract, and this is a circle, we go round and round.

KJ: I recently attended a supply chain event in the UK and I was never so frustrated because effectively I said the same thing again and again: “We like what you do, we encourage you to go into tower manufacturing (for example) in the UK, we encourage you to go into foundation manufacturing, but that’s it, we can only encourage you.” I can’t put Areva’s name behind it because from a UK perspective, until we have the developers putting their name behind us, we are faced with exactly the same problem as our suppliers are. We need a commitment before we are able to pass this on to our wider supply base.

PS: Can the capacity be met by larger players or players perhaps just taking a punt on the political motivation? Clearly Germany has stepped away from nuclear. You could argue, “If I don’t have a contract in my hand I will have one soon.”

TMar: We have a  clear political statement in Germany .But from our perspective, we can only grow with a clear contract. We can’t grow with ideas and possibilities alone. We need contracts and business. Maybe the first step is a clear partnership with somebody telling us, “Okay, for these 4 or 5 projects, you will get 30% or 25% on that.” Then we can grow, then we have a clear target.

SL: The irony is that despite the uncertainty in the long term UK market that’s where we’re seeing the partnerships, two or three utilities buddying up with the pipeline suppliers, foundation fabricators.

CJ: Because of the size of the deals?

SL: Yes, planning ahead for Round 3.

PS: And in your view this is a specific problem to Germany?

TMar: No, I don’t think that is a special problem in Germany, that’s a special problem of the offshore market, there are so many points that are not really clear: the time schedule is not really clear today, when is the next start point for the next area? And so everybody hopes to cover his targets and to figure out, “What is the next step and how can I get the next partner?” But step by step there is no full time schedule for the next 15 projects so that they can say, “Okay, we will buy this there and this there, and so we will go ahead.”

KJ: I think the only caveat I’d put on what Tomas has said is, and I imagine it’s exactly the same in your company as well, is that we are investing an awful lot to get ready for this but we can’t do the step where we go to things like ex stock where we really go to where people need, and that’s the problem, we’re investing in new designs, in new technique, and I’m sure you’re investing in new machinery, but not to the point where we can just flick a switch. We still need that magical piece of paper that puts the longevity of the business case in.

TMar: Yes, the next phase is not possible without that.

CJ: But you can still work on the partnering structures.

KJ: Definitely partnerships can certainly path the way but ultimately there still has to be a contractual obligation.

CJ: But they do provide kind of a bedrock for you to go forward once that piece of paper is generated.

KL Absolutely, absolutely, it generates the needed confidence with all parties

SL: It’s the timing though, isn’t it? Because France and the UK have seen partnerships forming in both markets, but what’s the certainty of these things happening? You know they will happen but how big and when? And that has a massive difference for suppliers as to when you could put money down to ramp up. It happened with installation vessels a few years ago, some vessel companies saw the market coming, pre-emptively went and constructed vessels, the market then was delayed by a couple of years and the vessels were all sold to oil and gas extract. And then this kind of ‘once bitten twice shy’ thing came in, and when the market really did take off the vessel manufacturers were reluctant to ramp up.

CJ: And that leads onto a likely solution to the contracting issues because you’ve got a much stronger basis on which to grow a supply chain.

AR: Well that begs a question for me, because we see this in other parts of our project finance world. Nord/LB encourages its clients to have financiers as part of the supply chain trying to iron out issues as they develop. The risk you take with this approach of course is that your consortium may not win, so it’s all or nothing, but trying to get finance in place too far down the path can be fraught with danger.

PS: We’ve discussed finance and liquidity, we’ve discussed the supply markets, Thomas [Meerpohl for Global Tech] where do you see pinch points in the market at present?

TMee: I think with regard to the bottlenecks I can confirm what Tomas Marutz just said. It is a great challenge for sponsors to find suppliers that are big enough to deal with projects of that size and that are from their financial balance sheets strong enough to take enough risk that the contract is bankable. Especially with regard to foundations, we were facing a huge challenge to find foundation suppliers of a size that are able to take over the risks for deals of more than Eu100 million. As you know we decided to split up the supply of foundations to two suppliers because of that reason. I think the market needs to develop to have suppliers that are capable and financially strong enough to take over the risks from a project of our size.

PS: Is this specifically a counterparty risk or a capacity issue?

TMee: I think it’s a counterparty risk but a capacity issue as well. A small supplier does not have the capacity to build 80 foundations and to store 80 foundations for a project. This is why we chose a strategy with two foundation suppliers.

CJ: But that’s assuming you’re contracting direct with that supplier.

TMee: Yes, and that’s what we do: Fewer suppliers as direct counterparties providing more services. So for example, Areva with a sub-supplier SIAG - would of course be favourable, but with regard to the size of the project I would expect it to be very expensive. We would have to pay a risk margin to Areva for taking SIAG as sub-supplier. I would expect that to be another 10% or 15% on the contract value. So I think if ever turnkey contracts became available they would be very costly. The first calculation I heard is more than 30% of risk margin on a turnkey contract, and that is something which is not possible from a commercial perspective. Projects are not that attractive that you could pay an additional 30% for a turnkey contractor to take the risk.

SL: And the track record of turnkey is not great. From a project finance perspective, while banks don’t like interface risk, as a project owner you have much more control over what’s going on, up to a limit. However, you can go too far and have 20, 30, 40 contractors.

AR: I think the record is 110, isn’t it?

SL: On Global Tech we’ve got 4 or 5, a nice manageable number, you’ve got control over the key parts, it keeps the costs down and it lets people see where the risks are and do something about them.

