The Power Market is Shifting: Key Takeaways from Emerging Trends in Power Project Finance

Written By: Jen Neville
December 10, 2018

project finance

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The power market is shifting: Key Takeaways from Emerging Trends in Power Project Finance 

Trends

What’s most notable is the swap between coal and natural gas. A good portion of the market shift has been a result of natural gas replacing coal. Renewables are growing steadily. And hydro and nuclear is pretty stable. That’s important when it comes to new asset development and gaps that’ll need to be filled as some of these assets are decommissioned.

Construction financing took a breather last year, but capacity price for gas construction gas looks good again. If you compare it to the volumes that we're seeing in thermal, it explains why the price gets driven down so much when renewable deals come to market. It’s because everybody wants to do a renewable deal even if it's merchant.


Generation by fuel

Natural gas is becoming the transition fuel as far as generation goes. It’s a massive part of the story and will continue to be, primarily because there's a lot of it. In terms of base-load capacity, it's the one that is most scalable at this point. Now we're starting to see offshore wind, solar, some battery, recip. engines, and nat. gas, but not much coal, hydro, or nuclear on the horizon.

Long term utility BPAs are starting to wane. And the natural gas-fired market has not been relying on long term BPAs. Merchant market exposure will remain and may grow. And we're starting to see more portfolios of consumer middle-market and corporate credits. So distributed portfolios and different counter-parties have ramifications in the market. The scale is still small right now for a lot of these emerging areas in the market. If you do want to get in, get in early on a smaller transaction in order to be ahead of the curve.

We’re starting to see new technologies making their way into the market. Distributed resources are going to be a bigger part of the mix and that will flow through a smarter grid. Technology has definitely evolved to the point where control systems and aggregation of load is becoming more feasible and more efficient. So it's an enabler and it's a new trend.


Emerging project characterists and risk profiles

New applications

There's nothing new with wind and solar, but there are new applications emerging through storage. These transactions, from a projects and finance perspective, are fairly small, but there’s great potential. Distributed gen is a business model that’s emerging. Other technologies underlying it are quite viable. Energy efficiency is definitely a technology play. The ability to achieve efficiencies plus aggregate demand response and load are more feasible now than ever. So that's an area to watch. And beyond that, mobility has enormous potential. Although, from a project finance standpoint, it's very early days. The mix of financing solutions is going to be broader and there’s more risk associated with it, but it’s still an area to focus on.


Emerging Solar and their associated issues

With residential solar, it's a question of whether it’s project financed or asset-backed, like an ABS type of deal. The challenge when syndicating these deals is the type of collateral, since they’re comprised of 40,000 to 50,000 rooftop homes. Your counterparty is a homeowner instead of a business or utility. Pricing has been coming down over the last three or four years. Structures are getting more advanced and people are willing to leverage these assets higher. So that's becoming increasingly mainstream.

Community solar is also very financeable. It’s almost like a one-sided contract. These are solar farms located in an area where they sell the capacity or the exact PPAs within the local neighborhood. The problem for lenders is that people move meaning that contract rates may drop as homes are sold. This changes cash flows for the lender, so this needs to be considered when structuring these deals.

CCA is like a community solar asset. Instead of signing directly with a homeowner, you're signing with a marketer, an entity that doesn’t have a rating. That makes it a little more complicated. So you have to build in some kind of structural triggers to get a bank comfortable. So these financings are very complicated.


Emerging Wind

A major areas of new activity is emerging wind offshore generation. This is expected to grow over the next five years or so. One of the issues around offshore — it's been very successful in Europe, but hasn't been done on a large scale in the US, but it’s starting to emerge. Many European developers are interested in this market. There's a lot of experience coming in. We do have issues like the Jones Act that we have to figure out because there isn't a lot of infrastructure to support that bill. That also opens up opportunities around resources that support wind development. In the US, the issues are regulatory. The spreads on the bank debt financing are continuing to tighten to almost mainstream levels for Europe, so it’s certainly an area to follow.

