EU Renewable Energy Infrastructure Market Report Q1 2017

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1 Introduction For the last 15 years Tom Murley, the principal of Two Lights Energy Advisors, has been an active investor in European Renewable Energy infrastructure. The Two Lights Energy Advisors Quarterly EU Renewable Energy Infrastructure draws on data, analysis and insights that Tom has prepared for private investors since If you have any questions or comments, please contact Tom Murley at: Two Lights Energy Advisors LLC UK: US: Overall EU renewable energy infrastructure investment Overall investment in the EU renewable energy projects fell 18% from Q and was down 60% from Q This was primarily due to no significant investment in new or existing offshore wind projects in Q1. UK offshore wind has been a mainstay of EU renewable energy project investment for the last two years. The data source is Bloomberg New Energy Finance, based on BNEF s Asset Finance segment in their database, and its three subsectors (i) New Build which broadly refers to debt and equity investments in greenfield projects, (ii) Mergers and Acquisitions which broadly refers to assets that have already been financed, and may include operating assets and assets still under construction as well as project development pipelines and (iii) Refinancing which is predominantly bank debt and some capital markets debt. Investment in EU clean energy by style by quarter Source: Bloomberg New Energy Finance Last quarter we forecast the fall in investment based on the following factors:

2 Southern and Eastern European investment levels remain low over concerns over regulatory stability and continuing macroeconomic weakness. UK investment in new renewable assets is falling with the non-retroactive reductions and withdrawal of renewable energy support, especially for solar and onshore wind. With the deadlines for new projects to qualify for support occurring in early 2017, most new investment has already been committed in the UK. Further, most offshore wind owners looking to sell down interests in operating assets to financial investors have done so, leaving little inventory for future sales. Low power and green certificate prices in the Nordics are making the economics of projects difficult, reducing investment flows. German investment in new assets is falling because, as previously reported, Germany is switching to an auction-based feed in tariff system, which is leading to uncertainty. As with prior reports for the last two years, the UK and Germany continue to account for the substantial majority of sector investment, accounting for 71% of Q1 investment and 64% of investment over the last 24 months. With the fall off in UK investment expected to continue (but for the sale of the UK Green Investment Bank discussed below), we can expect further decline in EU investment. Investment in EU clean energy by country by quarter Source: Bloomberg New Energy Finance We do not forecast a material growth in investment in new greenfield assets in the near term, driven by continued economic and political uncertainty driven by Brexit. Further, the EU is in the process of deciding how to support renewables in the time frame. Brussels announced its proposals for in November 2017 and were covered in our Q report.

3 Institutional equity investment in EU renewable energy projects Institutional equity investments in EU renewables rose rapidly from 2008 through As reported last quarter, the 2016 saw a slowdown in institutional activity, due mainly to the issues described above. did see strong institutional investment in EU renewable energy equity, equalling nearly 50% of 2016 investment in Q1 alone. This was due mostly to M&A activity of operating assets, particularly in UK operating wind and solar parks, which accounted for nearly 70% of Q1 institutional equity investment. Q2 is likely to see a high investment level, driven mostly by the sale of the UK Green Investment Bank by the UK Government to Macquarie Bank of Australia for $3 billion. This transaction, however, covers a mixed portfolio of debt, equity and fund investments. The project equity portion of the transaction is circa $1.8 billion. Outside of this transaction, we do not forecast a material uptick in Q2. Institutional equity investment in EU renewable energy projects by investor type ( millions) Source: Two Lights Energy Advisors, Asper Investment Management, HgCapital research

4 Institutional equity investment in EU renewable energy projects by country ( millions) Source: Two Lights Energy Advisors, Asper Investment Management, HgCapital research Institutional equity investment in EU renewable energy projects by project stage ( millions) Source: Two Lights Energy Advisors, Asper Investment Management, HgCapital research EU and National Regulatory Developments There were no material national or EU regulatory developments in Q1, but there is an update to the EU State Aid and Investor State Arbitrations discussed in the Q4 report. As previously reported, starting in 2010 Spain embarked on a series of retroactive changes to its renewable energy feedin-tariffs that dramatically reduced compensation for existing renewable energy projects. Those changes culminated in a complete replacement of FITs for all existing renewable projects in 2012 with a regulated asset base system. Similar retroactive changes followed in Bulgaria, The Czech Republic, Greece, Italy and Romania. Faced with local court systems that favour national governments, many investors turned to international arbitration under the Energy Charter Treaty (ECT) to recover their losses. There are now over 30 arbitrations pending under the