TMee: To sum up on the question of bottlenecks, I think we are in a position in Germany, and probably in Europe, to get what you need to build an offshore wind farm. Everything is there: Vessels are available, suppliers are there, so I think we can start, but I think the market has to develop and capacity has to grow and the financial strength of the partners has to grow with the success of the first projects.

SL: But the issue is how many you can build in parallel? It can all get built but the worst case would be everybody has to take their turn for the same assets because of the rate the supply chain does or doesn’t ramp up at, and then rather than having people hitting their targets more or less on time, 2020, 2025, you can easily double that timescale. That hypothetical worst case for that is if the expansion doesn’t expand, you just take your turn in quite a big queue.

TMar: We have to figure out how we can deal with this vicious circle. We talk about partnerships, we talk about long term contracts, we talk about risk margin, all this is a circle and the items move from one player to the other, round and round. And then steel price is another item, the contractor says, “Okay, it’s your problem, you have to take over the steel price,” and so in the end when we say, “Okay, we should deliver everything, we need this risk margin because we have the steel price, we have the insurance, we have no long term contract.” We have to grow our capacity and then we need it only for two years, then we have to go down with the capacity, and all these items I think we can deal with but only together. That is one point from me, we need this partnership thinking and on the other hand long-term contracts to make sure that the capacity we will build is needed for the next five years.

PS: Is there a case for suppliers and even turbine manufacturers taking a slice of equity in these projects as an extension of a partnership agreement?

TMar: For sure, we discuss with our turbine producer to make a long term contract for the towers that can only be a partnership.

PS: Are there any connectivity bottlenecks?

MBec: Yes, I think we’ve talked about the supply chain and how you get the things into operation, and then in order of priority, it’s grid connection. There is some uncertainty as to how it will work out eventually but we can see how it should work out and we at least have a fixed timeframe and so on. But of course it needs to happen, and let’s assume it does. The next big issue in Germany is what happens to transmission capacity? And it’s not like you can just say, “Oh, well we’ll do this overnight.” It’s a big issue, requiring huge investments and the regulatory framework still lags behind. We saw some effort on this in the latest legislation round but there will be more to come. And the interesting question in Germany will be: How much support will this get from the people who will have to accept that there is a new cable line running close to their homes? There is already a discussion going on that and the interesting bit will be whether the same people who stood up against nuclear will stand up next time against the arrival of the new cable lines.

PS: A power line going through their back garden.

MBec: That’s right, and nobody wants a grid in their garden. But without enhancing transmission capacity we get problems. In Germany, looking at onshore and what the situation is right now, we do know that when there are strong winds there are capacity issues already, and we see a lot of shutoffs in the north of Germany because transmission capacity is not great. Now, with nuclear plants currently located in the south of Germany, which eventually, will be shut off, we need even more transmission capacity going into the south of Germany to substitute this. This is a midterm project at least, there is a lot of money needed to get this done that won’t be just taxpayers’ money, there will have to be private money as well. It’s a big infrastructure investment and that needs to be there to secure long term success for offshore wind in Germany and probably even central Europe.

CJ: In fact there is an international element to this between North Sea countries too because in a sense everyone is building out their transmission capacity on a national basis; one of the issues which we haven’t touched upon is intermittency risk, and there are projects, not underway but being discussed like Supergrid. There’s the other initiatives as well which, in a sense without them you’re not going to maximise the opportunity that a North Sea offshore wind development could bring. Having said that, when you have low wind it tends to be quite a wide area.

KJ: I think one of the important things you’ve got to keep in focus is that intermittency of wind. You can build up 20% of your capacity by wind easily enough because every country has got spinning capacity in case one of its big plants goes down, and the biggest plant is around 1.5 gigawatts or whatever, so you’ve got to have that spinning capacity. Above 20% of wind you would have to then start putting in some mitigation strategies be it import/export or be it fast response units/load shedding. We don’t see that necessarily from where we’re sitting right now as a major issue because it’s going to be a while before we hit that 20%, but it’s something from a grid architecture point of view that you should keep in your mind that you might have to invest in it.

TMee: Besides the connectivity issue there is something we haven’t discussed yet: I think one obstacle is also the potential group of sponsors and owners. I think we learned that the projects that go into realisation now are mainly projects owned by utility companies. This is true for Germany and we see the same in the UK as well. The projects that are being realised now are mainly or partly driven by utility companies and this is something which I think personally will remain true throughout the future because I think this is something where onshore wind business is different from offshore. I don’t think money is sufficient to bring offshore into operation and to operate offshore wind farms. You need know-how on the projects and you need sponsors that are able and willing with a long-term strategy to run these power plants; and offshore wind farms are serious power plants.
So, I am questioning myself whether we will see sufficient sponsors to build up the enormous pipeline that is needed to fulfil all political goals. We have four big utility companies in Germany, they all started one project now and they will have their experience and then they will decide whether to continue or not. Besides you have a group of mid-size utility companies such as Stadtwerke Munchen or others but they are not that big and I am not quite sure whether pure capital investors will go into offshore wind and whether it will work if they go into offshore wind.

KJ: But we’ve seen with the other deal in the market, Meerwind, that the infrastructure has grown into an asset class and there are some private equity houses with some very deep pockets. You’ve got Blackstone, so maybe that could be a template for the future where they buddy up with a midsize utility, or do you not see that happening?

TMee: I am questioning myself whether Blackstone would again enter into offshore wind and whether this is a case for the future or whether this is a case from the past.

