Australia’s Tony Abbott-led administration won recent federal elections in part because of its promise to shake up Australia’s renewable energy policy. The government made the abolition of the carbon tax, effectively an emissions trading system, one of the cornerstones of its manifesto and has proposed replacing the existing scheme with a new policy, under which government will buy emissions reduction certificates from polluters.

The government has also introduced legislation to wind down the Clean Energy Finance Corporation (CEFC), which the previous federal administration had established to provide financing for renewables projects, and has also proposed a reduction in funding of A$435 million ($398 million) for the Australian Renewable Energy Agency (ARENA), which the previous administration had established to consolidate existing grant programmes.

The cuts have increased investors’ concerns about an upcoming review of the renewable energy target (RET). The RET sets out how much of the country’s electricity consumption will come from renewable sources up to 2020 and is the main source of support for Australia’s large-scale solar market, because of its effect on the market for renewable energy certificates.

Concerns that government could slash the RET have led to a thinning of the pipeline for new greenfield projects until the review is completed. “The uncertainty is not good for investors, so we are hopeful that the review will be completed by mid-2014,” says Andrea Fontana, country manager of FRV Australia. “If the rules change too often, it reduces the perception of stability, which is difficult for infrastructure projects, as we are talking about long-term investment horizons.”

FRV’s origins

FRV was founded in 2006 with the support of Qualitas Venture Capital, a private equity firm founded by Timon Group, and initially focused on the European market. The company completed a second fundraising two years later with GE Energy Financial Services and Grupo Corporativo Landon, using the proceeds to fund its expansion in Europe, and in February completed a third $156 million fundraising with Denham Capital to fund its business plan until 2016.

The Denham Capital equity has been crucial in funding FRV’s expansion as it expands outside the European market, whose renewable energy is grappling with retrenchment from governments. “We have been successful in Europe in deploying our assets,” says Fontana. “Recently though we have been investing in countries where we see opportunities for new generation and where the price is comparable with traditional power sources.”

FRV has also sold around 30MW of capacity to MunichRe as part of an asset rotation strategy that frees up capital to contribute to projects in other markets, particularly Australia. FRV reached financial close on the 20MW Royalla Solar project earlier in 2013, and was also one of the last developers to win funding from the CEFC for its 56MW Moree solar project, before CEFC had to stop making new investments.

The Moree solar deal will be the first large-scale financing in the region for a merchant solar project. The plant is merchant primarily because of uncertainty surrounding the pending RET review, but also because of subdued demand for renwable energy certificates and utilities’ increasing preference for vertical integration, which has dampened their enthusiasm for signing long-term power purchase agreements (PPAs).

Pipe dreams

The difficulty investors face in signing long-term offtake contracts has been the other main reason for the scarcity of upcoming renewables financings in Australia. Royalla was one of a flurry of projects that included the A$280 million Taralga wind farm, the A$450 million Broken Hill solar project and the A$247 million Gullen wind project, which all closed before the change in government and the alterations to renewable policies.

FRV closed the Royalla financing in September through A$45.4 million in 3.5-year senior debt from ANZ and NAB. The deal demonstrated that lenders are willing to provide limited recourse debt for solar projects in Australia – provided that a project has the right risk profile. “The good thing in the Australian infrastructure market is the sophistication of the banks. Financial institutions know the risks involved and are very comfortable with them” says Fontana.

He adds: “We have a 20-year feed-in tariff with the ACT [Australian Capital Territory] government, which is a very solid counterparty risk and is easy for the banks to digest. In addition, the construction risk in solar is also quite limited compared to more complex projects. There are limited civil works involved, since the structure is mounted on the ground. For the Royalla project we expect to start operations in the second quarter of next year, which is a short duration from financial close.”

Solar projects in particular are attractive to lenders since the revenue stream is very predictable. There are generally very small differences in production forecasts between P50 and P90 confidences, at least compared to wind. Overseas developers expanding into the Australian market have been comfortable with shorter debt maturities since they are confident that it will be easy to refinance once a project is operational.

