As the UK aims to achieve net-zero emissions by 2050, significant additional generation capacity will be required to meet the energy demands of those sectors previously powered through fossil fuels – including transport and heating, which we expect to be electrified over the coming years. This additional generation is expected to be delivered through renewable power technologies and major investments are urgently needed, with market analysts suggesting that low carbon generation capacity will need to more than double by 2050 to meet decarbonisation targets.
Looking to 2021 and beyond, it’s clear that the UK Government’s primary focus is on developing the offshore wind sector as featured in its 10 point plan and the recent Energy White Paper, with a target of 40GW of offshore wind generation capacity to be in place by 2030. Its main mechanism to promote offshore wind generation capacity build-out is the Contract for Difference (CfD) regime that provides price support for power produced, and last year the government announced the doubling of the amount of new generation that could receive the CfD in its 2021 auction. This will be coupled with a new consultation looking at the supply chain and ways to support more jobs and private investment by increasing the competitiveness of UK manufacturers.
The number of investors focusing on this sector is also increasing. As well as the sector pioneers, such as SSE, Ørsted and RWE, we’re now seeing oil and gas majors such as BP and Total making significant investments as they seek to transition their businesses from fossil fuels. As well as looking to lead transition through investing in technologies such as blue/green hydrogen and Carbon Capture and Storage, these companies are now putting very significant investments into offshore generation. Just this month, Total and BP were awarded seabed licences from the Crown Estate to develop 4.5GW of offshore capacity in UK waters, via a competitive tender process.
Although these offshore wind transactions are large, the revenue support from the CfD regime will help ensure they attract liquidity from the bank market as well as potentially from export credit agencies keen to support turbine supply chains.
Perhaps the more challenging areas to finance are the UK solar and onshore wind sectors. These sectors continue to have an important part to play in getting us to net-zero, but Government support has been more muted. The Government has allocated part of the CfD pot available for these technologies but it is expected to be limited and competition will be fierce with low CfD strike prices, which will deter certain players from participating in the auction. Ultimately the development of the pipeline of consented onshore wind and solar projects in the UK may rely on revenue support from elsewhere and these transactions will be underpinned by a different mechanism – corporate or utility power purchase agreements (PPAs). As large corporates seek to address their own carbon footprint and Scope 2 emissions, as their stakeholders increasingly scrutinise their environmental performance, they are looking to procure their power directly from identifiable renewable sources. To do this they turn to long-term PPAs with renewable generators. The value of these contracts to the generators lies in the provision of a medium or long-term fixed price needed to underpin financing of new projects, which is no longer available from subsidies, in addition to the ‘merchant ‘ revenues achievable by selling power into the wholesale power market. These PPAs make the difference between an investment being viable or not.
For banks and institutions providing finance to the sector, the change from relying on fixed subsidy cash flows to a combination of PPAs and merchant revenues, presents a new challenge. Decisions need to be made on how to approach different counterparty risks arising and how to get comfortable that longer term market prices will remain within acceptable parameters to ensure debt can be repaid. Investments are only viable and investible where longer term investment and financing horizons are taken, and the bank market’s ability to continue to provide finance is vital to continued investment in the sector.
Other issues may also concern banks. High penetration of intermittent renewable generation (not available if the wind doesn’t blow and the sun doesn’t shine) causes electricity price volatility and uncertainty in future prices. The ability to continue to forecast power prices over the longer term in the face of these market changes is an important continuing question in lending decisions. Mitigations are available through lending to diversified portfolios or co-location with storage assets but these also bring new issues for debt providers to grapple with.
At NatWest we have the benefit of an established and strong track record of lending to the UK power sector and understanding new power markets, which places us in a solid position when faced with new issues and being able to structure innovative solutions. We continue to consider issues such as power price risk as we look to support the UK’s energy transition, and we’ve developed a set of criteria and benchmarks to apply to these transactions, recognising that projects are often quite different in approach and profile. Setting out these parameters also helps us to be transparent with our customers as to what we can do and which requirements our customer need to meet in order for us to provide finance.