Scotland's Earlsburn wind farm is at first sight a thoroughly ordinary project financing. Yet closer inspection reveals clues as to the future of onshore wind in the UK. And the deal was not completely devoid of surprises - the power purchase agreement saw the unexpected entry of a new player in the UK renewables market

April has brought mixed news for British renewables. Bad news is that according to Ernst &Young's latest survey of the industry (published 27 April), the UK has plummeted from first to fourth place in terms of attractiveness to investors.

'With planning and grid connection problems restraining the UK's onshore wind market, the UK could well remain a mid-sized market in the medium-term,' was the survey's view.

Good news is that this perceived decline seems to have gone largely unnoticed by investors - also on 27 April, Scottish ministers gave the go-ahead to the UK's largest wind farm, ScottishPower's 322MW Whitelee development. And as far as the project finance business is concerned, banks looking to lend to onshore wind projects should join a lengthening queue.

This case study suggests the state of project financing in the sector reflects a continuing boom - no longer is it a question of whether funds can be procured, but how quickly and on what terms.

The project

Only charitably might a blasted heath somewhere west of Stirling be described as idyllic; but conditions to send even the hardiest Scot scurrying for cover mean paradise for wind power developers. 'Wind speeds are anticipated to be attractive,' says German contractor Nordex, which will supply Earlsburn with 16 of its 2.5 MW N80 turbines, designed for Class 1 (strong wind) conditions.

The site, atop a raised plateau, is doubly well chosen. Not only is the area more exposed to prevailing winds than its surroundings; it is also out of view. While development plans provoked a predictable ripple of dissent, residents of nearby Fintry backed an expansion of the original 15-turbine proposal. Number 16 was added as a 'community turbine,' specifically to address the village's needs.

Continuing what has become a long-standing and productive relationship, developers RDC Scotland scouted the territory, secured planning permission and planted the flag in the name of partners Falck Renewables, who took over at financial close.

Falck, a subsidiary of Italy's Falck group, is on its way to being a leading exploiter of Scottish wind - it has planning permission for farms at Glenmoriston and Ben Aketil in the Highlands and has submitted applications for two others.

The ease with which the sponsors gained approval for Earlsburn stands in marked contrast with the recent rejection of their plans for a 300MW Cumbrian wind farm, which were adjudged to spoil the scenery.

Financing

Total investment for the project was £46.5 million - £37 million in debt and £9.5 million in equity, an 80:20 split. The loan has a 16-year tenor - 15 post-construction.

Financing was divided equally between lead arrangers Bank of Tokyo-Mitsubishi UFJ and HypoVereinsbank (HVB). Plans for mezzanine lending have been incorporated into the deal, although at the time of publication no further syndication had taken place.

 When it does, it is expected to follow the pattern of Falck's previous deals, with the same arrangers involved. A 10-year power purchase agreement (PPA) was signed with Gaz de France.

The Earlsburn financing is at first sight remarkable only for the smoothness with which it was transacted. 'Its salient feature is that there was no salient feature,' says Falck's Julian Horn.

'Onshore wind farm financing is becoming slightly vanilla-flavoured - the challenge is not procuring financing but procuring it quickly, cheaply and doing it well,' he told IJ.

But while the deal may have been straightforward for some of the participants, there was much of interest for the banks: 'This was a radically different deal,' says Laurence Fumigalli of Bank of Tokyo-Mitsubishi's structured finance team.

Two things made it so, he says. First, the entry of Gaz de France into the UK renewables market was almost entirely unexpected - even to many industry insiders. Large UK suppliers are obliged by law to purchase a fixed proportion of electricity from renewable sources, for which they receive Renewable Obligation
Certificates (ROCs). These can then be exchanged for cash.

This considered, GdF's interest in Earlsburn was mysterious. The company had no UK customers and consequently no renewables obligation - or so it was thought. Only in the course of the Earlsburn financing did it emerge that GdF had industrial interests qualifying it for Renewables Obligations - a fact new to many.

Second, Earlsburn saw an unprecedented interaction between the financing and the PPA. This, in turn, is twofold:

• The deal has a 'merchant tail' - a disparity between the duration of the PPA (10 years) and the tenor of the loan (16 years)
• Financing also involves a 'merchant slice.' Two variables are at play in the agreement - the price of electricity and the price of ROCs. A floor price for ROCs was included in the deal. But in a departure from previous convention, there was no floor price for power.

Financing will come in two tranches - the first £31 million, the second £6 million. The structure allows Falck leverage as markets and ROC prices fluctuate. 'The first tranche is a long term agreement that is not fully contracted and works in accordance with model assumptions,' explains Linklater's John Pickett, who advised the lenders. 'The second tranche is a loan on a short term basis which allows the borrower leverage between those assumptions and reality.'

All of which is a success for Falck, which has achieved a large degree of flexibility in repayment.

It might be presumed that what is good for the sponsor is bad for the lenders, who could be expected to favour the security of a fixed-price offtake agreement. Not so, say the banks, who were glad of the opportunity to demonstrate their creativity.

Conclusion

In contrast with Ernst & Young's slightly gloomy picture of UK renewables, Earlsburn shows the sector in remarkably good health. The ease with which finance for onshore wind farms is obtainable, and the lengths to which banks are going to provide manoeuvrability for developers, bode well. While some bottlenecks in the market remain - the high price of machinery, for example - the outlook is good.

'The onshore wind market is still booming,' Fumigalli says. 'Turbine supply costs are squeezing the market - but there's a lot of juice left.'

The project at a glance