Financing

lssues relating to wind farm

developments in the UK
be serviced (i.e. interest and principal repay-
ment) from the project’s revenues less its
operating costs.
Funding raised on an inter-company
basis can be inefficient because the true cost
of finance will be the parent group’s weight-
ed average cost of capital, which includes an
equity component (dividends) that is non-
tax deductible. Project finance tends to
accommodate a higher degree of debt lever-
age, which means it could be cheaper on a
post-tax basis. There is also the opportuni-
ty cost of tying up capital.
Although the bulk of funding will be
provided by project finance, a lender will
want to see a degree of investment capital
from the project sponsors. Such capital
will rank behind the project debt in the
event of insolvency. This provides an ele-
ment of risk protection for the lender as
well as comfort that the main project par-
ties are incentivised to ensure the success
he development of the renewable of and the potential issues relating to the

T
Government
electricity generation industry
set to speed up now that the UK
has stated its commitment,
is raising
project
developments.
of
finance
non-recourse,
for offshore
cost
wind
efficient
farm
of the project.

that
have
Various
could
been
tranches
add
announced.
up
of Government
to as much
Although
as E150m
grant

this can
via the Renewables Obligation, to be viewed as an additional source of
increase the level of the country’s electric- Project Finance finance, it cannot be absolutely relied upon
ity needs met from renewable sources to Broadly speaking, project finance is debt until the exact terms and conditions are

10% by 2010. With up to f150m pro- provided by a third party (usually a bank) to known. Ideally, projects should be eco-
a project company, usually a special pur- nomically feasible without these grants.
posed as grant funding for offshore wind
pose company (SK), in addition to capital In a project finance transaction, it is the
farms and the prospect of up to 18 devel-
injected by the project’s sponsors. An SK intention to minimise the project risks that
opments that recently pre-qualified for a
is set up to undertake the project, raise are assumed by SK and to pass them
sea bed lease from the Crown Estate, off-
finance and enter into the main project through via the contractual structure to spe-
shore wind is set to make an important
contracts. The liability of the project spon- cialist sub-contractors that are best able to
contribution to the UK Government’s tar- sors is limited to the amount of capital they assess and manage them. As mentioned
gets. Neil Robertson, of NORD/LB have injected, plus any obligations individ- above, a project finance lender relies on the
London Project Finance gives an outline ual sponsors may have under contracts with project income to repay their debt.
of the rationale behind, the mechanisms SK. A lender will be looking for debt to Therefore, they will want to ensure that all

