Financing wind farms in Australia

Offshore Wind Farm

Overview

Whether off-shore or on land, the momentous and global growth of the wind power industry comes with inevitable financial risks due to the resource’s inherent volatility.

The effects of these exposures are felt by a growing number of stakeholders in the wind energy value chain. Without a solution in the traditional marketplace to insure against renewable income unpredictability, stakeholders ranging from operators to developers and financiers are left absorbing the gap when wind yield impacts revenue flow.

In Australia, the wind market is beginning to mature after a decade of initial trials and tribulations from early movers, asset managers, energy companies and financiers staking claim to control these assets. Now a common sight in Europe, wind farms are becoming larger, more efficient and turning into a profitable asset for energy companies or asset managers to acquire.

The aim of this article is to summarise the market in Australia, unpacking key components of the construction and operations of a wind farm.

Gallantree assists wind farm developers on several of these points from a financing and operating standpoint, structuring investment into these projects through the value chain.

Wind Farm project lifecycle

In summary, the points we will cover include:

• Legal and due diligence matters
• Land, planning and grid
• Construction Contracts
• Offtake agreements
• Operations and Maintenance strategies
• Wind yield
• Financing and funders

Feasibility studies

Legal due diligence matters

As with any project, potential funders will need to understand key risks if they are being asked to fund a project’s construction on a limited recourse basis. Many of the risks are similar to those applicable to other forms of conventional or renewable power generation.

Land, planning and grid

As with any generation project, acquiring the necessary rights to land, connecting to the grid and obtaining the necessary permits is fundamental. For the developers, undertaking these activities on an offshore wind project can be a time-consuming process and usually requires state offshore licensing or permits.

Australian state and federal governments are beginning to entertain conversations on offshore permits in Australian waters. Specific projects including the Leeuwin Offshore Wind Project lodged documents to the federal government in March 2022 by Danish company Copenhagen Energy.

The website Reneweconomy.com.au tracks offshore applications in Australia.

In relation to ‘land’ rights, acquiring land rights offshore will inevitably involve interaction with the national or regional competent authorities responsible for the ownership and management of a country’s offshore domain, and some form of participation in a tender competition to acquire those rights.

In relation to grid connection, responsibility for constructing the necessary connection to link the wind farm with the national transmission grid varies. For example, in Australia, it is (invariably) the developer of the offshore wind farm who assumes the obligation to construct the cables linking the wind farm to the onshore transmissions grid. Irrespective of the contractual responsibility for the cables to grid, offshore wind farms are increasingly being built in remoter locations and so the timing and process for grid interconnection needs to be properly understood.

By the time potential funders become involved, land, planning and grid activities will normally be well advanced and funders’ due diligence will normally be able to focus on the fundamentals:

• Land:What onshore and offshore land rights are needed to build the wind farm and connect it to the grid? Have those rights all been obtained or are some still under negotiation? If onshore rights are required, does the project company have the benefit of compulsory purchase powers to obtain the necessary land rights?
• Consents:Given that offshore wind project development takes place over such a long period of time it is not uncommon to find that land rights or consents are not in the project company’s name and need to be transferred (often backed by appropriate credit support) or that the requisite consents need to be varied because the precise layout of the site has changed, or the turbine technology has moved on so that the capacity and number of turbines has changed.
• Appeals process: With regard to consents, have all necessary consents been obtained and have all statutory appeal periods expired? For example, in the UK decisions of a competent authority in granting the necessary licences can be subject to a judicial review. However, in all but limited circumstances judicial review proceedings must be brought within three months of the relevant decision.

Construction Contract

It is perhaps in the area of construction contract strategy that offshore wind practice diverges most from other forms of energy generation. Most comparable large-scale gas-fired independent power projects (IPPs) are developed on the basis of a single lump sum turnkey EPC contract.

However, while such structures were seen on a number of the early offshore wind deals, such structures are now quite rare. It is worth noting that while gas–fired CCGTs are quite complex integrated plants with a single high value gas turbine at their core, wind farms are much more modular, with different components. It is therefore very difficult to ask, say, the turbine manufacturer, to “wrap” every element of an offshore wind farm’s construction.

