4th April, 2017
ROUNDTABLE | The amount of large-scale solar needed to keep Australia on track to meet the Renewable Energy Target is truly vast. But why stop there? A nation with resources like ours would be crazy not to build as much photovoltaic generation as it could afford. Understanding that funding is the key to a clean energy future, EcoGeneration asked four industry experts for their take on the outlook for large-scale solar investment.
Investment in green energy around the world fell in 2016 (on Bloomberg data). Why do you think there is value in the Australian market?
Simon Kidston, Genex Power: The adverse climatic consequences of coal- and gas-fired energy production have resulted in a transition towards renewable energy on a global scale. Coinciding with this is the current political focus on promoting renewables and energy storage in Australia.
Unlike many other developed countries, the Australian renewable energy industry is in its infancy, coupled with various aggressive renewable energy targets set by the federal and state governments, there is expected to be significant growth in the sector in the next few years.
Andrew Smith, NAB: The combination of some of the world's best renewable resources (wind and irradiation), relatively low renewable penetration levels by global standards, supportive federal Renewable Energy Target (RET) and COP21 targets are propelling significant investment into the Australian clean energy sector. The attractiveness of the market is driving an influx of investor interest, particularly experienced investors from Europe and China who are looking for the "next" market.
Dr Tim Nelson, AGL: Australia has some of the best renewable resources of any country in the world. There is also a strong rationale for investment with both the Commonwealth and state governments providing investment signals.
Gloria Chan, CEFC (pictured): Australia's electricity system is experiencing significant new investment, with renewable energy being introduced at scale, replacing ageing infrastructure while also contributing to the achievement of Australia's carbon reduction commitments. This investment is critical, with Australia having one of the highest emitting electricity sectors in the world.
The cost of producing electricity from renewable energy sources has declined over recent years, and is generally agreed to be on a rapid downward cost trajectory. The CEFC is working with an increasingly diverse range of investors in accelerating the development and delivery of renewable energy projects. Renewed investor interest recognises Australia's natural advantages, including abundant sunshine and wind resources.
What do you look for in a project to consider it appropriate for investment?
Kidston, Genex Power: The key factor to consider is location. For instance, the Kidston Renewable Energy Hub in North Queensland is an ideal site. It is situated in the highest solar resource region in the country with a pre-existing grid connection. This results in a very high capacity factor with minimal infrastructure investment (capex/MWh is one of the lowest in the country at $793).
Smith, NAB: In order for us to form a view on project bankability we carefully consider the sponsors, the project underlying economics, proposed technology, level of market risk, contractual structures/general risk allocations, ESG-related matters and the strength of project counter-parties. A key diligence item for us is the technology and this is where we believe we have an edge.
In addition to advice from the lenders' technical adviser we benefit from skilled internal engineers with deep industry experience who help us determine whether the technology risks are acceptable. This is particularly important given technology is moving so quickly.
Nelson, AGL (pictured): It is important that the project has solid foundations - a good energy resource (that is, it helps if it is a particularly sunny or wind spot!); reasonable access to existing transmission corridors; and strong market fundamentals (such as energy pricing).
Chan, CEFC: We're building a project portfolio that is diverse by location, technology, project sponsors and energy purchasers. In addition to the bankability of our investments, we are also influenced by the broader benefits a project will bring to the Australian economy.
This means we're looking at how a project reduces emissions, how it is helping move clean energy technologies down the cost curve, or how it is bringing diversity into our energy mix. We also consider projects that encourage innovation, build capability and broaden expertise in the clean energy space.
Are super funds warming to renewables, in particular large-scale solar? If so, why?
Kidston, Genex Power: We have seen strong investment appetites from super funds. There is a growing knowledge base surrounding renewable projects and the technology is now readily understood. Funds are attracted to these assets as they provide long-term stable returns and are aligned with the thematic of carbon reduction.
Smith, NAB: In short, yes. Globally, we are seeing super funds invest into large-scale solar in a number of ways including direct investment (either at asset level or through platform companies) or indirectly through public and private pooled investment vehicles. The attraction for super funds is the long-term stable and sometimes indexed-linked cash flows.
Internationally, we have seen PSP Investments and the Ontario Teachers' Pension Plan form Cubico Sustainable Investments, through which they invest in a range of technologies including solar PV. Domestically, we have seen a few examples including QIC and Future Fund investing through AGL's PARF platform and also [super fund] REST directly into the Collgar wind farm.
We are also witnessing an increase in what we call the "rise of investors seeking to invest for purpose". That is, investors wanting a societal impact in addition to a financial return. We witnessed this demand in our recently issued 5.5-year €500 million green bond which saw strong green and SRI participation with 90% of the book being allocated to this investor group (30% to insurance and pension funds).