SL: I can’t give you details but I think there are. Because we’re working on Meerwind, we have discussions with Blackstone who see that very much as an experience gathering exercise and they’re very committed to Meerwind and they see that as the start of a process.

KJ: But these big financiers, what they need in a project is they need somebody who is taking the lead who knows what they’re doing to de-risk it, because that’s the danger.

SL: It’s the people who have developed the project and are the lead person or team, that’s usually the weak point on an offshore wind project.

KJ: Which is a shame because if our colleague from Dong had been here I’m sure we’d have had a word or two out of them - just because that’s where their particular expertise lies in – experienced developers like Dong and others de-risk the project if they’re leading it.

SL: Well I think for a big utility they de-risk it to a level that they are comfortable with, that’s the big difference, there are risks that Dong and other utilities take that are not bankable and that other utilities shake their heads at. There’s an element of ‘suck it and see’ in there, and, “If it goes wrong then we don’t care, we just put more money into it.”

TMee: This is something I can confirm. Stadtwerke Munchen is doing two projects: one with RWE Innogy, the Gwynt y Mor project, and the other one together with Vattenfall and I can confirm that the risk profile of the Global Tech I project is in my eyes the most conservative.

CJ: But it’s a learning process. All of those UK projects, the utility-led ones, were designed to satisfy the utilities’ requirements; now you’re seeing the change, and part of that de-risking process is underway. They’ve all got constrained balance sheets; they’ve all got issues whereby if they were to project finance themselves they probably wouldn’t get it off balance sheet so they need to bring in financial investors. Those financial investors tend to leverage, they look to the project finance market and you are seeing the utilities respond to that and they are changing their structures. You only have to look at O&M, in order to get a bankable solution to O&M the utilities will have to change the role that they currently use, that will cost them but it makes sense in the long term for them to do so.

MBec: I agree, and also if you look at other areas of investment, financial investors are not the ones first in line to go into a new market, and offshore is a new market. Parts of the technology are already proven so that’s not an issue but overall my impression is that it’s still a developing market and we are yet to see projects operating on a large scale and getting all the experience and so on. I am quite certain if we get to such a level of market maturity we will see many more financial investors getting into the projects. If cost and time (which are both further bottlenecks, I think) reduce then projects get more interesting financially. Then we will see more financial investors moving into the game.

KJ: Yes, I think that’s exactly the point that Heiko made at the very beginning is that we need to see success in the market and that’s going to unlock the liquidity, it’s going to unlock the supply chain, it’s going to unlock everything, which is why I can honestly say that I don’t take any satisfaction in hearing a competitor is having a problem in building a wind farm. Successful projects will breed further projects. We believe that risk should sit with the people who can mitigate it the best. Now, there will always be an element of risk somewhere because you can’t always mitigate it completely out of the equation, but we’ve got to stop passing risk secretly onto one another because it’s not going to help any of us.

HL: When we started to look at offshore wind we were confronted with comparable small or mid-cap developers, who tried to get their projects to the any kind of financing stage. We spent endless sessions trying to explain that we need a strong almost “school-book” like project finance structure; we need industrial type sponsors with deep pockets who can, as you said before, de-risk the project. The financial investors we are seeing are very, very welcome to join the club and I think they will play a more important role before this market matures, but let’s not look at the equity side only:
Let’s assume that the traditional bank market is not large enough in the long term to cover the whole offshore market bank debt demand. When the market matures over time investors could play a very precious role in trying to plug the gap which is on the funding side, on the debt side. It won’t be easy to move quickly to project bonds but we need real third party money maybe accumulated in senior debt funds with project finance banks as agents to manage that and also participate in this risk. I think the more mature the market will get the more we will have those parties on both the debt and equity side.
I think Global Tech is a very good example because we have the right and strong enough partners around the table and there wasn’t much of a compromise when it comes to the comparison of the real structure to the proposed structure. This is what the market needs in this early stage.

TMee: Maybe I can comment on that? It’s correct that on the Global Tech I project we decided to project finance. However, on the other two projects Stadtwerke Munchen decided to equity finance the projects for good reasons. The point I want to make is that the sponsors we currently see in the market for future projects are in my opinion likely to equity finance their projects because project financing is not attractive enough. The cost of project financing is very high and from a calculation of a sponsor - such as Stadtwerke Munchen - it is more attractive to do less projects with equity financing than to do more projects with project financing. I think this is a point the banks have to take quite seriously. In the end banks need sponsors that are doing many projects in the market and they need partners that are working with banks’ money. When we discussed this with Vattenfall or with RWE we came to the same conclusion: as long as a group of sponsors is able to equity finance a project it’s more attractive to equity finance it.
The situation with Global Tech was slightly different. We were a group of sponsors in the Global Tech project which was not able or hardly able to equity finance the project. It would have been necessary to reduce the size of the project. The option in the Global Tech project would have been either to build half of the size by equity financing or to go for the 400MW with banks’ money. With these options, the project financing structure was more attractive. However, I think it is a problem for the market that currently for sponsors that are able to choose between the two strategies it is more attractive to equity finance projects.

HL: I think that point nobody will be surprised about. Usually you don’t have the project finance solution applied to a sector in such an early stage with comparable limited experience and more is expected from sponsors and project parties to take risk off the banks. I think offshore wind is on the frontier of what project finance banks can do. The territory beyond this frontier is unknown and uncertain and that is why we need to leave this to the project sponsors and contractors for the time being before we have gained more experience on which we can build trust, and there’s a line where the banks cannot go beyond the risk appetite of their owners and the risk appetite of their independent credit committees. So I think where we are in the banking market that’s pretty much as far as we can go and we can expect the banking market to go for the time being, and only de-risking by positive track record will help to push that further ahead.