A bankable practice has developed whereby the construction is split into a number of packages with no overall EPC wrap. These packages could be:

• turbine supply and installation;
• foundations;
• offshore platforms;
• inter-array cabling;
• main transmission cable; and
• onshore works.

While the project sponsors will try to align the contract terms as much as possible and will build in extensive cooperation and coordination obligations on each contractor, there is no overall EPC wrap. In these circumstances, technical due diligence becomes key to bankability and the lenders’ technical advisor will be asked to do a top down analysis, testing the degree of practical interface risk between the various contract packages and assessing the project’s available contingency to cope with an agreed delay/cost overrun downside scenario.

Alternatively, some experienced developers still utilise a multiple contract strategy, breaking the project down into 20+ sub-contracts which they manage. While this structure has not typically been capable of attracting limited recourse finance, some more experienced developers may be prepared to put an EPC “wrap” round the project, thereby elevating its credit profile to investment grade and marketing the debt accordingly.

Offtake agreements

Offtake arrangements will vary from jurisdiction to jurisdiction, depending on the applicable regimes for renewables. There are essentially three types of arrangement:

• feed-in tariffs, where the project company is paid a fixed price for the renewable power it generates;
• green certificates, where the project company is given a certain number of green certificates for the renewable power it generates to supplement the revenue from its commercial power purchase agreement (PPA); and
• contacts for difference (CfDs), where the project company is paid an agreed top-up payment up to an agreed strike price to supplement the revenue from its commercial PPA (which, for the purposes of the CfD, is deemed to be the relevant market price and referred to as the “reference price”).

From a financing perspective, feed-in tariffs and CfDs both deliver a stable revenue stream (provided that, in the case of CfDs, the generator can also secure a long-term PPA). Green certificates, although used for many of the older offshore wind projects, are slightly more challenging because the project is still exposed to a fluctuating revenue stream under its PPA (which will typically pay the (variable) market price for power).

The key point about a PPA combined with green certificates or CfDs is that lenders will want an offtaker not only to purchase the power but also take the system imbalance risk that arises from a wind farm’s variable generation: a single wind farm is unable to balance its position such that it always sells precisely the amount of power it generates. Some of the key points in relation to the PPA will include:

• ensuring that the pricing mechanism is back-to-back with any CfD, such that there is no price leakage;
• negotiating the discount to the reference price that the offtaker pays (either on a fixed amount per MWh basis or on a percentage basis) for taking “imbalance risk” in relation to the wind farm’s output;
• negotiating caps on liability for termination that provide the project with a sufficient buffer should the PPA be terminated for counterparty default while not unduly negatively influencing the discounts; and
• credit support should the offtaker not have an investment grade rating, and risk mitigation strategies such as placing multiple PPAs with different offtakers.

Operation and Maintenance Strategies

Lenders will also need to be happy with the project’s proposed operation and maintenance strategy. While the favoured option may be for a long-term maintenance contract for the wind turbines with the original equipment manufacturer, more experienced developers may prefer to take such a contract for perhaps five years and then take over the O&M themselves. The project’s ability to undertake the balance of plant O&M will also need to be assessed.

Wind yield and risk

Electricity production from an offshore wind project and the resulting revenue will ultimately depend on wind speeds over time at the wind farm site. Lenders will therefore be keen to understand the forecast of wind energy resource at the project site and any uncertainty to which the expected electricity production from the wind farm is exposed.

The energy yield assessment (EYA) is therefore one of the fundamental pieces of technical due diligence. The project sponsors will have carried out their own EYA during the development phase and the lenders’ technical advisor (LTA) will need to validate that EYA. The sponsors’ EYA will be the subject of careful scrutiny: it may be that there will be some disagreement as to the data or methodologies used which will need to be resolved between the sponsors and the LTA.

