iven that most bankers report that there is little difference in the basic discipline between lending to renewable and conventional power projects, it is hardly a surprise that ratings agencies should adopt a similar approach to the two markets.
"We apply our project finance criteria to the analysis of wind projects," says Lidia Polakovic, director of infrastructure finance at Standard & Poors (S&P) in London. "In other words, we need to feel comfortable about wind resources, regulation and government policy, construction and operation, the guarantees and the counterparties, and the contractual and financial structures."
While the fundamental discipline of cashflow analysis may be comparable in the worlds of renewable and fossil-fuelled power, Dagmar Buhl, managing director and head of structured bond new issues at UniCredit Group (HVB) in Munich, says that there are still a number of decisive differences between the two areas, which are not always fully grasped by ratings agencies.
"The agencies started off by comparing wind energy with the gas-fired plants that they understood, because they had never worked intensively on a portfolio of windfarms before," she says. "In reality, there is no comparison between the two assets and it took quite some time to educate the agencies and to help them build up an understanding of how renewable energy sources work, and about the risks and other unique characteristics of wind."
Rating agencies say that it is an over-simplification to suggest that they have simply superimposed a project finance rating template on their methodology for rating renewable projects. At Moodys, Andrew Davison says that elements of securitisation technology and project finance analysis are both used to rate windfarm projects. "There are clear parallels between conventional power and renewable projects but we certainly dont adopt a cookie-cutter approach," he says. "We see windfarm projects as hybrid assets, which are part project finance, part securitisation, and we approach our ratings on that basis."
One of the key differences between renewable and more conventional energy sources that ratings agencies needed to understand, says Buhl, is the distribution risk associated with each. "If you look at the US power distribution market, utilities usually enter into power purchasing agreements with counterparties grid operators which in many cases have low ratings, which adds a risk component to transactions," she says. "The grid system in the German wind market is completely different and guarantees that if one grid company goes down then the next available operator has to feed energy into the system, which means distribution risk is negligible."
Another essential difference is the fuel source. "Supply risk in gas and wind is completely different," says Buhl. "Gas-fired power plants in western Europe dependent for much of their natural gas on countries such as Russia face very different risks than farms dependent on wind."
Agencies catch on to the variables
Buhl says that after a slow start the ratings agencies understanding of the risks associated with renewable energy is improving.
For their part, the agencies say that the twin variables they focus on are those arising from the vagaries of wind flows and of government regulation. Those are very different disciplines. While government regulation ought to be reasonably predictable, and in some cases amenable to lobbying, wind patterns can (and frequently do) confound all scientific research.
As S&Ps comments in a primer on its ratings methodology, "the risk most specific to wind projects namely the wind resource is the most difficult to forecast and therefore the most difficult to mitigate."
There is a large and growing mine of historical data on wind flows at the disposal of ratings agencies, although the quality and depth of this data varies from country to country, with Germany unsurprisingly tending to provide more in the way of historical information than most other European countries.
According to S&Ps post-sale report on UniCredit Group (HVB)s Breeze One transaction, which was backed by windfarms in Germany and Portugal, "generally, the wind forecasts used for the German wind projects benefit from some operational onsite data, which creates a longer historical database. The Portuguese projects, however, have limited historical underlying data."
Based on consultants analysis, agencies will typically model their ratings on an analysis of probability studies known as P90, P75 and P50 cases. A P90 refers to a 90% probability that the consultants base case will be exceeded. In other words, as S&Ps primer notes, "the higher a P estimate is, the greater the likelihood that the project will achieve the forecasts."
To date, the performance of wind deals has been strong, suggesting that the P90-based models are robust. According to S&P, "research conducted in the industry provided general statements that few, if any, wind projects have defaulted."
The agency adds a caveat, however, which is that "this apparently reassuring conclusion may... not be based on S&Ps definition of default, which includes any missed or deferred payment of interest and principal, restructuring, or restatement of the terms and conditions of the debt that would lead to an economic loss."