56 September 2001 RE, jr: ” www.re-focusnet

 FEATURE - OFFSHORE PROJECT FINANCING

of the project risks have been identified and to be covered for the usual fire, collision, sold into the electricity markets under the
where appropriate, mitigated. ground movement; as well as insurance recently introduced New Electricity Trading
cover for suppliers and vessels. There is Arrangements (NETA). It will attract pre-
Risks and Mitigants already a well-developed insurance market vailing market prices - whether via bilateral
Overall design, component manufacture, for offshore structures in the oil and gas contract, trading on a Power Exchange or
transportation, f oun d anons, construction, industries which should also be appropriate from the Balancing Market. The levels of
installation, connection and commissioning for offshore wind farm developments. The supply and demand for green certificates,
of an offshore wind farm are all highly spe- insurance will need to be placed with insur- and consequently their value, depends on a
cialised activities. The SPC will want these ers acceptable to the lender and the cover number of factors. These include each sup-
inherent risks to be passed through to a sub- must extend to both the construction and plier’s level of compliance with its obliga-
contractor or sub-contracting consortium the operation phases, with a degree of busi- tion, the rate of new renewable plant devel-
by way of a fixed price, date certain, turnkey ness interruption provision.. opment and the future prospect of pan-
contract. Given the nature of the risk, it is Put simply, revenues minus operating European trading in green certificates.
important that such sub-contractors are costs must be greater than debt service costs Nevertheless, the sale of green certification
experts and that the technology is proven. by a factor of more than one. A lender will can be seen as a source of supplemental
Project economics can be cushioned from be looking for this ratio to be maintained income.
the adverse effects of any delay in comple- for as long as the loan remains outstanding, Furthermore, NETA contains a
tion by an element of liquidated damages and therefore needs a degree of revenue and Balancing Mechanism that effectively
and subsequent faults by latent defect pro- expenditure predictability at the outset to penalises the intermittent nature of electric-
tection. be able to assess the long-term credit risk. ity production from wind. The Balancing
The turbines used will have to be of a The old NFFO (Non-Fossil Fuel Mechanism imposes prices on market par-
higher technical specification than those Obligation) structure guaranteed a buyer ticipants with an imbalance between physi-
used onshore because of the climatic and for the electricity generated at a fixed, cal production or consumption and con-
environmental conditions at sea as well as index-linked price for a fixed period. The tractual positions. A wind farm with out-
diminished accessibility. For as long as pos- proposed successor to NFFO is not quite so put contracted for on a windless day there-
sible and so far as is economically viable, the straightforward. The onus of the proposed fore faces its contractual position being
turbine manufacturer should be retained to Renewables Obligation will fall on electric- topped-up from the potentially volatile
guarantee availability and performance. ity suppliers, who will have to present Balancing Market. Also, various aspects of
Moreover, increasing turbine output and Renewable Obligation Certificates (ROC’s - NETA markets require credit cover from
size as well as greater rotor diameters lead- issued for each unit of renewable energy) participants, either in the form of cash
ing to an elevated hub height present addi- equal to a proportion of the total amount of deposits or bank letter of credit.
tional technical hurdles. electricity supplied. Suppliers can obtain Our investigations would indicate that
If all 18 developments given a green light these by investing in their own renewable suppliers are willing to enter into off-take
by the Crown Estate go ahead, there will be plant; contracting for or buying ROC’s arrangements for a fixed price for up to lo-
potential demand for up to 540 turbines; as from third parties; or buying themselves out 15 years. Such arrangements would give
well as their foundations, support structures of their obligation (currently proposed at 3p value, albeit discounted, to electrical output
and the appropriate vessels (which are also kWh). The proceeds of the latter will be and green certification, as well as assuming
used for other work) to install them within recycled to those presenting ROC’s. This Balancing Market intermittency risk.
the Crown Estate’s deadline of 5 years. gives ROC’s a theoretical value, equating to Without such an arrangement and the
That is just the UK, offshore wind farms are the buy-out price plus a proportion of the resultant predictability of income, it will be
also being developed in Scandinavia, recycled buy-out payments. Levy difficult to raise project finance.
Germany, Spain and France, not to men- Exemption Certificates
tion continuing development onshore. (LEC’s) are also issued for
Developers need to be aware of this and each unit of renewable elec-
take precautionary measures, either passing tricity, though it is not yet
the risk through to sub-contractors or by clear as to whether any mon-
taking out options on manufacturers’ capac- etary value can be attached to
ity and contractors’ marine plant. LECs. Some value however,
It will not be possible to contract so far can be derived from Climate
ahead for the decommissioning and Change Levy (CCL) exemp-
removal of the turbines and their support tion if renewable electricity is
infrastructure (a condition of the Crown supplied direct tothese an end
Estates lease). It should be possible howev- user with a CCL obligation..
er, to assess the timing and cost of this in An offshore wind farm sell-
advance and make adequate provision for it ing its electrical output inde-
during the operating life of the develop- pendently faces two market
ment. price risks - the price of elec-
It will be possible to offset some risks tricity and the prices achiev-
using insurance. In view of the operating able for “green certificates”
environment, it will be critical for the gen- (ROCs and LECs).
eration plant and connection infrastructure Electricity generated will be A view fromBlyth Harbom