5 ECT against Spain, the Czech Republic and Italy, many from investors based in EU member states. The EU intervened in these arbitrations arguing that the arbitration panels have no jurisdiction over disputes between EU investors (mostly French, German and UK based funds and German utilities) and Spain, the Czech Republic and Italy. The arbitration tribunals have universally ruled that the ECT applies to intra-eu disputes. The EU has also started to use EU State Aid rules to challenge arbitrations, arguing positions adverse to investors interests and supporting countries that have made retroactive changes. In the 1990s and early 2000s very little thought was given to the interaction between EU renewable energy subsidies and State Aid. In fact, in 2001 the European Court of Justice (ECJ) ruled that the German FIT (on which many other FITs were modelled), was declared not to be State Aid, and therefore not subject to notification to and review by DG Competition. DG Competition sought to reverse this decision, which it finally achieved in 2013 with a new decision from the ECJ declaring all FITs to be State-Aid and reviewable by DG Competition. In between those decisions, over 200 billion in capital was invested in EU renewable energy projects in EU countries with FITs that were not notified to DG Competition such as Spain, Italy, France and Germany. Thus, investments in those and other countries are now subject to EU review, even though the EU was aware the investments were being made and were reliant on the subsidies. Most importantly, until the ECT Arbitrations had gained traction, the EU had not sought any review of existing unnotified schemes. Under EU State Aid law, the EU can review unnotified State Aid for up to 10 years after it is granted, and can order cancellation and repayment if the State Aid is determined by incompatible (e.g., excessive) under State Aid guidelines in effect at the time. However, under EU Law an investor cannot have a legitimate expectation in the continuation of no-notified or incompatible State Aid and these investors are now unprotected from intervention by the EU with respect to investments benefitting from FITs not notified to the EU, even if this was consistent with prior legal precedence. Aware of this, in 2014 the Czech Republic notified to the EC its 2004 FIT as modified by subsequent retroactive changes. Similarly, Spain notified its 2013 law which made retroactive changes to its FITS dating from , which is now under review by DG Competition. In February 2017 DG Competition issued a decision to the Czech Republic setting forth positions well-beyond the State Aid matters at issue and are clearly designed to help the Czech Republic avoid liability under the ECT claims against it. These include: The ECT does not apply to intra-eu disputes and that the EC will challenge awards at the ECJ All FITs not notified to DG Competition cannot give rise to legitimate investor expectations under the ECT, and therefore investors have no basis for claims that they would continue That any ECT awards based on losses suffered by EU investors from changes to unnotified FITs will be considered unnotified State Aid in and of itself and may not be enforced in the EU prior to approval by DG Competition As the positons regarding ECT arbitration were not necessary to making the State Aid rulings at issue in the Czech Republic decision, we believe that the goal of the EU is to provoke an appeal the ECJ, where the EU can litigate the applicability of the ECT to intra-eu disputes and whether ECT awards are State Aid. This issue now appears to be joined. On May 5, 2017 the panel in Eiser Infrastructure v. Kingdom of Spain, (regarding solar thermal investment) ruled that Spain s actions violated the fair and equitable treatment provision of the ECT and awarded Eiser Infrastructure 128 million in damages. Spain had won two previous victoires, but those were considered unrepresentative cases, the panels of lower quality and the investors not well represented. Given the Commision s position that arbitral awards are State Aid, Spain has notified the Eiser award to Brussels, who will now determine whether it is compatable aid a decision that could take over a year. We expect that the EU or Spain will seek to stay any enforcement of the award whilst that decision in pending. The implications of the EU position in the Czech case are troubling, as investors in countries that have still not notified their systems are at risk. But it also goes beyond renewable energy. The EU s new expansive reading of what

