News & media Mobilising capital for mid-market energy transition infrastructure companies
In September, the International Energy Agency (IEA), the International Renewable Energy Agency (IRENA) and the United Nations Climate Change High-Level Champions warned in an illuminating report[1] that sluggish investment was seriously impeding the green transition needed to meet climate goals. If the world truly is at “the beginning of the end” of the fossil fuel era, as IEA head Fatih Birol recently proclaimed, then we must supercharge financing methods to address the acute deficit in green finance.
An important funding gap in catalyst capital
Simply put, the new financial reality of much higher interest rates and the retrenchment of central bank liquidity has led to a change in the capital structures of energy transition projects and companies. The days of high (and sometimes eye-watering) leverage in the form of long-dated bank debt have given way to much higher equity requirements, while an increasingly uncertain revenue line for renewables projects has only compounded the problem for project sponsors.
In Europe, where the market continues to be buffeted by two powerful trends – the drive to net zero and the need to improve energy security – the requirement for new sources of capital is particularly pronounced. It is estimated that more than €5 trillion in investment will be necessary to meet 2050 net zero targets, with €150-200 billion in annual investment required between now and 2040. In the face of seemingly impossible investment requirements and ongoing capital market headwinds, a real opportunity exists for credit funds to bridge the financing gap, especially in the increasingly critical intermediate capital layer.
A radically different energy landscape requiring the right investment strategy
Traditional approaches to project lending involve balancing four key parameters: leverage, tenor, pricing and coverage ratios. Changing one of these parameters, such as loan pricing, requires an offsetting change in other parameters in order to maintain the balance. Such is the case in the current market, where significant increases in interest rates have disrupted loan sizing for renewables project finance, and the levels of bank leverage to which borrowers have grown accustomed.
The issue is not so one dimensional, however, as another loan sizing parameter is also changing. As the renewable energy sector evolves, there are different risks that need to be taken into account by providers of finance. Whereas ten years ago lenders were able to provide leverage against government-backed feed-in-tariffs, investors today are typically faced with either more market risk or the risks and structural complexity associated with bilateral offtake agreements with corporates, utilities or traders. In any case, shorter term offtake arrangements have become the norm and a much more active approach must be taken when it comes to managing market risks, none of which bodes well for the enduring support of traditional lenders in reaching European energy transition investment objectives. Bank lenders may have accepted coverage ratios of 1.2x or below when deciding the amount of cash flow buffer required over their scheduled debt service on the basis of long-term contracted (and therefore stable and predictable) cash flows. Ratios will be well in excess of these levels when taking into account the revenue risk introduced by less creditworthy contract counterparties, short-term contracts, and the pure market forces involved with having no fixed price offtake contract at all.
Similar to the impact of increasing interest rates, the requirement for higher coverage ratios as a result of a less certain revenue line is also putting downward pressure on levels of leverage provided by bank lenders. Whereas previously a project may have been able to attract 70-80%+ senior debt in a low interest rate environment and based on long-term government offtake agreements, renewable energy projects are now looking at 50-60% leverage in the current environment creating a deeper need – and opportunity – for new sources (and types) of debt at the project level.
Other factors are also at play in changing the financing landscape for renewables. Development platforms are increasingly seeking more flexible growth capital for their portfolios of assets, rather than the more restrictive project finance structures which have provided the bulk of the capital going into this sector thus far. Such facilities may be for a combination of uses, from construction capex, asset acquisitions, working capital and even (late stage) project development costs which have historically been reserved for equity capital. The currently muted fundraising environment is also influencing how projects are financed. With newly raised equity not as plentiful over the last 12 months (with some notable exceptions) some energy transition investors are looking at non-traditional sources of leverage as a way to recycle capital on existing investments and ensure the longevity of their relatively scarce dry powder.
With less bank debt available and generally higher demand for non-traditional sources of debt capital, companies, platforms and project sponsors are increasingly looking to non-dilutive intermediate capital – namely junior debt, mezzanine finance or preferred equity – to fill the funding gap. Such instruments sit between senior debt and common equity in the capital stack, and for investors like Cordiant, can provide equity-like returns with structural protection to reduce downside risk.
Our approach in action
In May this year, Cordiant – through its global direct lending funds – provided a €30 million debt facility to independent renewable energy company Monsson Group. One of the most successful wind and solar project developers in Romania, Monsson’s track record in developing over 2000MW of projects in-country and their ESG credentials made them an extremely attractive investment for our Energy Transition Credit team. Current supply chain disruption has led to long equipment lead times and requires developers like Monsson to plan well in advance in placing down payments for key equipment, sometime in excess of 12 months before the start of construction. Cordiant’s flexible approach in providing debt capital to support capital expenditure requirements across a number of projects was particularly valuable for Monsson.
Looking ahead
The amount of private structured credit, as opposed to bank debt, is expected to rise significantly for energy transition infrastructure borrowers in Europe and beyond. The consequent need for knowledgeable energy transition credit investors in senior, and (increasingly) junior tranches of the capital structure, has therefore never been higher. This trend is only expended to continue as the energy transition moves away from only mature technologies like wind and solar PV, to new areas like storage, green hydrogen, and carbon capture, among others. New risks associated with novel technologies, unproven supply chains and operational complexity will only open up a bigger market for flexible private debt capital of the kind in which Cordiant specialises.
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The material and information provided therein does not constitute investment advice and is for informational purposes only. It is not a solicitation to buy or sell any of the securities or funds mentioned herein. It does not take into account any investor’s particular investment objectives, strategies or tax status. Professional advisors should be consulted before making any investment decision.
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