Is 2016 a game changer for renewable investment?

Is 2016 a game changer for renewable investment? Presentation at the by Matt Rennie, EY 4 October 2016

Matt Rennie EY Oceania Power and Utilities leader, EY Global Leader Transactions, Power and Utilities EY Global Leader, Energy Reform Page 2

Biography Direct Tel +61 (0)7 3011 3239 Mobile +61 (0) 439 670 765 Matt Rennie Email matthew.renie@au.ey.com EY Oceania Power and Utilities leader EY Global Leader Transactions, Power and Utilities EY Global Leader, Energy Reform Matt is a global energy advisor, having held a number of very senior positions in the energy sector over the past 20 years. Matt is currently the Global Transactions Leader for EY s Power and Utilities business, and leads the firm s Global Energy Reform and Unbundling offering. These positions involve working closely with Governments, new entrants, incumbent utilities and regulators in a number of countries around the world, including Africa, Mexico, the United Kingdom, Oceania, the Middle East, Japan, Korea, China, and Europe. Matt has also served as the Leader of the Oceania Power and Utilities business for the last five years and is well known in the global energy community as a regular commentator in the media and contributor to industry thought leadership through his monthly energy sector blogs. Matt s expertise lies in market design and economic regulation. He has been a member of Government expert panels examining market design and regulatory models. Matt has authored a large number of reports and thought leadership over the past several years, including EY s quarterly Power Transactions and Trends, six-monthly Power and Utilities Capital Confidence Barometer, six-monthly Renewable Energy Industry Country Attractiveness Index, and various reports on the markets in Japan, Mexico, and Australia. Matt has also authored reports for the OECD on market design and competition. Matt holds a Masters degree in Economics (research), a Graduate Diploma in Applied Finance, and a Bachelor Degree in Economics. He is also a visiting Fellow of the Economics School, Charles Darwin University in Australia. Page 3

Is 2016 a game changer for renewable investment? Page 4

Global power transaction trends are driving investment in energy A growing deal imbalance globally is increasing the demand for investment in renewable energy 1 2 Electrification in emerging markets Energy demand continues to increase in emerging markets such as Africa, Middle East, India, South America and South East Asia. Significant investment is required to provide sufficient generation capacity to fuel economic growth. Sub-Saharan Africa, Vietnam and Indonesia together require around 90 GW of new capacity over the next decade to meet targets, attracting interest from investors. Energy reform and unbundling Energy reform has emerged as one of the biggest drivers of P&U M&A across the globe as governments open up their energy markets to competition. Market reform and privatization processes are occurring in a number of global markets including Mexico, Japan, Eastern Europe, the Middle East, Africa, India and Asia-Pacific. Foreign and private investors are rapidly increasing their exposure in such markets. 3 4 5 Disruption and sector convergence Expansion in distributed generation, such as solar PV and battery storage, is disrupting traditional utility business models. Smart technology, telecommunications and data analytics are being used to optimize energy delivery and enhance customer experiences. New entrants have begun to offer customers innovative, behind the meter products and services, and utilities are acquiring new capability or partnering with telecommunications and technology providers. Consolidation and diversification of portfolios Weaker demand, lower electricity prices, global financial uncertainly and debt levels are continuing to drive consolidation and diversification of portfolios in markets, including Europe and North America. 2015 and Q1 2016 has seen a number of mega-mergers in the United States driven by strong market interest in stable, regulated gas and electricity assets. Valuation multiples for these assets remain high. Utilities in Europe are disposing of non-core assets to improve balance sheets, and diversifying into new markets and technologies to drive sustainable growth. A number of large utilities, such as E.ON and RWE, are restructuring and optimizing their business models and portfolios. Deal imbalance driving funds towards renewable and regulated assets A growing deal imbalance leading to increasing competition to acquire a tightly held pool of power and utilities assets. Amid low wholesale prices in a number of regions, more companies and financial investors are keen to diversify operations and deploy capital to an increasingly competitive pool of P&U assets particularly regulated network assets, stable retail operations, and long-term power purchase agreement (PPA) backed renewable energy deals. Demand for greenfield, long-term PPA (preferably sovereign backed) renewables projects is resulting in competitively low auction bids. A bid of USD 29.1 per MWh in Chile s power supply auction last month was considered the lowest for solar power globally up until bids were received in Abu Dhabi where an Asian consortium has placed a bid to build a solar power complex of 1,170 MW for only USD 23 per MWh. Source: EY analysis Page 5

