Crunch time for UK renewables

• Cumulative peak funding of £10 billion (about R114.6 billion) required by offshore wind developers by 2015;
  
• Current funding gap for offshore wind means UK would not achieve renewable target by 2020;
  
• Market reforms and capital structures outlined to attract pensions and life assurance funding.

New analysis by PwC shows the UK will miss its 2020 renewable energy targets unless a 'quantum leap' in offshore wind capacity investment is achieved, with reforms to the energy markets to attract pensions and life assurance funding.

Offshore wind plays a make-or-break role in the UK's renewable energy strategy. It is targeted with delivering around half of the additional 27GW generation capacity required to meet the UK's 30% renewable generation target by 2020. Last year, less than half the average annual roll out rate of 1.1GW needed to meet the 2020 target was achieved.

Developers will face a peak cumulative funding need of up to £10bn per annum to achieve the annual roll out rate needed to meet the target, assuming limited project finance is available during the construction stage.

It's make or break

Michael Hurley, global energy and utilities advisory leader, PricewaterhouseCoopers LLP said: "Offshore wind plays a make or break role in the UK's ability to hit its energy targets and time is running out very quickly on our ability to achieve them.

"The required roll out rate to achieve the 2020 targets is being hampered by the scarcity of pre-construction finance. We need to dismantle the barrier to investment by creating mechanisms to either limit the risk associated with the construction phase or to improve short term returns, without unduly pushing excess costs on to the consumer."

"If the construction and technology risks could be underwritten or transferred, this would open up offshore wind to pension and life company investors."

Meeting the 2020 renewable energy targets - Filling the offshore wind financing gap puts forward proposals to resolve pre construction financing issues in the sector. Reducing risk or improving returns for investors in offshore wind projects would attract more pensions and life assurance funding to the sector.

Implications: Four solutions

PwC examined the capital structure and market implications of four potential solutions, including the potential role of the Green Investment Bank:

1. Underwriting risk through a consumer levy: reducing construction and technology risks.
2. A regulated asset scheme: reducing construction, technology and price/volume risks.
3. Additional Renewable Obligation Certificates (ROCs) for a limited period: increasing short term returns for investors.
4. ISA bonds or equity funds: increasing short term returns for investors.

Solutions three and four focus on increasing the return on investment in the short term (the first few years of operation) to attract private investors who would seek a higher return in order to accept the risks associated with the construction phase, such as private equity houses, hedge funds and individuals.

PwC's analysis of possible capital structures demonstrated an important role for the Green Investment Bank in bridging the funding gap, if focused solely on the highest risk loan elements in the construction process.

A low-risk investor such as a pension fund could be attracted to a regulated asset regime for example, by participating as financier of the pre-construction phase of the project, with capped liabilities for cost over-runs, with the option of remaining as an investor for the duration of the asset life. Once the wind farm has demonstrated operational stability after an agreed period of operation, it would be auctioned off, and the finance arrangement would roll over to the operator acquiring the asset.

Hurley continues: "The stable and predictable annual cash flows of infrastructure investments are attractive to pension and life - companies provided that the construction risk is understood and steps taken to either insure or transfer it. They could provide finance for the 20 years plus duration of the project, providing an end - to end solution that avoids the uncertainty and cost of having a bridging finance solution."

Currently, with limited availability of project finance or new sources of equity, the lion's share of development is expected to come from big utilities companies. Yet analysis by PwC for the report shows that against an average £17bn per annum investment needed across the whole energy sector to 2020, the current combined capital expenditure of the six largest utility companies and National Grid in the UK was less than half the level in 2009.

Ronan O'Regan, director, renewables and clean technology, PricewaterhouseCoopers LLP said: "It would be highly risky for the UK to think it can plan for a significant increase in roll out towards the second half of the decade to reach the target once a recovery is in place, particularly if the targets were revised upwards in the interim, and given the reliance on a smooth supply chain, planning consent and grid access."

The report found that current incentive mechanisms, in the form of ROCs and the carbon price, even with a floor, while important, were unlikely to address the specific challenge of offshore pre construction financing alone. Using these incentives on their own to boost investment would also run the risk of pushing excessive cost onto the consumer warns the report.

Notes

1. The Green Investment Bank Commission report released in June, called for urgent action to unlock low carbon investment in the UK, describing the scale of investment required to meet UK climate change and renewable energy targets as "unprecedented", saying "market failures and investment barriers" particularly in attracting institutional investors, meant that without intervention, the UK's low carbon targets will not be achieved.
2. To meet a total renewable output of 103TWh by 2020, approximately 27GW of renewable capacity needs to be developed in addition to the current level of around 8GW. The strategy to develop this will depend heavily on wind generation. The split between offshore and onshore wind generation capacity is fairly equal, based on OFGEM's 'green stimulus' scenario (2009), with 12GW of offshore wind, and 11GW of onshore wind.