The Challenges of European Energy Infrastructure Finance

By Nicholas Newman
Contributing Author, Cornerstone

Energy infrastructure construction is expected to “take off” and undergo rapid growth in coming years. The world’s demand for global energy infrastructure investments is projected to reach some €421.14 billion in each year to 2030, of which 60% will be spent on electricity. Power generation as a whole will account for 46% and the remainder will be spread between transmission and distribution, according to the International Energy Agency.1 Despite the European aspiration to decarbonize the power sector, coal-based power generation is increasing with some 1200 coal-fired power plants planned to be built in 59 countries.

European Energy Infrastructure

A nuclear power plant at Grafenrheinfeld, Germany.
Source: Christian VisualBeo Horvat

There are many drivers of power infrastructure investment in Europe, chief of which is the commitment to decarbonize the electricity sector by 2030, although this objective is being undermined by the “dash for coal” which is widely available and whose price in relation to gas has crashed. Equally important is the state of the EU’s energy infrastructure which is aging and is unable to match future demand for energy, ensure security and diversity of energy supply, or support large-scale deployment of energy from renewables such as wind and solar. It is this factor that makes upgrading of the existing network and the development of new, intelligent, energy transmission imperative.  In Europe, with its aging power generation and distribution infrastructure, power utilities will need to spend an estimated €1 trillion by 2020 on new infrastructure to secure and maintain power supplies. Out of this total sum €750 billion is needed for power generation alone, €90 billion for transmission lines, and at least €150 billion to expand gas supplies and build new pipelines.2

European Energy Infrastructure Investment Projects

Despite the EU’s environmental policies, Europe is planning 69 new coal power plants with a capacity of 60 GW, reports the World Resources Institute.3 Germany, notwithstanding the emissions trading scheme, plans to invest in 26 new coal-fired power plants to compensate for its sudden decision to phase out its nuclear power capacity. In Britain, there are applications to construct 4.9 GW of gas-generating capacity between now and 2020, according to government figures. In Europe, according to the World Nuclear Association, as of March 2013, some 23 nuclear power plants are at various stages of development, of which 10, with a total generating capacity of 9.2 GW, are destined for Russia.4

European investment to upgrade its energy distribution networks is a prerequisite for the creation of a single European energy market for gas, oil, and electricity to overcome the current capacity issues and to allow cross-border energy trading. To facilitate ease of power-switching across Europe the Pike Research “Smart Grids in Europe” report5 of 2011 forecasts that, during the period from 2010 to 2020, cumulative European investment in smart-grid technologies will reach €61.48 billion. This “clean-tech market” firm anticipates that smart-grid revenue in Europe will peak at €7.5 billion in 2017 before declining somewhat to €6.97 billion by 2020.

At present, the European transmission grid for gas and electricity is incomplete. The plan to build three North-South power “autobahns,” or power corridors, to ship electricity from the North is well behind schedule. Furthermore, the grid is unready to absorb increasing energy from renewable sources, thus necessitating additional storage facilities; to obtain further improvements in integration, interconnectors are required to link the Baltic States with mainland Europe. Refurbishing, extending, and upgrading of existing transmission lines alongside the development of new energy transmission infrastructure will require investments of some €140 billion in electricity and at least €70 billion for gas by 2020.

The European Network of Transmission Operators for Electricity has outlined the total expected investment requirement for projects of pan-European significance by country to 2022. Under this scheme, Germany is required to invest €30.1 billion, Britain €19 billion, France €8.18 billion, Italy €7.1 billion, Norway €6.5 billion, and Spain €4.8 billion. The National Grid, which operates the high-voltage electricity transmission network in the UK, is required to invest £1 billion in additional North-South grid capacity in a new sub-sea power cable to link wind farms along the west of Scotland with Liverpool in England. This interconnector will be the longest 2200-MW capacity HVDC (high-voltage direct current) cable in the world.

Sources of Finance

The two traditional providers of infrastructure project finance lending, governments and banks, are under severe financial constraints at a time when worldwide demand for capital to fund ambitious energy infrastructure modernization and expansion plans is increasing. Banks, which provide about two-thirds of global project finance, are being required by energy policy makers and energy companies to raise their capital ratios at the end of 2013. At the same time, deep-rooted solvency issues will restrict lending and raise the cost of their loans. Western governments, especially European, have already cut subsidies, introduced tariff cuts, and are unlikely to maintain the level of support for energy projects provided in previous years.