CJ: It’s also a question of timing, in the sense that the type of institutional investor that we’re looking to fill this gap, we’ve seen a couple of examples in the last 12 months where interestingly it’s been a direct investment by, say, a pension fund. They haven’t invested indirectly through, say, an infrastructure fund or whatever but those institutional investors either need to develop an internal expertise to be able to evaluate these opportunities which is a difficult call, or they need to come up with an alternative arrangement whereby they can rely upon people who do have the expertise to evaluate these deals and they can go in. Maybe there’s some arrangement that project finance banks could, say, do the initial funding during the construction risk which is the area which it’s pretty difficult to expect an institutional investor to take that risk, particularly given Basel III limitations, then you go out after the operating phase and your debt is replaced by equity coming in from institutional investors.

AR: I think as a consequence of Basel III that is the model that is going to be the prevalent model going forward.

MBen: So you see the construction phases being project financed and then you see institutional investors coming in for the operation phase?

AR: Yes, the key issue is around managing and structuring risk and the natural players at the development/construction phase are the project finance banks with more risk adverse institutional funds coming in post operation. Equally, Basel III will be a disincentive for banks to hold long-term debt and therefore a mix of project finance specialists getting the project across the line and institutional funds providing long term debt should eventually prevail.

MBen: That ties in with what you said earlier about banks wanting these long term O&M contracts, 10 year SAAs or whatever, whereas the utilities, some of them really don’t want to go there, they think they are far better at doing the servicing themselves and why do you need Siemens for 10 years when you could do it far more efficiently?

AR: Oh I think that’s okay, you can see it shift from the original equipment supplier onto a utility who takes on the long term O&M. What the banks need, and indeed what these financial investors need is a different structuring of the O&M rather than the internalising of O&M that has typically been the utility model to date.

KJ: But the build-out phase doesn’t necessarily have to always be the project finance because I think certainly some of the rumours going around in the large UK projects, bearing in mind they’re phased, is that they’ll try and do that on balance sheet but they’ll, as soon as it’s got over that ‘risky’ hump then they can start attracting some of the financial investors.

PS: I  want to go back to a point Thomas said earlier about the attractiveness or unattractiveness of project finance; do you think that the terms for project finance and bank liquidity can move to a stage where it’s more of an even toss-up between let’s say a corporate or on balance sheet financing and project financing? Or do you think it’s just far and away easier for utilities just to go on balance sheet?

TMee: I think what we learnt on the Global Tech1 deal is that you can only project finance if the sponsors take a huge amount of the risk together with the suppliers, which is understandable from the perspective of the banks but in the end we have a lot of the risk on our balance sheet in any case, but we pay a lot more for the money than we would if we would directly owe it on our balance sheet on corporate finance.

MBen: But do you have the money to do it purely as equity?

TMee: We would have the money if we would go on corporate loans of course, the balance sheet is strong enough to finance on corporate loans and it would cost us 200 base points less, 250 base points less.

PS: Simon, do you get the impression that other large equity investors will be active in Germany? Because I think one of the issues with the new regulations that are coming up in the UK is that they’re changing to a contracts for difference tariff because it benefits, or supposedly benefits smaller independent generators and financial investors because they’re not dealing with ROCs; Germany obviously has a flat premium tariff regime, do you see other private equity investors active in Germany or looking to get into Germany?

SL: Not so far, it’s different from UK and other markets where it may be utility-led but they bring people in with them, either at the start or at a later stage. In Germany we tend to see, again Global Tech a good example, a small developer has the idea, the imagination to get the project to a certain point, they bring in a partner, a utility or conglomerate utilities, and then they push the project forward. Or you’ve got E.on, or other utility which again do it all themselves. The Blackstone thing for me was one of the exceptions. There are projects at the moment that are looking for equity people to come on board and they might bring in a Blackstone type vehicle but that’s far from certain.
But where we’ve seen them before is actually going straight to the source and buy into foundation suppliers or buying into turbine suppliers or some part of the supply chain where they can see potential for the future.

PS: How do you assess the turbine manufacturer market in Europe? Where are terms and conditions for availability warrants, how you see the competition, and do you see any new market entrants?

KJ: If you take everything that’s released in the press, it’s an incredibly competitive market: there are 20-30 turbine manufacturers, and there are 20 turbine manufacturers who have all got big machines coming up in the future. If you cut out who has actually got something - and this is now a plug for Areva of course, we’ve got one of the biggest turbines that’s here now - and if you look at any new turbine it has a technology birth in the sense that, does it work, doesn’t it work? And there’s a risk involved there, but more important I think is not necessarily that side, it’s getting that cost curve down, it’s getting the supply chain behind it to be able to start producing these in large enough quantities with the associated balance of plant eg foundation, cabling connection and everything based on that size, and I think that’s really where we are right now. It’s not who’s got the biggest plate power because you’ve seen some of the enormous plate powers that are being thrown around now of 15 megawatt turbines and things like that. Now, they’re great but there is a real engineering challenge also in making these turbines at a cost competitive level. It all comes down to LCOE. (Levelised cost of energy)

CJ: Does that feed into the other elements of, say, availability, warrants, etc?