The renewable energy sector is offering differentiated yields to project investors Emerging economies are providing a new supply of projects often with higher investment returns The relative maturity of the European solar markets means there are proportionally less projects with high returns in the market. On the other hand, the combination of opportunity and risk are driving higher investment returns for solar in emerging markets, such as Africa and South America. Average Unlevered IRR (%), solar Europe North America 4% 8.2% South America Africa 9.3% 10.3% Middle East 10.4% Asia 8.4% Australia 7.3% In addition to the opportunities created by a growing demand for electricity and associated infrastructure, favourable natural resources and policy support in key developing countries, there are several risks associated with renewable energy projects in developing countries, which are reflected in the higher investment returns: Higher sovereign credit, political and regulatory risk than in more established infrastructure investment markets Greater exposure to economic shocks as reflected in foreign exchange rate risk and inflation Lack of liquidity in financial markets. Few countries have liquid local currency markets a precondition for solely domestic local currency project financing For many developing countries with less established renewable energy programmes, local currency funding will not be an option and funding in USD or EUR will be more likely. Source: Mercatus Energy Investment Management (EIM) Platform Data, 2016 Page 6

Australian market fundamentals are in place to support increased renewable investment RET certainty and a growing project pipeline suggests that Australia s 2020 target is within reach 1 Certainty around RET drives project investment 2 Development pipeline suggests 2020 target is within reach In recent years, investment in renewable projects has been hampered by political uncertainty around the RET, but now the policy environment surrounding the RET has stabilised. The RET creates demand for LGCs, requiring around 6,000 MW of new renewable capacity by 2020. Federal bipartisan agreement on the target in mid-2015 contributed to A$1.2 billion being invested last year. Solar joins wind in the mix CER expects that 6,000 MW will be approximately 25% solar and 75% wind. Currently there is 9,000 MW of large-scale renewable projects with development approvals. Reaching the target depends on projects reaching financial close during 2016 and 2017 and proceeding to construction in time for the 2020 target to be delivered. The following may contribute towards the industry efforts to meet the RET: Pricing The combination of the high LGC spot price (recently seen at AUD $85.50 per certificate) and the average wholesale market price of electricity appears to make new build projects financially viable. Viable solar Falling costs is building financiers confidence in new largescale solar projects as it approaches parity with wind projects. 2015 fuel source of accredited large-scale generation projects by MW (Source: Clean Energy Regulator) Historical levelised cost of energy for Australian large-scale solar Page 7

Already there are signs that the market responding Numerous procurement processes focused on renewable projects are underway or in planning phases 3 Momentum grows for the next wave of development Procurement processes around Australia Since June 2015, around 760 MW of large-scale renewable energy capacity has been committed or started construction. The shortening runway creates a window of opportunity for developers to benefit before the RET ends in 2030. Already, we can see signs of the market responding with new investment funds emerging, greenfield project PPAs being struck and interest from corporates. These activities have a potential to create confidence in the market s ability to meet the RET, providing alternative offtake arrangements and increasing liquidity in financing markets. Procurement processes around Australia Page 8

However, transaction activity in Australia remains low Transaction activity remains below the levels achieved immediately before the Government s review of the RET scheme Total new clean energy investment in Australia (USD $m) Page 9

Coordinated interaction between project sponsors, debt providers and energy retailers is key These parties often have mismatched expectations, priorities and motivations Key commercial participants Page 10

Market participants revealed four main constraints hampering investment funding in renewable projects Project term, RET policy stability, debt requirements and LGC prices were identified as the top constraints Term Mismatch between different parties expectations of the term is arguably one of the most significant financing hurdles in the renewable energy market The longevity of the RET and policy stability Participants remain cautious about the stability of policy, which affects the way risk is allocated in contractual arrangements Debt sizing requirements and balance sheet treatment Ability to secure sufficient debt capital depends on the lender s view of the project s risk profile, which can be affected by exposure to merchant spot price volatility and the offtaker s credit rating Retailer LGC acquisition strategy Demand for PPAs depends on the relative cost of acquiring LGCs under those PPAs versus transacting in the LGC spot market Page 11

