The search for yield has meant overseas investors are exploring new opportunities in LatAm and East Asian renewable energy markets.
Despite all the negative news in the European market; Brexit shenanigans in the UK and slowing growth in Europe, we have seen a busy flow of transactions focused on refinancing activity. Primary transactions are still a challenge, but international investor interest in energy-from-waste (EfW) is picking up. This trend looks set to continue with technological advancements being developed year on year. Our recent article explores some of these themes in more detail.
The RPI market
Inflation assumptions within financial models have a material impact on debt sizing and overall project economics. The UK RPI market is well-established and derives its liquidity from the UK index linked gilt market. However, the House of Lords has recently condemned the calculation methodology for RPI, which has resulted in a knock-on effect to the long end of the curve. This has led to market participants focusing their attention on the possibility of future RPI linked contracts referencing some form of CPI (or CPIH), which trades about 70 – 100bps lower than RPI (the ‘wedge’).
Some projects have managed to hedge their CPI exposure through entering into an RPI swap along with a CPI – RPI ‘wedge’, accessed directly from the market. This synthetically creates a CPI swap that hedges the project’s true exposure far more accurately. Markets will continue to develop on the back of the House of Lords’ deliberations and the impact may be quite significant across the board. However, we do expect to see competitive hedge pricing, an increase in liquidity appetite and more innovation on how these hedges can be placed. But one thing is certain, this transition will take time, as the market evolves and more CPI linked issuances and CPI derivative flows are observed.
Global interest rates
While interest rates are falling across many markets, the active moves in monetary policy by the Reserve Bank of Australia (RBA) have now taken rates down to an all-time low of 1%.
The door has also been left open for further cuts – aimed to support employment growth and provide confidence that the inflation target will be met. This is allowing good opportunities for both greenfield and new transactions to fund at much lower rates than had been assumed in the original business plan forecasts.
Renewables hedging in LatAm and East Asia
The search for yield has meant overseas investors are exploring new opportunities in LatAm and East Asian renewable energy markets. The market risk arising in these transactions takes quite a different flavour, and detailed analysis is advised on the hedging inputs and assumptions. These can impact the IRR materially. The length of gestation between investment approval and financial close means pre-hedging decisions are becoming more commonplace, and hedging counterparties working to innovate on this front to stay competitive. Read our recent paper on deal contingent hedging. Market sounding from overseas investors into the Latin American and East Asian renewable energy market has risen as they are further looking to understand methods and solutions to mitigate their financial risk.
Activity in Africa is picking up, having recently concluded our first run of River Hydro of 44MW in Uganda and winning a large toll road transaction in East Africa, alongside a further deal in Uganda and another imminent in Djibouti. South Africa remains fairly quiet as the much awaited, integrated resource plan update has been delayed, now expected to be announced in October. This should trigger frenetic activity for round 5 for which we are well placed. A number of our existing clients are very bullish and anticipate winning a good selection of deals. We are also active with several round 1 and 2 IPP deals who are taking out additional hedges to protect shareholder returns.