KJ: Absolutely – improved availability has a positive effect on LCOE. What Alpha Ventus has given us is a track record of availability - 98% availability. Now if Thomas comes and says he wants an availability guarantee of 98% I imagine there are a few very long faces on our side of the table, but we’re there in that range and this is something that we’ve switched as an organisation in the last year to stop talking about capex and opex, it’s all about cost of energy. For example improved availability or improved capacity factors of the turbine give you a phenomenal impact because it’s not a one-off capex saving but a year on year increase on the revenue side.
It’s about that life cycle cost of producing a kW hour of electricity, and that’s where we’re seeing very encouragingly an awful lot of cooperation in the market right now where we’re picking certain developers and saying, “Look, you’ve got your models, we’ve got our models, we know exactly what’s going to happen to our turbine in years to come, more so than most people do, and let’s put this all in and see where are the levers and the technology that will have the greatest impact on COE.”

PS: If the deal pipeline takes off in Germany do you see the market changing rapidly where you’re offering shorter warranties?

KJ: I think one of the plays that we’ve tried to make in the market is that we’re happy to talk on a fair, open basis of what makes the best sense; one day we’re in a negotiation where we’re talking about 15 years O&M, and then we’re in a negotiation where we’re battling to have a couple of days of O&M in it but still to carry a 5 year warranty, and again it’s about the confidence in the market. That said we are very happy to stand by our technology and continue to offer 5 years warranty.

PS: How do banks manage this continually evolving technology risk?

AR: The more uncertainty there is then the more that risk has to be transferred back to the manufacturer, and, I think to your point Thomas, more risk will sit with equity. Whilst I do believe that project finance is an efficient form of financing, we cannot hide from the fact that the offshore sector is in its relative infancy, with limited track record, and therefore more risk will be passed back to the supply chain. Nord/LB as a bank has more than 20 years of experience in the wind sector which gives us the confidence to be more pragmatic than many however it is not sufficient to take experience in the onshore world and transpose this to the off-shore world. Not unreasonably, our credit guys will ask- “How much is actually in the water? How much track record is there?” A reliable manufacture, with a strong balance sheet, a track record of maintenance and delivery combined and a strong TA working alongside us, is key.

KJ: But this is, and it’s picking up Thomas’ point, you’ve come back the issue that you’ve got to have a supplier who will stand by and if we do negotiate a technical availability level at this level Areva’s balance sheet can take an awful lot of pain, we don’t want it to and that’s where internally we stand by our technology.

SL: That’s a big difference I think with Areva and one of the other suppliers, the size of the company backing the wind turbine, isn’t it? And even when you’ve got more turbines running than anybody else and banks still think, “Yes, but if you’ve got a big problem and you fold that then has serious repercussions on decision making”.

PS: Karl, are developers best to go for the latest, largest turbines?

KJ: The size and maturity of the turbine are the most important factors. Size - backed up by a mature supply chain and maturity of turbine with a known risk profile. As Andy said if you jump to unproven technology, all you’re doing is you’re putting up the risk. All large turbines are struggling with confidence – you really only get this after 20 years of fleet operation. At which point you are no longer a ‘big turbine’. Catch 22!

SL: They didn’t have that much maturity, when banks say, “Well, it goes 3 or 5 years so that’s ok but what’s going to happen with these after year 10 or 11?”

KJ: Exactly.

MBen: You are placing a lot of faith in the turbine manufacturers.

TMar: We are in a very brand new industry and similar to the car industry, when Audi or Mercedes were bringing out the newest car everybody will buy this car because he is sure this car will do everything I want. In our industry now we ask for a three year old car because we are aware this old car will do the way from A to B for sure. That’s the difference.

KJ: Yes. There are phenomenal amounts of parallels in the automotive industry; look at Kia Motors now who are willing to give you a 7 year warranty on their cars; the reason they’re able to do that is because they know what their warranty costs are so they find they can build them into the price.

PS: Moving on from equipment risks back onto financing, specifically construction risk. Will EPC contracts ever be a feature of the market?

HL: I think at a certain point in time we will have turnkey contracts. I think that there is a natural development over time and as much as everybody would expect the market to mature, at some point the level of experience and track record will be sufficient to enable a player to offer the turnkey solution to the market; this will change the game and will also slightly change the whole debate about financing. If the right company, if the right operator with the right kind of ingredients is offering turnkey contracts then the project finance capacity is also another question. I think when it comes to the multi contracts situation where the lawyers will agree it’s a great thing because it takes a long time of negotiations and the sponsors will agree it’s painful because it’s very costly and in the end they have to really work on those contracts. One of the big challenges for banks is also their approach to a project company and whether they have the right resources to mange the very complex contract structure. Turnkey contracts are offered for all different kind of sectors and technologies. As such I’m personally more optimistic that we might see the turnkey solution for offshore wind project a bit earlier than expected.

PS: My other contacts I’ve spoken to on this issus say that it’s far too expensive, the deals are far too big, and there are not enough large constructors. How close do you think we are to an EPC contract on a large offshore project?

KJ: I think until the track record’s been there and people know what the costs are, and as Thomas says an EPCI by its very nature is going to have double counting going on, it becomes too expensive.

AR: An EPC wrap will require a substantial balance sheet behind it; and in all likelihood banks will anyway require direct agreements as a fall back so you’re now actually adding cost. Undoubtedly it makes the credit process easier but it doesn’t necessarily make the project costs cheaper. I think, to your point earlier Karl, the risks should sit where they can best be mitigated. I think as the market develops, and as we get more depth of knowledge of what the risks actually are then the EPC becomes easier and less costly because the market is not trying to factor in every single risk that can possibly be imagined. That will come with time and confidence.

CJ: But I think you will see synthetic EPCs or the EPC type of wrap that the partnering structure is pushing you towards.

