Europe needs to invest hundreds of billions of euros in new energy networks and renewable energy production. Most of this money will have to come from "the market", but financial experts agree that, left to their own devices, banks and energy companies are neither able nor willing to do all that needs to be done. They say that a strong inflow from additional sources, such as dedicated investment funds and public institutions, will be indispensable.
The European Commission has already started preparing a "tool box" that will contain "innovative market-based solutions" intended to seduce investors. But one private investor warns that if the EU is to achieve its ambitions with regard to climate and the internal market, the EU and member state governments will have to take a much more active role. 'A strong regulatory push is required'.
The German public’s rejection of nuclear power in the wake of "Fukushima" has at least had one positive consequence for the electricity sector: it has led to increasing awareness among the German public that their country needs to invest in high-voltage power lines if it wants to achieve its ambitions in renewable energy. Although this does not mean that public opposition to transmission lines will magically disappear, it is likely to change the nature of the debate in Germany. It is scarcely a coincidence that German Economics Minister Rainer Brüderle and Environment Minister Norbert Röttgen called for a massive modernisation of the energy grid last week, after the German government’s controversial u-turn on nuclear power.
Germany is not the only country in Europe faced with the necessity of large investments in both energy infrastructure and generation capacity, particularly of renewable energy. As the European Commission noted in its "Infrastructure Package", which came out in November last year, one trillion euros must be invested in the EU’s energy system (infrastructure and generation) between now and 2020. That is, if the EU is to meet its climate targets and to ensure security of supply as well as a well-functioning integrated internal energy market.
The 64,000 dollar question of course is: where is the money going to come from for these huge investments? In its Infrastructure Package, the Commission says that it is confident that "the market" will deliver most of the investments. It even notes optimistically that ‘the policy and legislative measures the EU has adopted since 2009 have provided a powerful and sound foundation for European infrastructure planning.’
Nevertheless, despite this powerful and sound foundation, the Commission expects that there will be a "gap" of 100 billion euro in energy infrastructure investments that will not be taken up by the market over the coming decade. This shortfall is caused by ‘delays in permitting’, ‘difficult access to finance’ and ‘lack of adequate risk mitigating instruments’.
Even if the EU and the Member States manage to solve the first problem – the project delays – by improving the various permitting processes, there will still be an investment gap of 60 billion euro, the Commission notes. And this is just the shortfall for investments in infrastructure. Investments in renewable energy generation also face a gap, of some 35 billion euro per year, according to a detailed study by Ecofys, Ernst & Young, the Fraunhofer Institute and the Technische Universität Wien that was published along witha recent Communication on Renewable Energy from the Commission.
The authors of this study note that current annual capital expenditures on renewable energy production are about 35 billion euro and need to be doubled, leaving a shortfall of up to 35 billion euro per year – i.e. several hundreds of billions of euros over the entire decade. According to this study, it is ‘highly uncertain’ whether this gap will be overcome by the market. ‘Strong support’ from both governments and the Commission is needed, the researchers say.
So what is being done – or should be done – to make the EU’s energy ambitions come true? This was the topic of discussion at a breakfast meeting organised last week in Brussels by public affairs agency Interel in cooperation with European Energy Review, attended by representatives of the European Commission, the European Parliament, industry and NGO’s. According to Mark van Stiphout, Assistant to Director-General Philip Lowe of the Commission’s Energy Department, the Commission is currently working out legislative proposals following upon its Infrastructure Package.
He said the Commission is focusing on four major points. First, it is formulating selection criteria for what are called ‘projects of European interest’. One of the central insights of the Infrastructure Package is that the EU should set clear priorities. Rather than pushing hundreds of different small projects, it has defined a limited number of major energy "corridors", such as the Southern Gas Corridor and the offshore electricity grid for the Northern Seas. Projects that fall within these corridors will be strongly supported by the EU. Secondly, the Commission is looking at concrete proposals on how to speed up and streamline permitting procedures and, perhaps even more importantly, enhance "public acceptance" by better explaining the benefits of new energy infrastructre.
Public acceptance has become a key issue for the energy sector in recent years, as witness the strong opposition in Germany to new high-voltage power lines or in France and other countries to new wind parks. Thirdly, the Commission is trying to formulate principles on how to allocate costs for infrastructure investments. According to Van Stiphout, with the establishment of ACER (the Agency for the Cooperation of Energy Regulators), the EU has created an ‘ad hoc mechanism’ to solve conflicts of interest between network operators who cooperate on gas and power interconnections.
But this is just a first step. Now concrete rules have to be developed that make it possible for network operators and investors to recoup their investments in new networks. Fourthly, the Commission is establishing a new financial framework to encourage investment. It aims to create a ‘tool box’ with ‘innovative market-based solutions’. These include forms of equity participation, targeted facilities for project bonds, risk sharing facilities, public-private partnerships and loan guarantees. A concrete proposal is expected in June. It will be inspected with Argus eyes by some of the Member States, which do not want Brussels to take too much upon itself. Van Stiphout said the Commission wants to earmark some EU funds to kickstart projects, but admitted that the EU’s own contribution to financial investments will inevitably remain quite limited.
