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Covid-19 has seemingly impacted every aspect of our lives and the global economy negatively, but it is less clear how it will affect the speed of the energy transition. But while social distancing measures have limited our ability to meet in person, they have not affected our appetite for debate and discussion.
Kathryn Emmett, knowledge of counsel at Norton Rose Fulbright, caught up with Rob Todd, global head of power, utilities & renewables at HSBC, as well as her colleagues Rob Marsh, partner and co-chair Emea renewable energy practice, and Charles Whitney, head of energy for Emea, to ask them how the pandemic is affecting the funding of energy projects.
Kathryn Emmett: With curtailed economic activity and the imposition of travel restrictions, demand for power, oil and gas has significantly reduced. How will the resulting low commodity prices impact the finance and investment available for energy companies?
Rob Todd: One of the most common questions that we have been receiving in recent weeks, whether on the electricity or oil and gas side, has been ‘when will we return to pre‑Covid-19 levels of demand?’
There appears to be consensus that we will not be returning to those levels any time soon. The immediate impact of these demand losses is lower commodity pricing—we have seen reductions in the region of 20pc on the electricity side and even steeper on the oil and gas side. But looking across the power-sector landscape, many players have shown their ability to access the capital markets, so they are well supported from a liquidity perspective.
Emmett: How will energy company investment strategies be affected?
Todd: If we look at the public equity markets for the power landscape since the Covid-19 outbreak, we have seen integrated utilities, regulated utilities and renewable energy companies predominantly outperform the market indices given their more defensive qualities.
Renewable energy players have typically benefitted from supportive regulatory frameworks and legacy contracted offtakes as well as offering a significant growth angle, given the trajectory for new installed capacity.
In the last two months, we have also seen two oil and gas companies announcing their plans for targeting net zero in the future. Overall, we are seeing the reinforcement of new energy investment plans plus examples of players seeking to bring them forward.
Rob Marsh: I agree. We have seen a number of companies historically known as international oil companies—which now, of course, call themselves energy companies—come to market with declarations to decarbonise.
In many of the recent transactions in the clean energy space—particularly offshore wind but also onshore wind, solar and also some newer sustainable technologies—it is these companies that are bidding most competitively and winning.
That said, I do not see this as being driven by Covid-19. The sustainability agenda had been driving these players towards this market for some time. The message we are getting from these clients at this time is that while significant parts of their businesses are on hold, their new energy divisions are certainly open for business and the ability to invest is there.
Charles Whitney: Yes, and I expect they will be looking to compete in markets where they already have a substantial business on the traditional oil and gas side, using their existing relationships to develop power projects in those countries rather than moving to new countries where they may not necessarily have relationships.
Emmett: Do you see any long-term implications for the oil and gas commodity markets as a result of the crisis?
Whitney: From a commodity perspective, I cannot help wonder if we will see more of a move to regional and more localised pricing structures. The recent volatility in pricing may increase buyers’ reluctance to be tied to pricing structures that may have little to do with their own local supply and demand issues. Another trend seems to be towards fewer fixed price arrangements. Even with the current low prices, I would guess that we will continue to see more flexible arrangements going forward, particularly in the EU.
Emmett: Turning to the power sector, operational renewable energy projects may be somewhat insulated from the impacts of Covid-19 due to revenue support schemes, which often offer a fixed tariff or top-up to the market electricity price. Will this mean that renewable generation will be seen as a safe haven for investors during the crisis?
Marsh: The timing, as well as the status, of different projects is a consideration. Those projects that are operating seem to be less impacted, whether they are backed by tariffs or not. However, projects in the construction phase are certainly experiencing challenges. We are seeing a range of impacts across various regions from projects getting into full distress to those experiencing minor impacts in their supply chains.
There is certainly a slowdown in new projects coming to market, but we are seeing projects that are in the works moving through their process, raising finance and achieving financial close. As a firm, we have closed a number of significant transactions over the last couple of months while we have been in lockdown. Where projects are coming to market, it is taking a lot longer to put those packages together and to achieve financial close, and we are certainly seeing deals delayed.