European Energy Infrastructure 2

Map of the nuclear power plants in Germany shut down since the Fukishima disaster (shut down reactors are in red, operating reactors are in blue). Credit: Kernkraftwerke in Deutschland.svg: Lencer

Nevertheless, EU agencies such as the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB) will continue their support of Europe’s mega-infrastructure projects alongside sovereign wealth funds such as that of Norway and perhaps Russia. Given the scale of the demand for funds and the difficulties of traditional suppliers of finance, a shortfall in funding is inevitable. Europe is facing a €1 trillion shortfall in its energy network investment requirement over the next decade, according to a UK House of Lords Report6 released in May.

Funding the Gap

While capital market funding of infrastructure projects in Europe remains underdeveloped compared with America, Australia, and Canada, private equity investment, hedge funds, institutional  investors,  and  specialist  infrastructure  funds will  contribute  toward  lessening  the  funding  gap,  since “infrastructure lending has become a mainstream asset class”.7 However, it is estimated that institutional investors will provide only about 10% of the €200.59 billion of project financing to be raised in 2013 in Europe.8 Lack of a clear policy within the EU and its member states on how to deliver secure energy and decarbonize power is holding back investment and raising uncertainty and risk for investors. For private investors and specialist funds, there is no long-term certainty over demand, energy policy, or the relative cost of fuels, power, or carbon prices. For instance, Europe’s demand for power has fallen by 1.2% a year since 2008, and coal is plentiful and cheap whereas gas is dear. The carbon price has collapsed from a high of €30 in April 2006 to just €2.75 in April 2013, leading to financial losses for many gas power plants. In addition, investors need to factor in political risk and uncertainty. There have been cutbacks in feed-in tariffs for solar projects in Britain, Italy, and Spain. The current British government increased taxes on oil and gas production from the North Sea and then subsequently reduced them. At the national level, European countries offer a hodgepodge of competing regulations and subsidies, making Europe-wide financing, energy trading, and switching difficult.

However, it is clear that often the first source of new finance will be the power utilities themselves supported by quasi-state- owned banks, such as the EBRD and the EIB. The UK has led the world in public private finance (PPI). Certainly, PPI projects are seen as a good way to secure construction contracts for construction companies, such as Skanska, one of the world’s leaders in such projects. Project developers, especially in the renewable sector, offer power purchase agreements (PPA) to provide security of returns to investors.  In addition, some equipment manufacturers have set up their own dedicated funding subsidiary: for example, General Electric’s GE Energy Financial Services, which has invested $20 billion in energy investment commitments worldwide. Together, these projects have a capacity to produce 30 GW of power—equivalent to the total installed generating capacity of Norway. Like several large energy technology providers, GE offers its customers a range of financial packages, including structured and common equity, project finance, leveraged leases, corporate finance, asset- backed revolvers, acquisition finance, and senior secured debt. Finally, sovereign wealth funds such as those in Singapore, Norway, and Russia have the funds to invest in the kind of mega-power projects Europe needs. For instance, the construction of Gazprom’s €6 billion Nord Stream gas pipeline linking the Russian gas grid with northern Germany was financed with 30% raised by the project partners Gazprom Wintershall, E.ON, Ruhrgas, Gasunie, and GDF Suez. The rest of the funding came from major banks such as Royal Bank of Scotland, Deutsche Bank, and Crédit Agricole S.A.

Financial Innovations

To meet the required scale of energy investment demand necessitates new sources of finance and financial instruments. In Britain, the government has established the Green Investment Bank. This quasi-public/private bank has been set up specifically to provide both green and commercial capital for green-related energy projects. Similarly, last November, the EIB launched a pilot Project Bond Initiative designed to stimulate capital market financing for infrastructure delivered under “project finance” structures, including PPIs. This initiative will seek to enhance the credit rating of bonds issued by project companies to a rating level that is attractive for investors and to lower the project’s overall financing costs. The pilot phase, lasting until 2016, will benefit to the tune of €230 million from the EU budget and will focus on encouraging capital market contributions worth more than €4 billion for infrastructure investment in the transport, energy, and communications sectors. However, in comparison with total lending of €61 billion by the European Investment Bank in 2012, this sum looks insignificant. It is widely expected that, in the future, insurance companies, financial advisory service companies, and pension funds will become mainstream investors in energy infrastructure as they seek higher, and hopefully secure, long-term returns in a world of low yields.

