In the decade we have been advising infrastructure clients in the space, the market has taken off. Last September, we saw the government comfortably achieve its mandatory renewable energy target of 33,000 gigawatt hours by 2020. As clients and market watchers ask what next, we reflect on the key trends currently driving financing activity.
1. Interest Rate Expectations
With interest rates at historical lows and widespread speculation that the Reserve Bank of Australia may reduce the cash rate further from its current level of 0.75 percent to boost employment and alleviate low inflation, our renewable energy clients are reviewing their financing options. Given the complexity of renewable projects with multiple variables and stakeholders, effective risk management is an essential accompaniment to any financial strategy.
2. Refinancing Deliberations
Refinancing existing debt is high on clients’ agendas. Some sponsors are taking advantage of favourable interest rates to improve their lending agreements. Others are refinancing to reap the benefits of an upgrade of a project’s risk profile as it nears commercial operations. In August, project sponsors global asset manager BlackRock and Australia’s Edify Energy did just that, closing an A$287million (£152 million) refinancing of Daydream and Hayman solar farms in Northern Queensland as the final construction phases of both projects neared completion.
3. New Investment Slowdown
While refinancing accelerates – a trend we expect to see continue in the coming year – the latest Bloomberg data suggests new investment in renewable projects, which dropped from close to A$5.3 billion in first half 2018 to just below A$3 billion in 1H 2019, may have peaked. One issue contributing to the slowdown is an increase in marginal loss factors (MLFs) – the difference between the amount of power generated and that lost in transmission due to distance, grid deficiencies and congestion.
4. Marginal Loss Factors
As more greenfield projects come online, the ability of the existing grid to accept intermittent renewable power is being stretched, reflected in the MLF revisions released in mid-2019 by the Australian Energy Market Operator. Some sponsors have had to revise their profitability assumptions, particularly those developing highly leveraged schemes, and reassess existing financing structures and future investment plans.
Last summer, one of the biggest investors in Australian renewable projects, UK-based John Laing reported a £66 million write down due to MLFs across three projects. The investor also announced a pause on any new investments.
Looking forward, concerns about changes in MLFs are likely to push sponsors and lenders to increase scrutiny of the viability of greenfield projects, which are certainly expected to be a more expensive to get off the ground.
5. M&A Acceleration
At the same time, the market has seen an uptick in M&A activity as developers recycle assets to release capital to deploy into new projects, and others buy-in.
Among notable transactions, Australian developer Tilt Renewables completed the sale in December of the 270 megawatt Snowtown 2 Wind Farm to Palisade Investment Partners and First State Super for an EV of A$1 billion. The farm, situated 150 kilometres north of Adelaide, was fully commissioned in 2014.
6. International Investor Interest
In another key deal, in March last year, the UK’s Lightsource BP acquired the 174 megawatt Wellington Solar Farm in New South Wales from its US developer First Solar, reaching financial close in November. The acquisition exemplifies a second prevalent trend – that of international investors seeking diversification and better yields looking beyond their traditional markets to new territories, including Australia. Their presence in the Australian market has increased competition for assets and pushed up pricing. However, the effect is nuanced. The influx of international lenders accompanying international buyers has resulted in improved pricing on debt financing and hedging products.
7. Hedging Considerations
Sponsors are paying attention to their hedging strategies. Implementing an efficient one is a small but critical part of any project financing arrangement. It is central to the ability of sponsors to lock in projected returns over the long term. Devising a strategy entails making an informed set of decisions. Each project and each subsector – solar, wind, hydropower – carries distinct credit risks and assumptions. They do, however, have common elements: interest rate and foreign exchange exposures are common elements for project sponsors across the board.
8. FX Risks
For a non-domestic sponsor, the foreign exchange component of investing in an Australian project is multifaceted. The initial equity investment is likely to be in Australian dollars, entailing foreign exchange risk. Conversely, the project, operating in Australian dollars, may need to acquire equipment and services from overseas companies, incurring more FX risk. And third, once the project begins generating revenue, it may pay its international owners dividends in local currency, introducing another FX consideration.
We typically assist our international clients invested in Australian assets by establishing long-term FX programmes through which they can dynamically hedge their positions. Some hedge opportunistically based on market price action, while others top up as hedging contracts fall off. Our role is to advise on strategy, benchmarking, pricing and documentation, and to coordinate with all stakeholders. Then, once the project is underway, we support our clients with ongoing valuations and hedge accounting.
9. Corporate PPA Complexity
Another notable feature of the Australian renewables market has been the increase in corporate power purchase agreements (PPAs). This is an area where sponsors seeking to manage their financial risks encounter additional complexity. Sometimes the price agreed with an off-taker is indexed to inflation. For clients wishing to hedge that inflation component, the absence of a liquid local market for inflation derivatives is a constraint. However, given the number of projects in development and PPAs struck, we expect the volume of trades to increase over the next 18-24 months.
This shift signals the progressively sophisticated approach to financial risk management apparent in the Australian renewables market. It also indicates the market is maturing as a whole.
For more information please contact Rishin Patel, Director at Chatham, at firstname.lastname@example.org.