Emmett: Before the crisis, debt terms were very competitive and we were starting to see renewed interest in merchant power projects. Will the preference be for contracted revenues in the current climate?
Todd: We have observed a growing debate among clients about how to prioritise the allocation of capital for expansion plans with a backdrop of ‘contracted-revenues in emerging markets versus uncontracted-revenues in developed markets’. As development platforms become increasingly diversified, we have seen them prioritise markets where they can secure contracted revenues because it provides more cashflow certainty for equity while also enabling debt financing for new projects.
That said, in clean energy, we have seen increasing influence of merchant risk by virtue of the lower cost of projects and the sheer competition to win new capacity through auctions. In parts of the world an element of merchant risk is already taken into consideration when it comes to debt sizing for new loans or future refinancing. The financing community applies more conservative debt sizing parameters and other metrics to try to accommodate this risk and places an emphasis on electricity price projections, energy yield assessments plus loss factors from the project perspective.
A consequence of the current conditions is that it will make those projects that benefit from vintage tariffs and longer duration offtake contracts more attractive to investors. By contrast, those projects with greater merchant exposure may find more selective liquidity going forward.
Marsh: I would echo that. We certainly were moving, albeit slowly, towards merchant financing in the renewable energy sector and there were a number of projects in the market slated for this year that would have been partially merchant, but also a number of fully merchant projects as well. I think those projects will find a smaller pool of lenders that are either willing to take that risk or willing to do so at a level of leverage or pricing that makes sense right now.
But I would sound a note of caution, as there are definitely regional differences. If the scale of global economic recession that is being forecast takes hold, then there would be more pressing priorities and cheap, accessible and ultimately affordable energy for end-users is absolutely key.
We may see that some of the fixed-tariff agreements that have been put in place more recently may get revisited, particularly for projects that are not yet fully operational. So I think there is, perhaps, sense in holding judgment on the global picture and particularly some emerging market economies where the renewable regulations and structures are relatively new.
Emmett: Do you anticipate a significant number of defaults and restructurings as a result of the pandemic? Or, given the checks and balances built into projects, do you think that projects will weather the storm?
Whitney: I have seen a little bit of everything. I have seen a little bit of default, a little bit of restructuring, loads of waivers. Some projects that are in operation, though certainly not all, have seen force majeure notices. We have also seen ‘technical’ defaults and some restructurings of payment terms under commercial contracts. We have yet to see debt restructurings for individual power projects, and certainly have not seen any enforcements.
Todd: Project structures are designed to withstand impacts, so we are not expecting to see a significant number of defaults or restructurings across the industry. We are seeing support for the projects themselves, particularly as they are viewed as delivering an essential service to the economy.
From an M&A perspective, amid current market conditions, people may feel that more favourable prices can potentially be achieved. However, those projects which benefit from strong sponsorship and contracted revenue arrangements will continue to attract investor appetite and command the best valuations. For those projects involving exposure to merchant risk, there will be a focus on refreshing energy yield assessments, power pricing forecasts and threshold levels of return.
Emmett: A number of organisations such as the European Parliament and the International Renewable Energy Agency (Irena) have stressed the opportunity for the recovery from the pandemic to accelerate the energy transition. What steps would you recommend governments consider to encourage a low-carbon recovery?
Marsh: Perhaps at a social level, the past few months have made the world more conscious than it already was about the environmental impact of fossil fuels, with fewer planes in the sky and cars on the roads, and lower levels of pollution. There is no question that to restart the economy we need to be putting money into infrastructure and that infrastructure is going to have to be developed sustainably.
Todd: From a renewables perspective, it would be helpful to confirm support towards existing frameworks and provide guidance for any adjustments to upcoming schemes given the significant investment in new capacity expected over the coming years. Alongside this there is a need for governments to take an enabling role with funding and policy to encourage investment in smart infrastructure and new energy technologies to support the transition to a carbon-free or net-zero emissions energy system.
Marsh: Yes, and the reduction in electricity consumption may accelerate the need for a smart energy system as must-run renewables will have a greater share of total generation. That places a really big emphasis on secure energy delivery. It will be an interesting topic to look at over the next year or so.