The Commission is not likely to counter much opposition from the European Parliament (EP) in its attempts to promote energy investments. On the contrary. As Francisco Sosa Wagner, Rapporteur on Energy Infrastructure Priorities for the European Parliament made clear, the EP is squarely behind the Commission. If anything, it wants the Commission to do more. Sosa Wagner has drawn up a draft report about the Infrastructure Package which the EP’s Committee on Industry, Research and Energy will vote on on 12 April. According to Sosa Wagner, the report stresses ‘the need to develop a harmonised method for the selection of infrastructure projects, welcomes the Commission’s proposal to streamline and speed up permit-granting procedures, and underlines the need for more electricity and gas interconnections’.
Sosa Wagner also agrees with the Commission that investments must be financed mostly by the market. The rapporteur also stressed some points of his own. For example, he said he ‘welcomes the priority given to the North Sea grid as an essential element of a future European super-grid’ and urges the Commission to speed up the identification of ‘electricity highways’.
He also called on the Commission to conduct a thorough evaluation of the possibilities of unconventional gas, to continue with carbon capture and storage (CCS) projects and to speed up the implementation of smart meters and smart grids. Not all stakeholders in Brussels are so unreservedly enthusiastic about the Commission’s plans. ENTSO-E, the European association of electricity transmission system operators, which has drawn up its own "Ten Year Network Development Plan" outlining necessary investments in transmission lines, notes that the Commission’s focus on certain "priority corridors" entails a risk that other infrastructure projects might be neglected.
‘Of major importance is the fact that the overall EU grid capacity depends on the weakest lines or cables all over Europe as well as within Switzerland and Norway’, said a spokesman of ENTSO-E. ‘In other words, upgrading cross-border capacity and building the priority corridors are not sufficient to achieve the ambitious EU targets for 2020 and beyond.’ But for ENTSO-E ‘the greatest short term concern’, said the spokesman, is ‘the lack of discernable progress in debating public acceptance of transmission infrastructure and addressing the permitting delays’. He added that ‘without wider cooperation and leadership to gain greater public acceptance within the EU, regions and member states, delivering the needed grids will be most difficult to achieve’.
Still, even in the unlikely event that all the necessary policies are put in place on time, the question is whether sufficient money will be put up – and by whom. The most obvious source for funding would be the banks, but several financial analysts present at the breakfast meeting said that banks at this moment are reluctant to take on too much risk. ‘They have no problem putting up money for a major gas pipeline project such as Nordstream’, said one source. ‘But a wind farm or a solar power project is something else.’ Another financial specialist confirmed that ‘short-term, smaller ventures are of no interest to the banks at this moment. And this is a problem because the backbone of the European economy is small and medium-sized enterprises.’
Jan Prins, former Global Head Structured Finance at ABN Amro Bank and currently chairman of the investment committee of the Dutch Infrastructure Fund (DIF) and the DIF Renewable Energy Fund, noted that ‘European banks already provide a substantial and increasing amount of project finance’. But he added that ‘we should not rely too much on the banks to fill the projected shortfall’.
According to Prins, there are concerns that the new Basel III capital and liquidity requirements may hamper the global banking sector’s ability to provide long term debt and project finance. ‘This may in particular become a problem in Europe, where traditionally corporates and project developers are much more dependent on bank finance than in the US. It should also be noted that in the aftermath of the financial crisis the European banking landscape is very uneven. Domestic banking sectors differ widely in terms of financial strength.’
Prins also noted that according to projections from the McKinsey Global Institute the costs of capital will rise in the coming years. Especially in the emerging world more infrastructure, residential real estate and other productive investments, such as factories, will have to be built. At the same time global saving rates may drop as a consequence of global ageing and also because of increased consumption levels in emerging countries like China.
‘Thus we may see a surging demand for capital, higher interest rates in both nominal and real terms, and a shift from short term finance towards longer term funding’, said Prins. ‘This may have strong implications for the renewable energy sector, which by its nature is highly capital intensive and has long pay back periods. Key players in the sector may have to reconsider their future financing strategies.’ Particularly in Europe, where the banking sector may become more challenged to provide long term finance, developers may have to explore funding alternatives in the capital markets, said Prins.
‘Project bonds, securitization of project finance portfolios, secondary sales, and so on, are in theory the techniques to tap institutional investors. But experience shows that this is a very difficult path for project finance deals. Especially now that monoline insurers covering credit risks on project bonds have fallen by the wayside. Nevertheless, maybe this time around it could become a trend given the European banks’ constraints to fully accommodate the renewable energy sector.’
Green Investment Bank
In fact, the trend to tap into alternative sources of capital, which Prins described, may have already started. Several banks and companies have set up dedicated "green funds" in recent times. For example, Siemens has just launched a £550 million investment fund jointly with the Carbon Trust which will finance "green" equipment for UK businesses. In the Netherlands the Dutch Infrastructure Fund (DIF) has invested in over 80 infrastructure and renewable energy projects throughout Europe, with a total project value of over 4.5 billion euro.