In reference to price, people are looking at utility rate credits and high rate credits. They’re looking for a little yield but still want to be in renewables. The main areas to focus on are offshore wind development as well as non-utility and merchant wind development and financing.


Storage

Storage has a role to play, especially with the growth of renewable assets, intermittency and the grid. There is enabling legislation, and specific initiatives that are being rolled out. So it's certainly a hot area of focus and there's good reason — it will play a role in the grid. The primary focus is on lithium-ion because it has the most potential in the short term. That doesn't negate flow batteries, hydro and other sources of storage. They will have a role to play too. At the moment, lithium-ion just seems to have the upper hand. There’re a variety of remedy models, and that's going to be the key.

With lithium ion you still have to get comfortable around their warranties. It all comes down to revenue model. Pure battery storage deals have a capacity contract. If your revenue model relies on ancillary revenues, it requires some creative structuring to make it financeable. One of the key factors that will be relevant is getting the markets' heads around the CNI risk unrated credits. Residential has a role to play there as well. That'll be a large portion of market.

A key factor is battery costs. Lithium ion is currently the short-term choice. If you're either acquiring, or retaining an asset, storage is on the horizon and is a competing resource. It will be and has to be factored into the conversation.


Distributed Generation

Distributed gen can be a lot of different asset types such as small fuel cells, solar or wind farms or even tiny gas plants. There’s a greater ability to aggregate load than ever before. So these are starting to be large-scale acquisitions plus strategic and private equity interest in this space. This suggests that the grid will become more distributed and some of these technologies have a significant role to play. Because each asset is so small, the ideal financing solution is similar to a credit card so they can be financed one at a time and then rolled up into one lump sum portfolio financier.


Efficiency Projects

Whether it's distributed gen or efficiency, where the individual projects are even smaller, companies are starting to build credit capabilities internally. That simplifies lending here. HVAC swaps, lighting retrofits and very large-scale build outs must be viewed as portfolios since it's not practical to review every individual project. There’s growth in efficiency projects like HVAC swaps due to old infrastructure nationwide. So there is a fundamental need for the host that can do it efficiently.


Mobility

There’s a need to build out support infrastructure when public transport, fleets and entities have multiple vehicles they need to charge. That’s a more traditional project type deal with a counter-party that needs assets to service a fleet. It's still fairly early now, but if you look forward to about 2025, that's the projection where there's parity in the automotive market in terms of gasoline versus EV. Then work backwards to figure out when the build back will start and where the mass market starts are to adopt. There’s going to be more of a switch over to electric vehicles. To make that happen, of gas stations in the US need to put in the EV infrastructure for charging stations. So this is an area of focus.


How the financing market adapts

Of these emerging asset classes, there’s something for everybody. You have various players that focus on different areas and who want differing balances of risk versus yield. High-grade infrastructure is going to be your safest. That’s going to be your cheapest cost of capital. The middle tier, energy and energy transition, is going to be for more aggressive banks or debt funds who are willing to add some leverage by taking on a higher risk profile to get paid for that yield. And it continues all the way down to equity. The more proven the technology, the more stable the revenues. It doesn’t have to be just one asset type. You can layer on one, two or three of these levels of leverage. That’s the message for everyone who’s looking to potentially finance these assets. Bottom line – the industry is going to have to adapt. In terms of liquidity, there’s plenty. It’s just what flavor does it come in and how do you fit against the structure?

Read the full Q&A Transcript from Emerging Trends in Power Project Finance here

[read more]

Ralph Cho is Co-Head of Power & Infrastructure Finance North America with Investec USA. He came to Investec six years ago and has been there to build a business in this space. His focus is around the capital market financings. He’s been doing these types of finances for more than 20 years.

Ren Plastina is Lead Originator Emerging Energy Technologies Power & Infrastructure Finance North America with Investec USA. He joined Investec last December to focus on clean tech, emerging energy and infrastructure. 

How is the power market shifting?