Wind output will typically be assessed over three projections and for the following purposes:

• P50 probability — the wind yield estimate can be expected to be exceeded 50 per cent of the time. Project sponsors will often base their own economics around the P50 analysis. In connection with the financing, P50 is typically used to determine whether or not projected coverage ratios are met for distribution purposes.
• P90 probability — the wind yield estimate can be expected to be exceeded 90 per cent of the time. Typically the lenders’ debt sizing case is based around the more conservative P90 and any events that give rise to a recalculation of base case ratios will typically employ the P90 definition (see below).
• P99 probability — the wind yield estimate can be expected to be exceeded 99 per cent of the time. P99 is typically used for certain downside sensitivity analyses (e.g. does the project meet a one-year P99 debt service cover ratio of 1.0) and it may also be used when calculating pre-completion revenues (PCRs).

Funding

Financing and funders

As offshore wind financings have increased in size and the cost pressures have become more intense, so the facility structures have become more complicated. Set out in the figure below is a typical facility structure for an offshore wind deal.

Equity Investors

A key part of the overall financing plan will be the equity structure from investors. Like any project, sponsor equity can be contributed up-front, pro rata with senior debt and even after debt, subject to the provision of appropriate credit support. Project sponsors may also choose to utilise an equity bridge loan to defer the funding of their actual equity commitment. In particular PCRs (pre-completion revenues) can play a significant role in the funding structure for wind farms.

Large offshore wind farms can generate a significant amount of PCRs during the commissioning period and before the wind farm as a whole achieves its commercial operation date (COD). Project sponsors will likely want to use the PCRs to reduce the funding burden on them and indeed will in most cases want to treat PCRs as equity.

In more recent offshore wind deals, strong project sponsors have been able to introduce other features that are favourable to equity, namely the concepts of wind reforecasting and equity cure. Equity cure, namely the right during operations to inject equity to cure a ratio breach and/or prepay debt, is not specific to offshore wind, but the prevalence of this feature is a good indicator of the strength of the sponsors and the banks’ appetite for financing these projects. Typically project lenders resist granting sponsors automatic cure rights like this.

Not all project sponsors want to use project financing to undertake offshore wind projects. A number of the leading sponsors in this space are large-scale, well-rated utilities or multinational companies who typically fund project development on their own balance sheet.

Banks and debt funders

Historically, Banks struggle to ascertain the risks with construction of a wind farm and the length of returns and the assets themselves. This is why sovereign funds and pension funds have played key roles in financing the development and operations of wind farms.

In saying this, several banks have embraced dedicated teams to specialise in funding offshore wind energy as the figure below represents in 2019.

Source: WindEurope

In Australia, Macquarie Group under Macquarie Assets has established the Green Investment Group (GIG) to specialise in financing and asset management of these assets.

Other banks simply buy bonds (Green Bonds) in projects or corporations that finance these assets, which is considered to be the simplest method for most banks to participate in financing without requiring in-depth market knowledge.

Suncorp has invested into Palisade’s green bond which has developed several projects including the Granville Harbour Wind Farm, a $280m project over 1,200 hectares of cattle farm. Westpac and ANZ provided senior debt. Suncorp committed $100m to Palisades Renewable Energy Fund (PREF).

Green Bonds

Green bonds for wind energy and renewable portfolios including wind saw strong growth between 2016 and 2018. The funds raised from these bond issuances serves to finance renewable energy portfolios, including wind power projects and offshore transmission lines.

Ørsted, a danish-based asset manager that specialises in green energy issued green senior bonds with a value of over €1bn to invest in the Hornsea 2 offshore wind farm off the coast of England.

Green bonds enable access to greater sums of capital from mostly institutional investors around the globe, not just in one location.

Summary

With over 15 offshore wind projects currently lodging applications to the Australia federal government from both new and traditional developers and operators, enabling financing and understanding risk is fundamental to the aim and development of the any wind farm.

Added to the fact that most Australian Bank’s are often lacking in renewable energy project understanding and financing, particularly with offshore as there are permits, not land challenges their credit models and ability to finance. Macquarie Group’s GIG showcases that supporting and financing this vertical requires it’s own segment internally, not an add-on vertical to the existing business.