SL: Well, the German projects are a good example of splitting a project up into say four main contracts and each one is effectively turnkey for that package, and that helps a lot, so you’re getting the best of both.

CJ: And you’re getting a manageable interface risk which if you can bank that why do you need to go to a single point?

SL: And you’re not getting the price impact of doing that, and you don’t have the risk of a) not knowing what what’s going on inside that EPC wrap, and Greater Gabbard is a fantastic example of what happens when you don’t know what’s going on inside that, and b) it’s already expensive enough without that wrap going on top. And who is it that can offer that? It’s bad enough getting individual project managers with enough expertise to deliver these let alone putting your faith in a completely separate company.

CJ: Possibly someone who wants to break into the market, I’m thinking Chinese maybe, could come with a wrap, with the financing backed by their ECAs - a complete solution. Would that be something that would be attractive to European developers?

AR: No - well, from a finance point of view - not at the present time.

MBec: We had this experience; at least we tried to make that happen on Global Tech. At first from a lawyer’s perspective, I thought EPC is heaven and the independent contracting is hell. Without an EPC, there’s interface management and so forth, so that’s kind of a lawyer’s nightmare, but ultimately we found out that – apart from the financial implications for balance sheet strength – when you start discussing liability issues, when you start looking at how the contractor is placed to really cope with the challenges that they have to cope with, you end up with exactly the same issues. Then, you need to check if you do work packages for example. Ultimately the benefit of an EPC might be really limited and given the mere size of the projects I think it’s very difficult to see EPCs coming up as the structure in the offshore wind market.

TMee: I do share that view. As it was mentioned before, I think there are only very limited players who are able to offer EPC services: probably only Siemens, maybe Areva and maybe large utility companies such as Dong or E.on, but currently - as far as I know - that’s not their business model to go into the market as EPC contractors. Besides that I would expect that the additional cost of an EPC taking over the risk would be too big to make the projects fly. But it all depends on the cost decrease the turbine suppliers can manage. If they are quicker than the government’s tariff reductions, then it might become possible.

KJ: Internally we’ve coined the phrase ‘a virtual EPCI’, which is possibly a dangerous thing to say too much in public, but in our internal language this is the limited partnership approach. From outside this will give the results of an EPCI contract but internally the partners will apportion the risk where it can be best controlled and hence the increased cost of contingencies that EPCI are plagued with will be removed.

SL: The models we see that work really well are with a good project management team, which is the be all and end all.

KJ: Absolutely.

SL: If the project management team isn’t there then we will just kill it.

KJ: Which is ironic actually because you could always make the argument that you could do it whichever way you like providing you’ve got a good project management team.

SL :Well, I’ve said that because there were no right answers, it’s the answer that suits that specific project.

MBen: That the project management team can be an external?

SL: It can be if you look at something like Thanet or Borkum (West II), but there are very few people that are up to the job, it is better to have your own project team.

TMee: That’s our experience as well. I think we learned that it’s a huge improvement for the project to have its own staff on the project which is more reliable, which is cheaper. And with regard to an EPC contract I would assume that it would be necessary to have your owner side project management team with an EPC contractor as well. Currently we have 25 to 30 people working on the project. Maybe you could reduce that number with an EPC contractor down to 15 but that’s not the critical cost of the project.

KJ: There have been some great examples of how not to do it, one of the UK projects did go ahead with 80+ contracts and they basically ended up having to setup a team to resolve (at extra costs) where contracts did not correctly interface.

PS: In terms of specifics and looking at risk deconstruction are there any risks that sponsors have to take in the market at the moment which could be shifted onto the contractors?

SL: Because of the whole design code screw up, that’s where the project risk is. For some foundation types it’s not applicable but certainly the ones on the monopiles, the project companies are taking the risk that they shouldn’t be taking.

PS: And do you think that will shift over time?

SL: Eventually. It will take time.

PS: So I guess a big potential open ended risk is installation vessel availability?

SL: That’s the three models we’ve seen that work really well: the project company gets the boat and they’ve got that and everything gets built on top of the boat, it’s secured and they free issue it to the contractor, sometimes it’s the foundation installer who then hands it over to the turbine installer later and that’s an interface and a schedule risk. Or you have, as in the Global Tech case, a single installation contractor who installs everything, maybe one or two sub-contractors who won’t do the big stuff, it’s one contractor with their own boat; that works very well.
What we’re seeing on a German project at the minute is the turbine supplier is going to be doing the turbine installation as well and they’ve said, “We’re going to use this boat and pre-empting the project finance issues they’re saying, “Right, well if we don’t have this boat for the full time then we want basically the freedom of contract to go and get another boat.” And as the banks advisers we’ve thought: “That’s good, you can keep the vessel risk, but we want some involvement in which boat, you can’t just go out and grab any boat, just so you fulfil contractual requirements, you’ve got to get the right boat.” We’ve basically pre-agreed a list of alternative vessels, and to start off with there were 20 boats on that list and we went through it and went back, “Those 10 haven’t even been built yet...“ And we got it down to a list where we thought: “This is a realistic choice.”

PS: And that delay of risk is shared among the sponsors?

SL: Yes. It’s not removed the risk entirely from a project company but it has reduced it and shared it more equally.

CJ: In the model where the project company has the boat and the project company is a utility and the utility’s got other projects, isn’t there a risk if you’re an investor in project A that they might move it to project B?

SL: That’s when it starts getting complicated because you can’t have a situation where a utility with shares in these two projects A and B goes away, basically argues with itself in front of a mirror that it’s not going to bugger up Project Co A even though Project Co B is bigger and more important to that utility.

