Wednesday, 3 February 2010

EIB energy head interviewed

Christopher Knowles is head of energy, environment and investment funds at the European Investment Bank. EIB has emerged as a major provider of project finance to the renewable energy sector, committing Euro6bn in 2009. Deals included the underwriting of Belwind's 330MW offshore wind development off the Belgian coast, the first time that EIB has assumed project finance risk for such a venture.

I interviewed Knowles in December, as part of my research for a feature on renewables project finance for Envirotech & Clean Energy Investor magazine. Although the focus is on project finance rather than venture capital, I thought the interview would be of interest to Clean Ventures readers, so herre present a complete transcript of the telephone interview.

For the full story on renewables project finance, including comments from a range of international developers, investors and advisors, see my article in the February 2010 edition of the magazine.

How does EIB approach renewable energy project finance - do you look to make a commercial return, or are you driven by policy aims?

"We are an institution of EU policy. We use the phrase 'policy-driven bank' to describe ourselves. The policy drivers are all European policy drivers formulated by the European Commission. We have policy drivers in the transport sector and social sectors, and these days, some of the crucial policy drivers are in the environmental and energy sectors. Also with the economic crisis, there's been an objective to put together stimulus policies.
"We run our lending on a three-year rolling corporate plan which takes these different policies and translates them into quantitative and qualitative indicators, which is what we then try to achieve. It's a normal corporate planning process.
"We will not do anything which isn't ticking the right boxes for us in policy terms. That also means that we may be presented with a project that looks fabulous in commercial terms, but we won't do it if it's not ticking the boxes. It's fair to say we're primarily guided by policy, and as a secondary consideration we start looking to more commercial things. We're very rigid on environmental considerations, and would certainly expect our customers to be law-abiding EU citizens.
"Up to September 2008, we were essentially operating a policy of managed growth. Our shareholders told us they didn't want us to come back to them for more capital to finance growth. Any additional capital, we have to generate ourselves. This led us to adopt a policy of managed growth where, taking into account all the same regional development policies, we were basically operating a policy of slow growth in the older parts of Europe. With the collapse of the financial markets, our shareholders said: 'Forget about managed growth, we need you to start helping us to douse the fires of recession. Increase your lending as fast as you can.'
"What that meant was that, in three months, we were asked to revise our lending quantitative targets from a steady state of around Euro50bn/a to around Euro70bn/a, which is what we think we will achieve this year [2009]. We have in the last year increased our lending by 40%, which is quite an achievement.
"In the energy sector, we have for some time now targeted renewables as a focus sector. We have, from 2006 to now, basically increased our lending to renewables by a factor of six, from Euro500m in 2006 to cEuro3bn this year. We don't have an absolute target for lending for renewables. Currently our target is renewables should be not less than 20% of total lending for the energy sector.
"We've had this growth in renewables lending which has exceeded even our total lending."

What is your typical lending arrangement or structure?

"We do all sorts of things. We can lend simply to the public sector, we can lend to the private sector, or to some mix of the two. We can lend on people's balance sheets, or off. We're relatively lightly staffed which means that we're in some sense a wholesaler. One of the consequences of that we don't particularly like, but it's not possible for us to get directly involved in large numbers of small projects. We have to focus on doing a small number of largish transactions.
"We have a number of structures that allow us to support small projects on an indirect basis. A popular product is the global loan which is basically a line of credit. About 30% of our lending is lines of credit which we put out to banks operating on a regional or national basis, which basically provides them with liquidity for use in certain types of activity. In this way, we influence the lending of the bank."

Is that the structure you're using to support UK windfarms? [In November 2009, the EIB provided £700m to support UK onshore windfarms, with match funding from RBS, Lloyds and BNP Paribas.]

"It's very similar. We operate something called a framework loan. It's fully intermediated on risk by the local banks. The UK one does have an obligation. When we lend, we like to say we're advantageously priced. We're one of the few AAA-rated institutions in the capital markets at the moment, so we can access money at very modest terms. We make a modest return that leaves us with a loan interest rate which we like to pass on to the people actually investing in the asset, rather than leave it with middlemen. It's a stimulus to them as well - that's another difference.
"A third difference is these framework loans can be used in comparatively big investments, sometimes over Euro50m. When that's the case, we exercise a little bit of decision-making control with a trusted intermediary.
"Another thing we started doing is to become an investor in renewables equity funds, providing third-party equity to investors. We're basically assuming an equity risk. This isn't something we would have done a few years ago."

What rates do you offer?

"It varies according to the level of risk. For example, the three banks in the UK are quite low risk. We borrow money from the markets so we know what we pay to get hold of it, and we know our overhead is about 13bp and simply add that on, and that's what the customer gets it for. That's the risk-free scenario.
"At the other end, we have the case of lending on risk to something like Belwind. That's partly guaranteed by the Danish export credit, but the other half was on risk. That's a considerable risk because the risk starts during construction, and construction of offshore windfarms is still as much an artform as a science. The margins there are clearly much higher. The commercial margins at the time were around 300bp, which is high. They have since come down to something resembling normality. We were not up there with the others. We were typically in a project finance transaction bringing a financing advantage of 50-100bp.
"There was a time when commercial lenders didn't welcome that because they said it was putting pressure on their margins. But we don't compete on price. We have a very mechanistic process for setting price. It's not an opportunistic thing."