Nelson, AGL: Absolutely. There is significant interest from investors in utility-scale renewables, as evidenced by the launch of the $1 billion Powering Australian Renewables Fund (PARF) investment vehicle. Interest from superannuation funds was one of the factors that led to the development of the PARF concept by AGL Energy.
Chan, CEFC: We're seeing a growing appetite for renewable energy-based investment opportunities to meet super fund members' growing demands for responsible, sustainable and ethical investments. The CEFC is has invested in the $500 million Palisade Renewable Energy Fund, which is aiming to provide mid-tier institutional investors with easier access to renewable energy investment opportunities, as they lack the scale to be direct investors. The CEFC and Palisade are also seeking to finance a $1 billion renewable energy portfolio, providing co-investment opportunities for larger institutional investors.
If the National Energy Market is substantially redesigned in years to come, how might this affect the value of existing renewable energy assets?
Kidston, Genex Power: Existing projects with PPA arrangements are unlikely to be affected by changes in the NEM. Overall, as renewable projects have short run margin cost of zero it is unlikely any changes to the NEM will adversely affect renewable projects.
Smith, NAB: Without knowing what the changes are it's difficult to answer.
Nelson, AGL: I don't see the NEM being substantially redesigned. Rather than creating further distortions on the operation of the electricity market (by implementing capacity markets and the like), it may be preferential for policymakers to alter the design of climate change policies or renewable energy obligations to ensure unintended consequences for "energy-only" markets are avoided.
Intermittent, non-contractible generation (wind, solar, etc) could be required to contract with complementary plant such as open-cycle gas turbine, advanced batteries or pumped hydro to create a "synthetic financial generator" capable of bidding into the spot market and participating in forward derivative markets. This could be achieved through a market mechanism (such as a "firm capacity right" certificate which would be required to be stapled to renewable generation facilitating some proportion of the capacity being "firm") or a generator registration mechanism.
This development is necessary for at least two reasons: it would facilitate retail market innovation and competition by ensuring that sufficient price mitigation hedging tools are available; and it would allow the "synthetic financial generator" to optimise investment to ensure the right lower capacity factor plant is forthcoming to complement renewables (rather than the sub-optimal use of higher duty incumbent plant that is not suited to such operation). Renewable generators would be better able to participate in the market and be less reliant upon subsidies.
Chan, CEFC: Australia's energy mix can incorporate higher levels of clean energy with strengthened transmission, better demand management systems and increased storage capacity. Renewable energy offers an immediate and cost effective means of reducing Australia's electricity emissions.
As more renewable energy is delivered at scale, and at reduced cost, it is inevitable that investors will extend their focus towards addressing other elements of our electricity infrastructure. One important area is large-scale storage, such as batteries and pumped hydro storage, and this is a new area of focus for the CEFC, working alongside ARENA. We also see strong opportunities for behind-the-meter solutions, to enable increased solar and storage, as well as demand response solutions as core components of a resilient network. New business models that use innovation and technology to unlock more value from distributed energy resources, as well as frequency control services, all have a role to play.
What would need to happen for projects to go ahead confidently without any government support at all (in a world without ARENA or the CEFC)?
Kidston, Genex Power: The establishment of agencies such as ARENA and CEFC were a necessity when the cost of renewable projects was prohibitively high. There has been a continual decline in the cost of renewables, aided by the exponential decline in the cost of equipment. Projects are now on the cusp of being economic to operate without any government funding. With retailers beginning to write PPAs for projects, it is expected that standard solar and wind projects will soon be viable without any government funding.
Smith, NAB (pictured): I think we are seeing that already. We are aware of a number of large-scale solar projects that are proceeding without either an ARENA grant or CEFC funding. Over the past 15 years NAB has committed over $5.8 billion in finance to the renewable energy sector globally. As the number one arranger of project finance in the Australian market, we believe that the clean energy sector has and will continue to receive private sector support.
Nelson, AGL: Long-term and durable climate and energy policy is the only pre-requisite. Achieving a 26-28% reduction in emissions by 2030 relative to 2005 levels will require significant deployment of renewables. Therefore, as long as a sensible, long-term approach to climate and energy policy is taken, projects will continue to be forthcoming.
Chan, CEFC: We continue to see our role as a catalyst to new investment in delivering a clean energy system of the future - one that ensures that the objective of sustainability is viewed alongside those of security and affordability.
What is the potential for political debate to undermine investor value?
Kidston, Genex Power: Any political uncertainty surrounding the Renewable Energy Target will detrimentally affect investor confidence and hence investment into the sector. Retailer's appetite for PPAs, which are essential for project financing, would evaporate if there is perceived uncertainty surrounding the RET.
Smith, NAB: Political and regulatory stability is paramount for investors across the entire capital stack. This has been particularly evident in Australia and we only have to look at the levels of investment since the revised RET was agreed to prove this point.
