One of the barriers to increasing the level of wind energy in Europe’s fuel mix is finding financing, especially for large-scale projects. PEi examines the factors analysts examine in deciding whether a wind project makes the investment grade.

Nigel Blackaby
Features Editor

Few would argue that generating electricity from the wind makes environmental sense. Wind is a clean, renewable energy source and, if sited sensitively, wind parks have limited environmental impact. Making the economic case for wind energy is more difficult, particularly given the inability of wind to generate power consistently. As a result, financing difficulties have hampered the development of this form of renewable energy production. Projects rely mainly on sponsor capital and bank financing and face a number of obstacles if they are to reach investment-grade debt rating. However, in the right circumstances analysts now believe that wind power projects can reach investment-grade.

Ratings companies assign ratings in a spectrum ranging between highest credit quality on one end and default or “junk” on the other. Ratings agency Standard & Poor’s (S&P) currently considers that offshore wind projects remain too high risk to achieve an investment-grade credit profile. At S&P, investment-grade debt is rated BBB- or above.

Although the techniques for analysing wind power projects are the established ones used in a wide range of project finance transactions, the key elements and challenges that differentiate wind power projects in Europe are the strength of regulatory support and the reliability of wind forecasts. Not surprisingly therefore, in countries like Germany, Spain and Denmark, where there has been a supportive regulatory framework, wind power projects have been widely developed.

Capital cost of typical 5 MW wind project Source: BWEA
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Regulatory risk

Energy market liberalization within Europe has increased competitiveness and lowered power prices making it harder for wind energy to compete effectively with coal and gas fired plants in terms of economics or consistent output. It has been government targets for clean power, international treaties and diversification of fuel sources that have largely driven the growth in European wind power.

Support for wind projects comes in many forms including tax incentives, green certificates and renewable obligations. From a credit perspective, a key factor is the robustness of the regulatory framework, the level of political support and therefore the degree of certainty that incentives will remain in place for the duration of the debt.

Germany has offered a supportive and stable regulatory regime, which essentially provided a minimum fixed tariff for a period of 20 years, depending on the level of winds. By contrast, the UK has not offered sufficient long-term regulatory support to financiers of wind projects. In December the UK government addressed this problem and extended its commitment to operate a Renewable Obligation scheme providing incentives for producers of “green” power out from 2010-11 to 2015-16. It hopes that by gradually increasing the percentage of electricity sales that must be from renewable sources from three per cent in 2002 to 15.4 per cent in 2015-16, the industry will respond and deliver its target of generating ten per cent of its electricity from renewable sources by 2010.

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Commenting on the impact of the changes to the UK wind market, Paul Lund, associate director for infrastructure financial ratings at S&P said, “It could make a material change in the UK, however the horizon is still short in project finance terms.” With the UK now offering longer-term support and talk of a removal of subsidies in Germany, the UK has leapfrogged Spain and the USA to head Ernst & Young’s Renewable Energy Country Attractiveness Index.

Operational risk

A wind park needs to assessed in terms of the technology to be used, the arrangements for the construction and ongoing operations through the whole life of the project debt. Compared with a traditional power plant a wind park’s construction can be less challenging, however, account must be taken of the permitting process and likelihood of objections and delays. In the UK for example, of the 17 licences granted during 2001 only two have been completed.

When S&P looks at a project it needs to ensure that the construction programme complies with its established construction criteria, requiring an independent technical assessment of the process and the technology to be used. With technical problems usually appearing in the early years of operation, it is important that risk is mitigated with warranty agreements.

Advances in wind technology have only affected the risk assessment a small extent. “Wind turbines have got bigger and this has had the effect of reducing the front-end cost,” says Lund. In some cases S&P is willing to give some credit to small developments from proven designs. The longer a technology has been in operation, the more confidence is possible in its production capacity and availability.

Fuel source risk

In a wind project, the most difficult risk to accurately forecast and mitigate is the availability and reliability of the fuel source – namely wind. Although wind is free, it comes with the major disadvantage that the project has no control over it, unlike traditional power projects where fuel can be guaranteed through contractual agreements.

New wind projects often rely on onsite measurements at the height of the tower for just one year. Analysts look to historical data from nearby sites and weather stations, using long-term averages for the location. Past data may not be an accurate guide to the future, however. Wide short-term fluctuations in wind patterns can occur or a change in the longer-term trend may emerge. These fluctuations present a hazard to a project committed to regular repayments of interest or principal.

The rating process requires an assessment of historical data, discussions with forecasters and comparisons with regional indices. A probability factor (P) is attached to the forecasts based on an average for ten years ranging from P50 to P90. The higher a P estimate, the greater the likelihood that the project will achieve the forecasts. These forecasts have to be looked at in the context of the financial structure of each project. Clearly, a project with a high P estimate, coupled with a low debt structure is much more likely to achieve an investment-grade rating than a highly leveraged project where the probability of fuel supply fluctuation is greater.

To reduce the financial risk associated with the accuracy of wind resource estimates, Black & Veatch Consulting Ltd. has recently teamed up with Ssesco Inc., a meteorological software and services provider, to provide a service to European wind developers and their financiers. Ssesco’s WindLogics suite of advanced wind resource assessment services uses a combination of atmospheric physics models combined with local and site specific data to accurately map and model the available wind resource at proposed wind farm sites anywhere in the world. Global long-term weather information is then applied to produce accurate financial estimates for proposed projects.

Contractual risk

All projects have contractual agreements that need to be scrutinized to determine which risk lenders will bear. Independent wind projects generally have medium to long-term power purchase agreements (PPA). Because of the intermittent nature of the power supply, wind power contracts provide energy but not capacity payments. In this respect they differ from traditional PPAs, putting wind projects at what S&P describes as “a major competitive disadvantage”.

Model project

In view of the high level of uncertainty that exists in a stand-alone wind energy project, few projects would succeed in achieving a rating level at which risk capital could be attracted to the project. As a result, few projects have sought to obtain an investment-grade rating. This has meant that private capital has had little involvement in the development of Europe’s wind energy industry to date. Instead, projects have largely been funded by utilities capable of balancing the risk with the remainder of their energy portfolio. “For utilities the sums are more simple,” says S&P’s Lund. “They may as well invest in wind projects and generate ROCs (Renewable Energy Certificates), rather than pay the buyout costs. At the same time they diversify their portfolios.”

To date, S&P has given its BBB- rating to only one wind-based investment, FPL Energy American Wind, owned by independent power developer FPL Energy. American Wind consists of a portfolio of seven separately located wind farm projects across four independent wind regimes using five wind turbine technologies. The debt of $380m over 20 years is repaid from revenues earned from energy sold under long-term PPAs plus the value of federal renewable energy production tax credits (PTC). Regulatory risk is minimized as FPL Group guarantees the revenue stream from the PTC payments, regardless of a change in tax law.