6 constitutes State Aid could be applied to any sector in which a government sets prices, such as gas and electric transmission and distribution tariffs which are not routinely notified to Brussels. Further the 10-year limit appears to have limited effect. The EU seems to be taking the position that under FITs the aid is not from when the FIT was passed, but when it was paid. As FITs run for more than 10 years this means that there is a continual look back potential by the EU. With this emerging position investors in regulated EU infrastructure should carefully evaluate to what extent their investments may be subject to later review by the EU under State Aid guidelines. EU and Global Energy Markets, Utilities and Power Prices The previous discussed trends namely low oil and gas prices, weak energy demand and falling renewables costs continue to shape the energy landscape. The falling costs of renewables, and falling investor return requirements have meant that the investment pace has continued, but with sustained low prices, and new expert forecasts that show a continuing low price environment, means that greenfield asset investment is falling. For some commentators, we have entered an ear of energy abundance, which is marked contrast to the perceived age of scarcity that characterized most energy outlooks since the 1970 oil embargoes. The age of abundance is driven by (i) fracking, which opens vast new reserves to exploration and offers extraction costs below other options, such as the Arctic Ocean and oils sands, and (ii) rapidly falling renewable energy costs, especially wind and solar, as the technology improves and the industry scales up. The implications of this are continued pricing pressure. For example, if oil and gas prices rise, fracking rigs can be deployed rapidly, bringing additional supply to market, pushing prices back down. Similarly, with falling solar and wind prices, in many markets below the cost of coal and in some markets below the cost of gas, and their ability to be installed more rapidly than conventional power plants, means supply imbalances can be addressed faster at lower cost, holding prices down. This continues pricing pressure, for which we see no respite, means that wholesale power prices in most EU markets, and indeed in many OECD markets, will remain low, depressing utility valuations, and share prices. It also has implications for investors in new assets. Most new power generation project investments are based on contracted or tariff-based revenues for There have been no material developments since the Q3 report, and the overall trends outlined in that report remain in place. Two developments of note that may be worth following: In September, E.On completed the spinout of ifs conventional power generation and trading business (often referred to as the bad bank, remained Uniper. Since the September listing Uniper has traded up about 40% from the IPO price. E.On itself, which is the networks, customer and renewables business has traded down 30% since the spinout; not the result that was expected. With the Brexit vote, the Euro, but especially the UK pound, have fallen against the USD. With oil and gas generally priced in USD, this means that oil and gas prices are rising in the EU and the UK. With its heavy reliance on gas fired generation, the UK is beginning to see some electricity price inflation. Whether this portends the start of an upward trend in EU power prices remains to be seen, and we will watch the trends and report more in the coming quarters. Competition, Deal Flow and Banking Markets The bank project finance market continues to become more attractive for borrowers. Banks have fully moved away from mini-perm structures in most markets, returning to the traditional 15+year amortising loan market. For highly regarded markets Germany, France, UK, Finland and Ireland, there is more lending interest than there are deals. As a result, lending terms are shifting further in favour of the borrowers months ago, lending margins were still in the range of 300 basis points over LIBOR or EURIBOR; margins are now in the range of 200 basis points, and could decrease further. In addition, the ECB decided to charge banks to keep money on deposit, after a faltering recovery in Europe led to a fall in market rates, with 10-year LIBOR swap rates now below 1%. This makes for some of the lowest borrowing costs

7 ever for renewables in particular and infrastructure in general. Conversely, this has substantially increased the costs of refinancing existing projects, where the interest rate swap break-costs have increased materially. As noted above, investor appetite for cash yielding assets, especially lower-geared infrastructure assets, remains strong, with Yieldcos being the principal buyers of assets. Consistent with the downward investment trend in EU renewables, overall EU deal flow is down. Competition for deals is more intense than ever in stable attractive countries with feedin tariffs or long-term contracts (Germany, UK, Ireland, and France). The renewables sector is at a turning point. We are on the cusp of the most established technologies onshore wind and ground-mounted PV becoming fully cost-competitive with conventional power in developed markets. In emerging markets they are often already the lowest cost new generation option. Europe has been a leader in driving that cost reduction, but that leadership also means that Europe is still bearing the costs from more expensive, earlier technology that is still in operation. This cost burden comes at a time when European power demand is flat or falling and renewables penetration has drastically reduced the difference between peak and off-peak power pricing. The result of this has been falling wholesale power prices but rising consumer and SME energy costs. The falling wholesale power prices hurt utilities profits and valuations, while the rising consumer and SME prices create political concerns about consumer affordability and competitiveness. This is playing out against a political backdrop of the EU seeking more central control over energy policy while member states seek to protect their utilities, consumers and businesses with varying national policies. What does this mean for investors and asset owners? Tread carefully and focus on least cost renewables and diversification by market, jurisdiction and technology (including heat). It also means be careful with development pipelines both in quality and timeframes. Pipelines need to focus on deliverability of projects both today and in a lower cost future, and development spend needs to be minimized. It also means taking advantage of the low interest rate environment, but also being prudent in terms of avoiding excess gearing, appropriate hedging and break cost exposure that could affect yield or hinder exit.