Nelson, AGL: This is one of the most preventable issues within the control of policymakers. Long-term credible policy is a necessity for these types of long-lived infrastructure investments.
Lastly, what is the outlook for merchant models versus PPAs? Debt versus equity? Long tenor versus short?
Kidston, Genex Power: Banks are showing signs of warming towards merchant models. However, to date projects are still able to support much more debt if a PPA is in place. The tenor of project debt will largely depend on the length of the PPA. Further, European banks have shown an appetite for longer tenor debt whereas local banks have only been comfortable with traditional mini-perm structures.
Smith, NAB: As projects tend to have an economic life of about 25-plus years it's fair to say that all projects face an element of merchant risk - the question is just how much. Whilst there are some developers pursuing a full merchant model we find that this is generally a short-term strategy as the developers are seeking to benefit from current high LGC prices, opportunistically time the PPA market or are intending to sell the asset on a "PPA free" basis to allow the incoming investors the flexibility to contract as they see fit.
From a project finance perspective, whilst there is considerable liquidity for contracted/semi-contracted projects from commercial banks, that liquidity evaporates when faced with unabated full merchant risk.
We consider the outlook for debt and equity to be strong. Near- and medium-term investment is being buoyed by the RET and various state-based initiatives. The three main retailers are also pursuing renewables opportunities - whether through a newly created dedicated fund or through power purchase agreements with third-party developers. Long-term investment is expected to be driven by domestic COP21 decarbonisation targets.
In terms of short tenor versus long tenor loans, for a project with certain characteristics we see a market for both from commercial banks. Whether one tenor is more attractive than another really depends on how investors balance refinance risk with IRR impacts. Whilst each investor looks at this differently, we often find that investors end up pursuing short tenor debt as they get comfortable with refinance risk (once they unpack it) and to take advantage of cheaper all-in debt costs. Indeed, in view of the advantageous pricing of the shorter debt, the general appetite for longer dated debt in the Australian market has been very limited.
Nelson, AGL: The merchant model is effectively dead. Long-term PPAs are likely to be less used as well, in my view. It's all about aligning investors with project tenors that suit their risk profiles. Retailers and customers are likely to be looking for certainty in the short-term whereas super funds are more likely to be less focused on short-term certainty but instead be seeking exposure to longer-term opportunities.
Financing will increasingly become more innovative. For some time we have articulated a need for "financing innovation" to keep up with "technology innovation". The Powering Australian Renewables Fund is one of many emerging examples of such financing innovation.
Chan, CEFC: We invest in both debt and equity, recognising that projects have different financing models. While investors tend to prefer long tenor, which we have provided to many projects, we also consider shorter tenor where requested. As the renewable energy sector matures, we are seeing more private sector capital entering the market, offering terms and conditions that support the needs of borrowers while making good business sense for investors.
When we first began investing, the lack of a Power Purchase Agreement was a major impediment to the construction of solar and wind farms, but we are now seeing projects proceed when only a portion of the supply is guaranteed by offtake agreements. Ahead, as the sector continues to transform, we expect to see corporate Australia move towards an even greater uptake of renewable energy sources and energy efficiency technologies.
Simon Kidston has an investment banking background with more than 20 years global experience with groups such as Macquarie Bank, HSBC and Helmsec Global Capital. Simon is a co-founder and executive director of Genex Power and has responsibility for project finance and business development. After reaching financial close for the 50MW Kidston Solar Project he is focused on securing funding arrangements for the 250MW Kidston Pumped Storage Hydro Project and the 270MW Kidston Solar Project.
Andrew Smith is NAB's global head of clean energy. NAB is the No 1 arranger of project finance in the Australian renewable energy sector and is also active in Europe and North America. Andrew was previously the London-based head of NAB's Specialised Finance team and after 11 years relocated back to Melbourne. His major focus over the past 10 years has been providing project and leveraged finance to renewable energy customers operating in the onshore wind, offshore wind, solar PV, landfill gas and waste-to-energy sectors.
Dr Tim Nelson is the chief economist at AGL Energy. He is a member of the Westpac Stakeholder Advisory Council and the Grattan Institute Energy Reference Group. Tim is an adjunct associate professor at Griffith University. He holds a PhD in economics, for which he earned a Chancellor's Doctoral Research Medal, and first-class honours degree in economics. Tim is also a qualified Chartered Secretary (AGIA and ACIS).
Gloria Chan leads the large-scale solar financing program at the Clean Energy Finance Corporation. Gloria is a director in corporate and project finance at the CEFC and was previously a director at the Commonwealth Bank of Australia. She has worked in project and corporate finance across a variety of business sectors, including renewables, utilities, mining and mining infrastructure, and oil and gas. She is also a solicitor to the Supreme Court of NSW.