Ren: I’ll take you on a bit of a journey. This is what's happening in the power markets. What we see are a few trends unfolding. And primarily, what's most notable is the swap between coal and natural gas. This has a variety of different implications, especially in terms of the financing market, which Ralph will cover. The US has made great strides in terms of reducing CO2 emissions, but when we take a look at the market shift a good portion of that has been as a result of natural gas replacing coal. And it's about a 50% reduction in CO2 profile. Renewables are growing steadily. That's a big part of the story and will continue to be. So we can see that growing over time. Also, hydro and nuclear is pretty stable. There's not much happening in terms of growth. That'll play into the story with respect to new asset development and gaps that’ll need to be filled as some of these assets are decommissioned.

Ralph: Construction financing, especially at PJM, did take a little bit of a breather last year. I guess people were nervous around capacity prices. But capacity price for construction actually looks pretty good again for gas. I mean, we're aware of at least a dozen opportunities in PJM region by itself. When I look at Investec's portfolio, we would certainly love to continue to diversify and do more renewables. If you compare it to the volumes that we're seeing in thermal, like gas, it explains why the price gets driven down so much when renewable deals come to market. It’s because everybody wants to do a renewable deal. Even if it's merchant I think they'd be willing to do that.

Ren: And we'll touch on that a little further in the presentation, but that's definitely a trend that we're seeing at this stage. I'll sum it up that gas is becoming the transition fuel as far as generation goes.

Generation by fuel in 2017 is largely what we've seen historically as far as resources go but we have seen a bit of a shift. Coal at one point would have been about 40, 45%. Now it's down to 30. Nat. gas is up to 32. That was probably around 25% not long ago. And nuclear and hydro had been fairly steady and stable, and we're starting to see wind and solar come into the market as well as other resources.

Clearly, natural gas is a massive part of the story and will continue to be, primarily because there's a lot of it. And as far as base-load capacity goes, it's the one that is most scalable at this point. So that's going to be part of the story. Now we're starting to see offshore wind, solar, little bit of battery, recip. engines, and nat. gas. So that variety is shifting and certainly not much coal, hydro, or nuclear on the horizon. So there are a few takeaways that we can start to see. Long term utility BPAs — not as many of those. They're starting to wane. And the natural gas-fired market has not been relying on long term BPAs. Merchant market exposure will remain and may grow. And then we're starting to see more portfolios of consumer middle-market and corporate credits. So distributed portfolios and different counter-parties have ramifications in the market.

The scale is still small right now for a lot of these emerging areas in the market. We're seeing smaller projects out of the gate and the question is, do you want to get into that? If you do want to get in, get in early on a smaller transaction in order to be ahead of the curve.

So these are some of the trends that we see. In general, we're starting to see new technologies making their way into the market. The question is how do we finance those and what are some of the issues that come up as a result? New applications of existing technologies, in terms of merchant wind and some of the other areas of solar for example. Distributed resources are going to be a bigger part of the mix and that will flow through a smarter grid. Technology has definitely evolved to the point where control systems and aggregation of load is becoming more feasible and more efficient. So it's an enabler and it's a new trend. Intermittency with renewable resources is one of the big reasons why storage development is to counter intermittency, but that's certainly part of the program. And then evolving revenue models grow.

What project characterists and risk profiles are emerging?

Ren: And here's the way we see the world in terms of potential market opportunities. There's nothing new with wind and solar. But there are new applications that we're seeing continue to emerge, moving through to storage. That's been a big topic of conversation. Still fairly early in the game for storage as well. These transactions, from a projects and finance perspective, are fairly small, but there is great potential. Distributed gen, isn’t really technology, but more of a business model that we see emerging. Other technologies underlying it, that I've been seeing for a while, are certainly quite viable. Energy efficiency is definitely a technology play. The ability to achieve efficiencies plus aggregate demand response and load are certainly more feasible now than ever. So that's an area to watch. And beyond that, we think mobility has enormous potential. Although, from a project finance standpoint, it's very early days.