MBen: Especially when as a utility you’re selling off shares in particular projects.

KJ: We very lightly touched on the whole O&M side which is also a big area where confidence builds. It builds confidence because again the financing side, and whether the project is going to work or not, is heavily down to the availability of the turbines. Unfortunately we can’t take the weather risk in the sense the wind’s not going to blow, that’s in the lap of the gods, but certainly how well your turbine is going to function is a relationship of the O&M side. If you’re boasting about these high 98%s, maybe the O&M cost is going to be reflected in that, but you’ve got to balance that to prove that - overall bottom right hand corner of your spreadsheet - this project’s going to have a better return on investment than if you had a lesser model. It’s exactly the same thing as buying a car, don’t bother servicing it, the car will run for three years and then suddenly things will start going wrong and the incremental cost would be greater than had you done the servicing.

PS: Where is the line between an insurable event, sponsor and lender liability? Martin, obviously you have a big insight in this market, how is the insurance market?

MBen: The first thing to understand is that when we speak in terms of project financing, - and we need to talk in terms of project finance because otherwise you could say, “Well, there’s been offshore wind insurance for the last 20 years,” - but the utilities certainly during construction wouldn’t procure delay in start-up insurance and in some cases not even business interruption insurance, but from a senior debt perspective the delay in start-up and business interruption exposure is key so we are really only looking at a window of only five of six years or so since insurance programmes acceptable to banks have been a feature of the offshore wind business.
Where is the insurance market now? In 2004 the banks key concern would have been whether or not adequate insurance was available at all, not understanding what they even meant by 'adequate insurance', in 3 or 4 years’ time once the thing was built? Now the banks concerns have moved on within 6 years to the extent of defects cover on the foundations, the electrical infrastructure and the offshore platforms because they’re not worried about the wind turbines, as all the technology and defects risks in the wind turbines are with the contractor through warranties and availability guarantees. The focus for banks in terms of risk is probably also reflected in where the insurance market perceives the risks to be located: Initially it was in cable damage losses from the early wind farms before project financing, now the risk focus has turned to foundations, not necessarily just because of the grouted connection transition piece design flaw as, in terms of impact on performance, that hasn’t really fed through and in terms of insurances losses that hasn’t fed through at all, (although I understand from one utility the cost of remedial works on a particular project is now three times the original estimate made two years ago). Looking at the actual project financed wind parks that have been constructed so far, there was a relatively small deal, not German, with just 6 wind turbines, not Alpha Ventus, and that has resulted in an insurance claims cost in excess of Eu30 million with most of that a delay in start up claim. Because we have only had 5 years of project experience so far with only 7 (now that Meerwind has closed) having reached financial close in that time (with an 8th Global Tech I also due close in August) the actual premium income to the insurance market for delay in start-up and business interruption is very limited and that creates an issue especially when you consider that in project finance deals, the scope of cover that the banks need is so broad, the critical mass of premium has not yet been generated to cope with the potential liabilities that insurers are being asked to accept.
. The underwriting market globally for the offshore wind construction space is probably around Eu1.8 billion. However, if you want the type of cover the banks need, the capacity willing to offer it is probably down to Eu800 million. Once operational, the underwriting capacity is also probably about Eu1.8 billion but with the type of cover banks need that drops down to approximately Eu1.2 billion. The major insurance issue at this time faced on offshore wind parks in Germany and the UK is when you then factor in the requirement for underwriting capacity to cater for one of the worst risks on UK or German offshore wind projects, that is the contingent delay in start up and contingent business interruption risk represented by the loss of the grid interconnection that is owned by a third party. We believe that the capacity for contingent delay in start-up is around Eu350 million and for contingent business interruption is around Eu500 million. The big problem with the capacity constraint on that is that if you lose the grid interconnection that’s owned by someone else you have no recourse to anyone. The grid operator, be it TenneT TSO in the German North Sea or 50 Hertz in the Baltic Sea has no liability to the generator at all once the grid interconnection is built. In the UK the OFTO has no liability at all, so you potentially have this stranded asset where the only recourse is to insurance, therefore if the capacity available to you is less than Eu500 million for contingent business interruption, when you start 'clustering' a number of generators around a single grid interconnection as is the case on German projects you face a potential dog fight between project companies to access available capacity. That said, it is only a short to medium-term concern pending construction of the grid infrastructure that will technically mitigate the risk and it should fall away as an issue. Also, as we are dealing with an insurance market that is so young, whilst it is taking these quite high severity exposures, they are pricing them conservatively, so from a cost and premium volatility point of view, over time they should both reduce with insurance becoming cheaper and the volatility reduced. However in the interim we are facing 4 or 5 years where if we suffer a significant loss, and it doesn’t have to be that major, maybe Eu30 million on a contingent BI or a specialist vessel DSU extension loss, that will introduce a significant inhibitor to the maturity of the insurance market. It will only be an interim thing but in that four or five years that could have a major impact.

PS: How is the interconnection risk mitigated in Germany?

MBen: The grid interconnection? Well, at the moment in Germany you’re only talking about one supplier in each sea, the Baltic Sea or the German, so there you have an opportunity for all the generators to work together in partnership with this entity, but I think politically that entity has to be brought along into the programme so that they understand they have to work with everyone because at the moment I don’t think there’s any meaningful technical assistance being offered to projects at this stage to cope with a major outage. If you did lose the high voltage direct current platform (rather than the export cable because you could probably overcome that in 12 months) potentially you're faced with a 26 months outage with 100% loss of generation although in reality it probably wouldn’t be that long. What is needed is technical mitigation that could be brought in that would remove the far end of the exposure; the short end of the exposure, if under the EEZ, if it’s possible to get some alteration to that so that if you have grid outage due to the fault of TenneT or 50 Herz you could then receive an extension in your tariff.

