While PPA usage is set to proliferate, investors’ merchant appetite will also increase, by ENERGY REV

The European market will see a continued rise in the financing of PPA-backed renewable energy projects over coming months. However, investors may also push to increase their merchant exposure, both due to a desire to capture higher returns and in the face of a potential shortfall in available offtake deals

Europe’s renewables market saw a continued rise in financings of post subsidy onshore wind and solar PV in 2019 – largely in Nordic and Spanish markets. And, while in many cases sponsors opted to negotiate offtake deals for all or most of a project’s output in order to lock-in price certainty, it has also become increasingly common for both solar and onshore wind investors to leave a portion of capacity uncontracted to benefit from currently higher wholesale prices.

The European market is likely to see much of the same in 2020, although an increasing number of investors may look to increase their merchant exposure by selling a greater share of a project’s generation directly to the grid, or hedging it only on a short-term basis. Those that are able to may increasingly even opt to go all-equity on deals, forfeiting extensive use of project debt and selling the majority if not all of their production on a short-term basis.

“I expect to see investors increase their appetite for merchant risk in 2020, with a corresponding increase in all-equity deals, because if they don’t need the debt they won’t need the PPA, which only benefits the lenders in the current structures,” says Mortimer Menzel, partner at financial advisory firm Augusta & Co.

Indeed, fund managers typically use debt and then need a PPA for greenfield projects in order to achieve 8% return rates, which then allows them to secure performance-related fees.

“However, as the PPA only benefits the debt, it’s usually a better project on a risk-return basis if they do it all equity and target a 6% return – imagine if the benefit of the PPA and the typical (bank) security package is for the equity, that would dramatically improve the risk on such projects,” Menzel argues.

Adopting the all-equity approach also has the benefit of allowing investors to deploy more capital into each deal. This is a strategy that appears to have been favoured by Copenhagen Infrastructure Partners in its purchase of a 374MW Spanish onshore wind portfolio from Forestalia in 2019, for example, while also in Spain, German institutional Talanx ended the year by starting construction on its newly acquired 180MW Bienvenida solar project on the same basis.

Cubico Sustainable Investments too could opt to go debt-free for post-subsidy projects. And others may follow suit in 2020.

“We think increased realization of merchant solar projects without long-term PPAs will be one of the big talking points of 2020,” says Luca Pedretti, chief operating officer at Switzerland-based PPA advisory platform Pexapark.

Pedretti also distinguishes between the Nordic onshore wind PPA market, which has, generally, seen a significantly lower discount between PPA prices offered and wholesale forward prices, and the Spanish PPA market, which is a driver for having more merchant projects “due to savings of liquidity costs.”

Safety first 
Long-term PPAs with investment grade counterparties still appears the preferred choice for many fund managers investing in renewables projects, even if they have to settle for discounted prices, as this most closely mirrors the subsidised tariff system that the entire industry has grown up with, and allows them to fully utilise competitively priced debt.

The potential consequences of getting a merchant risk approach wrong – which in the worst case could see project equity wiped out and reputations tarnished – also understandably acts as a check on such strategies.

Yet with project sponsors across Europe often lamenting a lack of available corporate PPAs to back their projects, and supply and demand dynamics meaning the negotiating power often lies with the offtaker – as seen with one Nordic wind PPA tender in Spring 2019, which saw 10-year prices allegedly fall to the mid-EUR 20s/MWh – investors could be well served evaluating alternative options.

“I think investors will get a lot smarter in their use of leverage – merchant risk can also be hedged, and there are more sophisticated approaches to doing so than people realise,” Menzel says.

“Nordpool, for example, is massive as it’s the most liquid power market in the world, which follows the German power market closely – that’s a behemoth of a power market and there’s good trading liquidity up to three years out, and good visibility for up to five years or longer in some cases,” he stresses.

“You can hedge your revenues making use of liquid forward markets at up to two to three years at very low liquidity cost instead of accepting larger discounted long-term PPA prices,” agrees Pedretti.

However, while “there’s been a large increase in knowledge with regards to PPA options on the part of investors over the past two years…there are concerns that the sheer volume of capital looking to park money into renewable projects eventually may distort perceptions of certain risk elements,” he says.

For the many developers and investors whose project base-case still requires a PPA in order to secure debt and get off the ground, 2020 should nevertheless see an increase in companies looking to offer offtake agreements, both in existing markets and newer geographies, even if there is likely to be a corresponding increase in consented projects on the hunt to secure them.

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