DIF focuses on public-private partnerships, Private Finance Initiatives (PFI) and onshore wind and solar energy projects and typically attracts pension funds and insurers. Public agencies have also become active. In December 2009, six public financial institutions set up a pan-European equity fund, the Marguerite Fund, to enable investments in energy infrastructure and renewable energy production. It was the first-ever joint initiative of Europe’s leading public financial institutions. Each of the six launching partners – the European Investment Bank (EIB), the Caisse des Dépôts (France), Cassa Depositi e Prestiti (Italy), KfW (Germany), the Instituto de Crédito Oficial (Spain) and the PKO Bank Polski (Poland) – has committed 100 billion euro to the Fund.
The aim of the Marguerite Fund is to collect 1.5 billion euro by the end of this year and to leverage additional investments of up to 5 billion euro. The European Commission is contributing 80 million euro to the Fund. In the UK the new coalition government has opted to set up a Green Investment Bank which is being underwritten by the Treasury. Just last week the British government announced that it would triple funding for this Green Bank to 3 billion pounds. With this money, it hopes to leverage another 15 billion pounds in private investments.
The Green Investment Bank, which will begin operations in 2012, will only be allowed to borrow money from 2015 on. Some commentators in the UK were disappointed by the scope of the initiative, which they find too modest. The Environmental Audit Committee, a multi-party panel of lawmakers in the UK, has calculated that at least 200 billion pounds of investment is needed over the next two decades to put the British economy on a green footing. Prins believes a publicly supported Green Investment Bank is a sound idea, which he has long pleaded for in the Netherlands, but so far to no avail.
Jérôme Guillet, co-owner of Green Giraffe Energy Bankers (GGEB), a French-Dutch specialist advisory company focused on the renewable energy sector, sounded a slightly different note at the breakfast meeting. According to the Frenchman, who has been active in the financing of virtually all offshore wind projects in North West Europe to date, money as such is not the biggest problem for the renewable energy sector.
The problem is that unlike gas-fired power plants, renewable energy projects require large upfront investments and therefore yield a lower initial rate of return. As financial markets are always looking for high initial rates of return, said Guillet, a purely market-based regulatory framework will always favour investment in gas-fired generation.
‘Gas-fired electricity is not necessarily cheaper’, he said. ‘But since gas-fired power sets the price in the market and has low capital costs, it does tend be more profitable – and in a shorter time. Gas-fired power also provides more trading opportunities.’ For this reason, he said, investments in renewable energy will require a strong ‘regulatory push’ from the EU and Member State governments. ‘Nothing capital-intensive will get built without firm supporting policies’, he said. ‘The key investment requirement is long-term price visibility – and this can only come from public decisions.’
Credit ratings for renewable energy projects?
Jan Prins, former Global Head Structured Finance at ABN Amro Bank and currently chairman of the investment committee of the Dutch Infrastructure Fund (DIF), has an interesting idea to offer as a way to stimulate pension funds and other institutional investors to provide debt finance for alternative energy projects. He suggests to create a credit rating system for European renewable energy projects.
‘While not intended to substitute established credit rating agencies it could be developed as a quick scan of the risk profile of a project’, he says. ‘Such a rating could for instance foster the secondary sale of project debt by banks to investors, or it could facilitate the securitization of project finance portfolios. Developing a reliable credit rating system will of course require years of practice to build a credible reputation. But setting up an agency for that purpose could also lead to a European knowledge centre and platform for the public and private sector to meet and address the obstacles to finance the renewable sector.’
Prins noted in this context that Europe will likely become more dependent on foreign direct investment from sovereign wealth funds and other overseas investors. But if sovereign credit ratings of one or more of the EU Member States are downgraded below investment grade – like recently has happened in the case of Greece – this will also affect the debt rating of projects in those countries. ‘To induce foreign investors to invest in or lend to projects in the weaker EU countries we must start to seriously think about special instruments like transfer and currency conversion guarantees, or co-financings with the European Investment Bank.
Maybe we have to get used to the idea that in the future the credit status of parts of Europe should no longer be taken for granted. But it would be a pity if lower sovereign credit ratings would lead to reduced investments in renewable energy and energy infrastructure.’
EU Energy Policy Breakfasts: A new forum to shape EU energy policy
Interel European Affairs and European Energy Review (EER) have formed a partnership to provide EU influencers with a forum to debate and propose new innovative solutions on energy policies to policymakers: the EU Energy Policy Breakfasts. The Interel-EER Energy Policy Breakfasts, of which the first was held on 23 March in Brussels, are a series of free policy debates in which EU policymakers and stakeholders can discuss EU energy related issues.
These breakfasts aim to facilitate the exchange of opinions and propose new innovative solutions to policymakers. For its first meeting, around 30 business representatives, academics and policy makers debated on how to finance the new energy infrastructures in Europe. If you want more information, please send an email to firstname.lastname@example.org.