Market participants are working to overcome constraints by using various financing innovations These innovations may support the financing of large-scale renewable energy projects in Australia Financing opportunities and innovations Term Longevity of RET Debt sizing requirements by banks Retailer LGC acquisition strategy Description Corporate support structures Purchasing power directly from an off-site project Direct equity investment in an offsite project Energy purchased from an on-site or adjacent project Aggregate procurement models These innovations offer the greatest potential for the market to overcome key financing constraints. By offering an alternative to the traditional retailer-led PPA, they could provide further liquidity in the PPA market, giving financiers the certainty they need to deploy their capital. Merchant financing Financial instruments for managing merchant risk: Synthetic PPAs Insurance and hedging products to mitigate price and volume variability Some overseas markets have developed hedging and financial products in response to a shortage of longer-term bankable offtake agreements. These products help project sponsors to achieve price certainty over the project cash flows, supporting their efforts to raise finance. Export credit Utilising debt capital markets These innovations are very focused on the debt market and as such offer some benefits to parties seeking finance. The limiting factor for these innovations is their reliance on an offtake agreement. Attracting new types of equity investors Accepting key risks such as RET risk and merchant risk offers investors real opportunities to advance their projects; however, as has been noted by many market consultation participants, these remain key obstacles for many investment committees. Page 12

Corporate support structures Large corporates are emerging as a driving force for developing renewable energy projects around the world Corporates are looking to access energy from renewable projects as a means to: increase energy efficiency and security, improve energy price predictability. 2 Direct equity investment in an offsite project Corporate support structures has the potential to address all four major financing constraints identified. In 2015, approximately 1.6 GW was contracted by corporates in the US. There are three different approaches for corporates accessing energy from renewable projects as follows: 1 Purchasing power directly from an off-site project 3 Energy purchased from an on-site or adjacent project Page 13

Aggregate procurement models Aggregate procurement models enable several energy buyers or end users to combine their energy procurement into one transaction Large buyers with good credit ratings who act as anchor buyers, make financial institutions more comfortable and can result in reduced financing costs for the project. The benefits of aggregation can be best achieved with a handful of large buyers (whose aggregate demand is at least 1 GWh /annum). This means that, even if a large buyer pulls out of the project, the rest of the buyers can purchase the left over power, reducing financial risk. Current model for small-scale users Aggregate procurement model Page 14

Merchant financing In lieu of long-term PPAs, a few Australian projects have already used merchant financing in various forms to capture first mover advantage Capturing first mover advantages Three approaches to merchant financing Financing projects with a partial merchant exposure Financing over entire capital amortisation profile Projects financed on a merchant basis and secured a PPA with an energy retailer once the project has been constructed. This approach requires a higher level of equity in the initial capital structure, but can improve the project sponsor s negotiating position with energy retailers by having a project that is ready to supply LGCs and power. On signing a PPA with a retailer, the project sponsor can typically refinance and increase the amount of gearing in the capital structure of the project to improve equity returns. Some projects can obtain financing despite constraints in offtake volume using a commercial structure that requires the project sponsor to retain some exposure to merchant price volatility. Some financiers are willing to take some merchant price exposure against their amortisation profile. Restrictions on the volume of debt lent to un-contracted revenue mean the additional risk is ultimately borne by equity financiers. In other cases, project sponsors have managed to raise sufficient capital to fund construction where financiers have been willing to provide capital despite shorter (e.g. 5-7 years) offtake contracts. Unlike their counterparts in other markets, Australian project sponsors rarely raise finance with a view to exposing the entire amortisation profile of the finance raised to merchant price volatility. Feedback from market consultations suggests that equity returns are too low for projects that have a reduced level of gearing such as these. Some participants also believe the expected demand for LGCs will enable future merchant projects to take advantage of a combined LGC spot price and wholesale spot electricity price that may offer better prospects for higher returns. Page 15

Thank you Questions? Page 16

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