September 2001 REi-i)r, s;i www.re-focus.net

 FEATURE - OFFSHORE PROJECT FINANCING

In terms of debt service, principal repay-

ments are fixed. The repayment term and Background to NORD/LB
structure will be determined by a combina-
Norddeutsche Landesbank Girozentrale The Neuer Markt in Germany is a stock
tion of the useful economic life of the
(NORD/LB) is the tenth largest bank in market specialising in small to medium-sized
machinery, the underlying contractual
Germany with its Head Office located in undertakings engaged in forward-looking
structure and the term of the Crown Estate’s
Hanover. Germany is a leading advocate of activities in growing markets. NORD/LB
lease. Floating interest rate movements can
renewable energy and in recent years, con- has succe&ully managed the initial public
be hedged using a number of different
siderable development in the sector has offering of shares into the Neuer Markt of
financial products.
been encouraged by tax incentives and a two German renewable energy companies.
The need for the maximisation of avail-
favourable regulatory environment. The The bank’s international strategy focuses on,
ability (and therefore revenue) makes a pro-
NORD/LB Group has established a lead- among other areas, the utility and infiastruc-
ject’s O&M strategy and contractual struc-
ing market position in the renewable ener- ture sectors. NORD/LB London Project
ture crucial. It is also important as O&M
gy sector, having lent to 6 German wind Finance has extensive experience in the UK
costs are the largest element of cost outside
farm developments (4 as arranging bank) electricity sector. As well as the UK,
debt service. Unexpected corrective main-
that have an aggregate of 138 turbines. NORD/LB London is also responsible for
tenance costs due to component failures
The bank has also financed a number of Ireland. NORD/LB London Project Finance
may be passed through contractually to the
single windmills for individual customers, acts as financial adviser to the Beaufort
manufacturer, perhaps with a damages
as well as larger wind farm developments Consortium which recently pre-qualified for
penalty element to compensate for lost rev-
in Spain, Portugal and Greece. a sea-bed lease from the Crown Estates.
enues. Life-cycle maintenance and preven-
tative servicing are, in theory, more pre-
dictable and the risk of cost overrun in this operating expenses) to the same period’s percentage of the total loan amount.
respect can be passed through contractually principal and interest payments; Remuneration for the ongoing risks of lend-
to a specialist operator. Loan Life Cover Ratio - the net present ing to the project will take the form of a
It may not be possible or economic to value of projected net cash flow for the margin over the funding basis. Lenders’
hedge changes in or fix other costs such as remaining life of the loan to the amount of expertise lies in assessing the credit risks
insurance premiums and ongoing grid the loan outstanding at the time of calcula- inherent in a project. External and inde-
connection charges. An element of flexi- tion; and pendent (i.e. working for the lender, not the
bility in the project’s economics needs to Project Life Cover Ratio - the net present project sponsors) advice will be sought on
be factored in to cover these and other value of projected net cash flow for the meteorological, technical, insurance, legal
contingencies. remaining economic life of the project to and accounting matters. The cost of this
Revenue will not be generated at a con- will be borne by the project sponsors via
the amount of the loan outstanding at the
sistent rate, because of maintenance outages the SPC.
time of calculation.
and seasonal weather changes. Therefore, As a project finance loan is limited
Not only are the above used to test the
to give lenders some degree of cover, it is recourse, the lender is exposed to greater
viability of the project at its outset, but they
usual to establish a Debt Service Reserve risks than a straightforward corporate loan.
are also used on an ongoing basis on pre-set
Account and a Maintenance Reserve Therefore project finance margins tend to
dates to ensure compliance with financial
Account. These accounts accrete over time be higher at somewhere between 1% to 2%
covenants that dictate certain events such as
such that they have a balance sufficient to over cost of funds. This needs to be com-
shareholder distributions and events of
meet projected debt service and O&M costs pared with the sponsor who is likely to be
default.
respectively for the following 6 months on a targetting a margin return of circa 9% to

Security 14%. Banks are often criticised

rolling basis. for taking a
conservative stance, but the key to a suc-
Financial Model A lender
support
will require
the obligations
security
under
to be taken
the facility.
to
cessful financing solution is to optimise the
Projected cost, revenue and expenditure fig- risk/reward equation.
Elements of this will include:
ures will be fed into an audited financial
Conclusion
l Fixed and floating charge over SIX’s
model prepared by the sponsors or their
assets;
financial adviser. The lender will use this The foregoing is not an exhaustive list of
l A charge over the sponsors’ shares in
computer model to generate projected requirements, nor is it a recommendation
SPC;
financial statements and to test certain sen- that project finance is the most appropriate
l Assignment of all insurances, leases and
sitivities that will test the resilience of the source of funding for an offshore wind farm
k ey contracts;
project economics to various contingencies development. The aim of this article has
l Step-in rights to appoint sub-contrac-
such as cost overruns, changes in the rate of been to give the reader a feeling for the
tors in the event of unsatisfactory
inflation, interest rates, electricity prices, issues that will need to be weighed if project
performance.
and higher operating costs. The probabili- finance is being considered.

The Costs of Project

ty, nature and level of certain sensitivities
will be devised in conjunction with bank Contact: Neil Robertson, Manager,
advisers. The effect of sensitivities on the Finance NORD/LB London Project Finance, 71
project’s economics are demonstrated by Typically, a lender will seek remuneration Queen Victoria Street, London EC4V
certain ratios: for the work it undertakes in assessing, 4NL, UK. Tel: +44 20 7972 5418; Fax: +44
Debt Service Cover Ratio - 12 months’ structuring and underwriting a project 20 7972 5455; neil.robertson@nordlb.com;
projected net cash flow (revenues less finance loan by way of a fee, expressed as a www.nordlb.com

58 September 2001 RE, :;’ www.re-focus.net