Developers I've spoken to say the current commercial rate is around 250bp and up - is that right?

"Maybe closer to 200 on less risk than offshore, such as PV farms with a good feed-in tariff and government support. You're basically talking about sovereign risk."

What demand you seeing from renewables developers?

"Stratospheric. There are several drivers. The positive drivers are the fact that most governments in Europe have put their weight behind the development of renewables - Germany, Spain, Belgium and France have got rather solid policies in place for some years, and those are countries where we've been very busy. In the UK, it's only now that the volume of investment is beginning to rise.
"The negative driver is the problem of the credit markets. All of a sudden, we've had this dramatic reduction of capacity in the finance markets, and the number of people active in project finance dropped from about 60 to 30 among European banks. Globally, the money there was then halved.
"Under these circumstances, people started looking under all the stones to see where they might find a bit of credit. Because we have substantially increased our volume in the renewables sector, which is a policy-driven thing, people have become more aware that we are anxious to be active in this space. There's been an increase in awareness that's seen a big increase in approaches to us.
"People have also seen a broader appetite on our part. People have traditionally associated the EIB with being a bit old-fashioned and conservative and wanting to be fully risk-intermediated, but they've seen with Belwind that we can take a serious project risk onto our balance sheet. In the case of Belwind, we provided half the financing on a risk basis, half on guaranteed basis. We provided 50% of liquidity on a pretty large offshore windfarm - there's probably no one else around who could have done that. It's a result of that that we've picked up a couple of very flattering industry awards."

What factors make a project attractive for you?

"It's generally the policy compliance, the extent to which it fits in with what we look for in policy terms. That covers the totality of the renewables space. We're particularly keen on helping new technologies come through. The rationale is to help those technologies come down the cost curve.
"Today we've only got two industries we would consider as mature in cost terms - onshore wind and biomass. Those two probably have come down as low as they're going to get, and if they're ever going to be competitive it should be now. By the time we've made an allowance for CO2 benefits - we do apply a shadow carbon price to help us deal with that [of Euro25-30/t] - I would say those are competitive. Even PV, and solar thermal and all the marine technologies, are another matter - we're very keen to also get involved with projects and developing those new technologies and help them come down the cost curve to the point where they can be mainstream as part of a utility's asset mix.
"Another example is CCS. It's fossil fuels, but unless you're a very hardline militant ecologist, you'll realise we're not able to complete jettison fossil fuel generation.
"Because we're policy driven, even if a project is commercially attractive - for example, Italy has an extremely generous feed-in tariff at the moment - sometimes we look at a project, say an onshore windfarm where these days the economics are mature and it should be competitive, but not all windfarms are. We would say it's not economic but the investment is still being encouraged because the FIT is so generous. We would say onshore wind needs to be economic in the economic sense of the word, not just the commercial sense. If utilisation is too low, we would not support that project. We have a rule of thumb that mature technologies should produce electricity at a levelised cost over the lifetime of the project of Euro96/MWh. When you compare that to a coal plant with Euro50-60/MWh, that leaves a lot of space in.
"We've been quite cagey about biofuels. We've seen about 80 projects and got into two of them. Where they've got a role to play, the economics and interactions with the food sector need to be understood. Second generation biofuels may make more sense."

Is the renewables sector becoming more attractive to commercial lenders?

"Project finance is always attractive if the price is right. The problem hasn't been lack of interested lending institutions, so much as their inability to direct if they had no capacity to lend. They had two problems, with shortage of liquidity and their risk-bearing capacity. In both those respects, they're beginning to see the way forwards a bit more clearly, and are beginning to come back into the credit markets. Some won't be coming back, but those who did know what they were doing but were staying down for reasons on liquidity or risk capacity are more able to venture forwards.
"We never do the totality of a project. We never do more than half of total costs, and if it's on a project finance basis we'll only do half the debt. The balance is from a commercial lender alongside us."

Do you expect any changes or new trends in the coming year?

"We could begin to see a return to normality, but the normality we're going to return to is not the normality of 2007. There was clearly a bubble in the process of bursting, and we saw some complex transactions and crazy pricing.
"The normality we'll go back to may be that of three or four years ago, before the bubble got to grips. You're not going to see equity-debt ratios of 10-90, it'll be 15-85 or 20-80. You're not looking at crazy margins of the ridiculously low levels we've seen. They'll remain at a level lower than today, but the pure risk margin closer to something we were seeing three or four years ago.
"Commercial lenders under competitive pressure were going up to 18 or 20 year tenors. I don't expect to be seeing that for certain projects. You're looking at normal commercial lending tenors of 10 or 12 years. At the moment you're doing well if you can get six or seven years out of them."

What do you hope to see come out of Copenhagen? [The UN COP15 conference was ongoing at the time.]

"I hope the world makes use of institutions like the EIB. We're the biggest, and it's important people use that capacity to leverage taxpayers' money, which is going to be a scarce commodity. We also need to use the capacity in these organisations. What I want to avoid is losing the time of creating new institutions."

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