Research

June 26 - Financing to meet the needs of the renewable energy sector between now and 2030 will exhaust the capacity of banks and utilities, and lead to the involvement of the capital markets, among others, believes Standard & Poor's Ratings Services. Speaking at a panel discussion at the recent United Nations Conference On Sustainable Development, or Rio + 20, Regina Nunes, head of Standard & Poor's South Cone Latin America, drew attention to the fact that banks and utilities are unlikely to provide financing of about $1 trillion per year for clean energy schemes. To date, however, the small secondary debt markets and the absence of large volumes of liquid, investment-grade securities have limited the involvement of institutional investors in this sector.

"Given the huge, and increasing, financing requirements of the renewable energy sector, it's clear that funding must go beyond that provided by traditional sources such as utilities and financial institutions," said Ms. Nunes. "Achieving this funding will therefore rely heavily on attracting other investor pools including private equity, pension funds, and the capital markets.

"Renewable energy projects have often been considered high-risk, owing to their reliance on government support and relative immaturity--a view accentuated by the difficulty in measuring their revenue streams compared with other investments," added Ms. Nunes. "Our role as a ratings agency is to be completely transparent about what the risks are, and to provide insight on structures that may facilitate financing in the clean energy sector.

"To date, the ability of institutional investors, pension funds, and the capital markets to access clean energy investments has been somewhat limited, given the small secondary debt markets and the absence of large volumes of liquid, investment-grade securities."

In this respect, we believe that long-term renewable energy fixed-income debt securities, otherwise known as "green bonds," could spark interest. Indeed, the initial $17 million worth of issuance was snapped up by the market--especially by institutional investors and pension funds keen to comply with their corporate social responsibility mandates. The majority of these bonds were issued by multilateral agencies or banks and have, as such, mostly been assigned 'AAA' ratings. While the initial interest is promising, we consider it insufficient in light of the incremental financing requirements of the renewable energy sector. According to the International Energy Agency (IEA), the sector will require approximately $1 trillion of funding per year worldwide until 2030.

Projects such as Topaz Solar Farms LLC (which, at $2.44 billion, is the largest solar power project financed in the U.S. capital markets without Department of Energy loans or guarantees) may therefore provide a blueprint for the sector. In this case, we assigned our 'BBB-' rating to $700 million of unsecured notes issued by Topaz. The rating reflects our view that the project uses proven solar panel technology, with low operational and maintenance risk. It also takes into account that construction is under an engineering, procurement, and construction contract with a subsidiary of First Solar Inc. (not rated). The contract includes incentives to achieve completion and with a contingency equal to 44% of variable costs. On the flipside, the rating is constrained by the project's high counterparty risk exposure to First Solar, which has a credit profile below that of Topaz.

Ms. Nunes believes that such financing structures may provide the answer to the clean energy financing challenge. "Investors are increasingly looking for fixed-income instruments that provide yield without going too far down the credit curve. In our view, it's very much a trade-off between risk and yield: Previously, investors may have looked for bonds rated 'BBB'. Now, however, we believe that 'A' rated investments are becoming the new minimum standard," she explained.

"Sometimes, private or public credit enhancement is needed to create project-backed bonds with an 'A' rating. That said, renewable energy projects can also achieve an 'A' rating from the outset if they are well-structured, with low leverage and strong support from key project counterparties."

The conference panel--which also included Nick Robins (Head of Climate Change, HSBC), Chad Holliday (Chairman, Bank of America), Michael Liebreich (CEO, Bloomberg New Energy Finance), Peter Hoeppe (Head of Geo Risks research, Munich Re.) and Rashad Kaldany (vice president of Global Industries, IFC)--agreed that the need for private investment in renewable energy will become tougher as the effects of the Basel III and Solvency II regulations increase over the next three to five years. Basel III, for instance, will increase the capital charge for banks holding long-duration loans and therefore provide an incentive to rotate capital. This, combined with ongoing pressure on bank credit quality, could reduce the amount of long-term bank lending and increase costs. Standard & Poor's estimates that corporate borrowers in the European Monetary Union (EMU or eurozone) could see annual additional interest costs of almost $50 billion under Basel III (assuming a bank return on equity target of 10%). At the conference, the panel argued that extensive collaboration between banks, insurance companies, energy utilities, and governments is needed to meet the global clean energy challenge.

The Rio + 20 corporate sustainability forum took place at Rio de Janeiro in Brazil on June 20-22, 2012. The event, which took place 20 years after the landmark 1992 Earth Summit in Rio, saw world leaders--along with participants from the private sector, non-governmental organizations, and others--come together to discuss how to build an economy around the principles of sustainable development.

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