MBec: But this point is already reflected in the regulations.

MBen: That’s definitely coming? Well then that opens up the whole issue because you would know that in the future you will receive revenue to cover the gap, so you can use the insurance market as a bridging finance mechanism, but to make it economic don’t go to the insurance market straightaway. At the moment you have to take 90 days anyway by way of a deductible yourself, so why not take 180 days or even longer, obtain a bit of standby equity or debt that’s secured on that future revenue stream, then you only need to approach the insurance market for the delta between the amount you are willing to carry yourself at the front end and whatever point the technical grid mitigation can come along down to at the far end, it could make it a lot more economic.

MBec: Maybe adding to this: It is not entirely true that you won’t have any recourse. But the tricky bit in Germany is that there is no absolute obligation for the grid operator to establish the interconnection. Instead it is decisive whether or not there was negligent action, on the part of the grid operator; this determines whether or not there will be damage claims. This is tricky which is why everybody is now looking at Baltic 1. This is very interesting from a legal perspective although, I agree, it would have been better for the market if there had been no such incident. I think it is fair to say we had some intense discussion exactly on this issue and at the moment, the only thing you can do is to take the necessary actions to secure claims in the future if you see things coming.

MBen: But at the moment the insurance market is able to plug the gap with contingent delay in start up and contingent business interruption insurance, although you need to self-insure quite a chunky deductible, but it’s there. But my concern is that if there was even a relatively small event in the next few years it would disappear in the short term until the grid infrastructure is in place.

PS: And how far can you see premiums falling if there is no major incident?

MBen: If, leaving all other factors aside, and leaving loss experience aside, I would assume that rates would come down in Germany more than anywhere else as German projects tend to be charged more than everywhere else on average. They’d come down say in the UK probably 20-30% conservatively whereas Germany could be as much as 40%. At the moment operational business interruption premiums are based on a very conservative view. You are not actually paying that much for the contingent business interruption risk, it is the pure business interruption risk, and yet with an operational wind farm it’s really just the infield sub-station platform that’s the key risk because if you lose the odd turbine it probably isn’t going to impact your revenue greatly, so it’s probably overpriced at the moment and I believe there could be a significant reduction as the market matures. The problem is in the short term that we’re about to enter a 'hard market' and whether or not that will offset the pressure for rate reduction from the maturing market, I don’t know, and how long this hard market will be and how severe it will be, I don’t know.

TMee: I think that is an interesting point and this goes in line with our analysis. In our other projects that are not project financed but are equity financed we decided not to insure for business interruption but to take that risk as sponsors on our side.
And maybe one other comment on the legislation: it is reflected in the new German legislation that will come into force on 1st January next year that there will be an extension of the period for which you receive a high feed-in tariff for days the grid connection is not available or late. The only open question to me personally is: What means late? Is that the date when I can expect the grid connection to be ready? Is that 30 months from the letter of approval or is that the day when I am actually ready with my turbines offshore? I think this question has to be answered by the authorities but if that discussion finally goes out positive we will have additional mitigation on the risks of grid connection through the new legislation.

KJ: Actually how does the mitigation process work? Because if you’re not generating how can you have a higher rate?

MBec: You will get an extension.

KJ: Okay, so for every day it’s not working you’ll get a bonus rate for when you do generate?

MBec: After 7 consecutive days, i.e. if the grid is not available for 7 consecutive days, you will get an extension by that amount of time after the end of the feed-in term. This is not equal to the money you lose because you receive the money later, but you will get the money paid at the end of the feed-in tariff period, but still it’s better than nothing.

PS: Thomas I’m not sure if it’s an unfair question, as you have just closed the first deal, do you expect a refinancing within say 4 or 5 years?

TMee: Good question. We had intense discussions within the group of sponsors of the Global Tech I deal whether this scenario is likely or not; as mentioned before I think the current financing is very expensive for the sponsors. So if there is the opportunity to refinance I think the sponsors will try to. Whether this is realistic on such an early project or not, I really don’t know and it probably depends on the success of the project. If the project is successful, if the turbines are running well and if the wind is better than we expect then I think it is very likely that we refinance. In such a case it would be possible to finance at a higher amount and at better costs. However, If there are any problems in the project occurring and if the assumptions we are currently using prove to be false then I would expect that it would be difficult to refinance and that it is probably not worth doing. Because it will raise additional costs to refinance and if you don’t get significantly higher amounts or better costs then you would probably not do it. So finally it all depends on how successful the project will turn out to be.

PS: Leading on from that refinancing questioning I was just wondering if the panel have any views on whether the capital markets will have a role on the debt side in any near future?

AR: Well in a way, and picking up on Thomas’ point, it’s almost a self-fulfilling prophecy. Once projects are successful and develop a track record then the capital markets will come in with volume. However, I believe we’re probably talking 2 to 3 years away. That’s just a personal guess to be frank but there are a number of issues to be resolved before we will see a flood of investment, but ultimately capital markets have to play a big role in the roll out of the offshore market.

KJ: It’s more anecdotal evidence, we’ve been talking to a number of pension funds who, talk about vast sums of money they have to invest on the scale of a very large wind farm. But before they are comfortable to invest they need to see a healthy track record. Like Andy, I imagine this will take time to build.