Blurred lines

For sponsors lacking long-term PPAs with utilities, raising debt financing becomes more challenging. This was one of the challenges that FRV faced on Moree, which has a protracted history. FRV originally won A$306.5 million in funding the project in 2011, along with consortium members Pacific Hydro and BP Solar as part of the federal government’s Solar Flagship programme to develop a 150MW plant.

The sponsors are understood to have had commitments in place from 8 banks – ANZ, BBVA, BNP Paribas, Intesa, NAB, Natixis, Santander and WestLB – but lost out on federal government funding after failing to meet a deadline to sign a PPA. The government reopened the bidding process shortly afterwards and FRV lost out to AGL and First Solar, which proposed to build 159MW in capacity at their 106MW Broken Hill and 53MW Nyngan projects.

The minister of energy at the time, Martin Ferguson, recommended the project to ARENA, but the loss of Solar Flagship funding prompted FRV to rethink the project. It reduced Moree’s capacity to 56MW and altered its connection and planning proposals. BP Solar left the consortium after parent company BP decided to close down its solar operation.

The sponsors are currently in the middle of development for the new project and are discussing its engineering, procurement and construction contract with potential contractors. The CEFC recently awarded A$60 million in senior debt financing to fund construction and the sponsors are also talking to ARENA and a number of commercial lenders about making up the rest of the project costs.

Merchant banking

Moree’s real novelty is its merchant risk profile. Wind developers in several markets have developed merchant plants, and several Chilean solar projects have come to market without offtake contracts. But Moree will be a first for Australia’s solar sector, and even if FRV hedges some electricity price risk, it will mean lenders accepting some market risk.

“The merchant risk needs to be properly analysed” says Fontana. “We have done that internally, of course, and we have developed a view as to where the electricity price curve will be in the next few years.” He adds: “Obviously if lenders were to come on board they would have to conduct their own analysis, but we have seen plenty of interest from banks already and we are very comfortable with our funding strategy anyway, including support from the CEFC.”

The likelihood is that even without the support of commercial banks, FRV would be able to close the financing as a mixture of equity, senior debt from the CEFC and probably additional grants from ARENA. But the CEFC is keen to reduce is participation and if the deal manages to bring in commercial lenders it would set an important precedent for financing for renewable power projects in Australia.

But lenders are likely to ask for additional comfort, in the shape of a more generous debt service coverage ratio. This would eat into a sponsor’s return on investment and might not be suitable for every project or every developer, but it would allow sponsors to work round the reluctance of Australia’s big utilities to sign long-term PPAs.

Emerging markets

The Australian solar market is suffering from uncertainty about the outcome of the RET review. But offsetting this lack of short-term stability in Australia’s energy policy is strong growth in the renewables sector in general. Decreases in the cost of solar modules mean that the price of solar power is slowly edging towards grid parity, and gives investors greater flexibility in making financing decisions.

This explains FRV’s decision to move away from Europe, where governments are scaling back subsidies for new, and in some cases existing, renewables projects. FRV is looking at markets like Australia, where the price of solar electricity is falling, or Mexico, where the price in some states is already competitive with conventional sources. FRV also plans to expand into Africa, the Middle East and anywhere else it senses opportunities.

The dearth of recent financings in Australia is probably an aberration, and one sign of health in the Australian market is increased interest from pension funds and other investors. “Renewable projects are a very stable investment. Following construction, the risks associated with the project are low, since you do not have to worry about gas supply,” says Fontana. “The projects are very suitable for investors that are interested in long-term cash flows.”

The various state governments in Australia, most notably New South Wales, have won plaudits recently with their successful privatisations of infrastructure assets. Lenders and investors remark on the sophistication and clarity of the processes, especially in terms of early planning and engagement with the private sector. The Australian renewable energy market would probably benefit if the federal government took a similar approach.