Capacity Constraints

The opportunities for industries and companies involved in the design, planning, construction, and operation of power infrastructures are large and growing. Whether there will be capacity constraints and where they will emerge will depend upon the scale and timing of individual projects. Industry insiders point to an expected shortage of specialized engineers, which has driven costs higher and higher. This, and other potential shortages, will be exacerbated by the nature of infrastructure projects in energy generation, transmission, and distribution. These are large-scale schemes, requiring massive upfront investments, in which economies of scale are significant. Consequently, the companies and sectors most closely associated with such projects are large, often international or even global, and enjoy high barriers to entry. Insufficient finance has often been a cause of delays in construction for energy projects within the EU, most notably in the case of the Nabucco gas pipeline linking Austria via the Balkans and Turkey to central Asian gas fields. Equally, government indecision has contributed, and still is contributing, to delays in projects.

Conclusions

Government will remain a major player for its ability to guarantee projects, thereby reducing the cost of borrowing below standard commercial loans as well as fixing the minimum price of power. Given the financial constraints of the EU and European governments, it is probable that there will be an increase in public-private partnerships to deliver EU-wide priority energy projects. It is clear that the modernization of European transmission networks alongside new generating capacity will require substantial new sources of funds. However, as a result of the EU’s financial and economic difficulties, important projects are being held up by longer-than-expected negotiations between ministries and companies over terms and rewards. For example, a lack of funding and insufficient government support has stalled the development of new offshore wind farms in the North Sea. The attractions of large- scale energy infrastructure investments are hampered by a climate of uncertainty surrounding both the EU and member states’ energy policies. Indeed, as pointed out by Peter Atherton, of Liberum Capital, successive governments have “grossly underestimated the engineering, financial, and economic challenges posed by the drive to decarbonize the electricity sector by 2030”.9 Such an EU-wide objective, while keeping the lights on and household fuel bills affordable, may, in the end, be politically impossible. The opposition of industry and of householders to paying for such an energy switch may prove incompatible with politicians’ ambitions to be re-elected. Investors in energy infrastructure projects will feel the consequences.

 

REFERENCES

1. International Energy Agency, World Energy Outlook 2012, 2012.

2. N. Bakhsh, Europe’s Utilities Need to Spend $1.3 Trillion by 2020, Bloomberg, 25 February 2013.

3. Yang, A., Cui, Y., Global Coal Risk Assessment: Data Analysis and Market Research, World Resources Institute working paper, No- vember 2012.

4. World Nuclear Association Information Library, Plans for New Reactors Worldwide, Accessed May 2013, www.world-nuclear.org

5. Pike Research, Smart Grids in Europe, 2011: Navigant Research, London.

6. European Union Committee – Fourteenth Report, No Country is an Energy Island: Securing Investment for the EU’s Future, House of Lords, 5 May 2013. www.publications.parliament.uk/pa/ld201213/ldselect/ldeucom/161/161/16102.htm

7. C. Lucchesi, BTG Said to Seek Portugal, Spain Assets: Corporate Brazil, Bloomberg, 5 April 2013.

8. S. Morris, Shadow Banks to Lend $25 Billion to European Projects, S&P Says, Bloomberg, 17 April 2013.

9. R. Evans, Electricity bills ‘may have to rise by 25pc’ to stop the lights going out, Daily Telegraph, 1 May 2013.

 

The author can be reached at www.nicnewmanoxford.com

 

Will the ETS Survive?

The European Emissions Trading System (ETS) is the world’s largest cap-and-trade market for carbon credits, and it is in trouble. Based on several factors, including the recent global financial downturn and the economic woes of some EU members, the number of emissions credits available to the market is far too high. From 2013 to 2020 it is estimated that there is an allotment of approximately an extra year’s worth of credits available, which is dragging down the trading price. As recently as 2011, the credits were worth €20, but today prices have fallen well under €3 (US$30 and US$4.5, respectively).

Will the ETS Survive?

The EU Commission proposed a plan to address the low prices— remove some 900 million tonnes of carbon allowances and return them to the market at some point in the future when (or if) the demand warranted it. However, this proposal was rejected by a slim margin in the European Parliament on 16 April. In the future, it will be important for the ETS to make a recovery, or it could fail to help achieve any of the goals for which it was established. Some have theorized that if the ETS does not show improvement, carbon emissions in Europe eventually will be controlled on a national level, rather than by the EU.

The content in Cornerstone does not necessarily reflect the views of the World Coal Association or its members.