While agencies and legal advisors can scarcely be expected to have an in-depth scientific understanding of the meteorological forces that make wind blow with more consistency in some areas than in others, they are on safer ground assessing the regulatory variables that are the other key determinants of performance in the market for renewable energy.
"Although there are commitments at the EU level to reduce carbon emissions, not every country within the EU is complying with their targets, and each has different regulatory frameworks which investors need to feel comfortable with," says S&Ps Polakovic. "So one of the areas we look at is whether there is political support and regulation that will last the life of the project, because we are generally rating debt that has a maturity of more than 15 years."
Law changes the biggest risk
At Linklaters in London, partner John Pickett agrees that the future status of regulatory frameworks is a key element in assessing any renewable project. "Change in the law is frankly the single most significant legal risk with a wind project, because such a large proportion of these projects revenues are dependent on the regulatory frameworks," he says. "And regulations are prone to change. Up until about six months ago changes in regulation were almost uniformly for the better across Europe as far as developers in the renewable energy sector are concerned. But in one or two countries such as Spain we are starting to see some attacks on the onshore wind sector, so this is an issue that is going to stay live."
Agencies say that if and when the tide does turn in a less favourable way for the wind sector, they will be looking to governments to honour any existing obligations through, for example, grandfathering of long term tariff agreements. In its update on the Alte Liebe windfarm securitisation, for example, S&P says that it expects "the existing regimes to be grandfathered should any changes in regulation be implemented".
Pickett says that the likelihood of grandfathering will vary from country to country, with some markets such as Germany probably more likely to offer legal protection to renewable energy producers than others.
But from a legal perspective in general, and with regard to grandfathering in particular, it is the Spanish market that is casting the longest shadow over the European renewables sector. A Royal Decree on renewable energy pricing structures has been published but yet not approved, and has been a source of considerable controversy in the Spanish market, largely because it seems probable that it will apply retroactively to existing wind and solar installations.
"Existing regulation has been very favourable to investment in the Spanish renewables sector, and it was taken for granted that any modification in the regulations would not apply retroactively," explains Maria Pilar Garcia, a senior associate at law firm Lovells in Madrid. "To change the rules in the middle of the match is considered by some players to be a dangerous precedent."
It is, however, important to keep the expected modification in Spanish regulation in context. As Garcia says, the planned modifications have been motivated by the regulators view that Spains tariff regulations have been perhaps excessively generous to developers in the renewable energy sphere. "Regulation in Spain has been so favourable that in some cases we have seen projects with over 90% debt to equity ratios which have given investors returns that have been considered too high by the regulator," says Garcia. "The government and Spanish legislation have been and still are promoting renewables, but they want to keep the returns within certain parameters."
Besides, as Garcia explains, the small print of the proposed change in regulation does not make huge differences to the pricing regime. Instead, it replaces a system in which developers tariffs are calculated on the basis of a percentage above an average market tariff (which in the case of some solar projects was as high as 450%) with one in which remuneration is fixed. "Even if the reference point is different, in practice we dont expect the amount in euros and cents to be much different," says Garcia.
The law also brings in positive modifications for the Spanish solar sector. Most significant, it does away with a system that restricted favourable tariffs to small projects with installed capacity of up to 100kW. That, says Garcia, merely encouraged developers to build multiple small facilities. Under the proposed new regulation, plants of up to 10MW are eligible for favourable tariffs up to a total for Spain as a whole of 371MW.
While the Spanish precedent suggests that the current regulatory environment supporting renewable energy should not be regarded, technically or legally, as a subsidy, nor should it be regarded as providing bondholders or lenders in windfarm projects with a quasi-government guarantee. "I think a lot of banks and other market participants have tended to look at the feed-in tariffs almost as a proxy for a government credit," says Pickett at Linklaters. "That is an optimistic way of looking at things because although most people assume that the licensed distribution companies are stable businesses that would not be allowed to go insolvent, there is always technically an insolvency risk associated with the privatised transmission and distribution companies."