Ralph: We would certainly look at and evaluate any of these opportunities. In fact, we've looked at them. They're all super interesting. I think the electric vehicles—definitely. I'm a big believer in the growth of that business. But you're right, all that stuff looks like equity to me.

Ren: Yeah, you're looking at late stage venture, you're looking at early ramp-up, so certainly there's a question of economics, there's a question of risk profile.

Ralph: Sure. Maybe one way we could play it right now is maybe some mezzanine lending? I mean obviously we could always play in equity, right? But maybe sprinkle some mezzanine capital around?

Ren: Absolutely.

Ralph: We would do that.

Ren: And that's the key. We'll get to that later, but the mix of financing solutions is going to be broader. And there’s more risk associated with some of the earlier stage, but an area to focus on.

Ralph: Yeah, I think what you're saying is if any of these assets can be financed today in some type of structure, or into some shape or form.

Ren: Right.

Ralph: I agree.

Ren: So how long's the horizon? This is one of the questions we often get around efficiency, storage and distributed assets. Our view is that that timeline, that horizon, is getting shorter.

Ralph: Not short enough, right? We've been talking about this for years. You know? It's coming now.

Ren: And the good thing about it is that the technology is evolving. It's getting cheaper, it's becoming more efficient, and then the big elephant in the room is that it's difficult to replicate the existing coal, nuclear, and hydro. So what do you do? You can build gas, and there's a lot of gas in the pipeline, but do you want to have a grid that's completely dependent on natural gas? Certainly, there's room for other resources in the mix.

Ralph: And just to be clear. We're doing emerging solar now. We're doing emerging wind now. The storage is what we're talking about that’s on the cusp. And we're doing distributed gen now. Right?

Ren: Absolutely. Actually, we're certainly looking at all those. The first four are a big part of the mix.

Ralph: It's just the question of where's the supply.

Ren: Right. Exactly. Emerging solar. So Investec has done quite a bit of residential solar in particular. I'll hand it over to Ralph to talk about some of the evolution with community solar emerging, and CCAs, plus some of the issues associated with them.

Ralph: Yeah. All three of these applications are financeable and are getting financed. Specifically, as it comes to residential solar, it's a question of, is this project financed or is this asset-backed on finance, like an ABS type of deal. What we've found, when trying to syndicate these deals, the type of collateral residential solar is the challenge. Resi. solar portfolios are comprised of 40,000 to 50,000 rooftop homes and cash is coming in from each homeowner. So your counterparty is a homeowner, not necessarily a business or utility. When you layer in on top of these complicated tax equity structures, you really lose the interest of a plain vanilla ABS type of lender. The project finance lenders get a little fussed about the nature of the collateral coming from 40,000 or 50,000 systems. So it does take quite some education. Pricing has been coming down over the last three or four years. Structures are getting more advanced and people are willing to leverage these assets higher. So that tells me that's becoming increasingly mainstream. But that's basically what you're looking at on Resi.

On the community solar side — these are also very financeable. I think where you have to get comfortable is, it's almost like a one-sided contract. These are solar farms that might be located in an area and they sell the capacity or the exact PPAs with the local neighborhood. But people move and they're not going to be held accountable for locking in 20 years under their contract. So, the contract gets reassigned to another homeowner. Problem is, as a lender you may get a forecast that that guy's rates. Depending on what type of assumptions you've made, if that guy leaves and the new homeowner signs the community solar contract, the power price can be lower than they execute at on the new contract. This means your cash flows have now changed while you've already put the money out as a lender. So you just have to solve for that. There have been some creative ways that people have structured these deals, but they’re definitely financeable assets.

On the CCA side, we've done those too. I look at that like a community solar asset. Instead of signing directly with the homeowner, you're signing with the marketer, an entity that doesn’t have a rating. That makes it a little bit more complicated for plain vanilla project finance lender. So you have to take a view on that area. Build in some kind of structural triggers to get a bank comfortable. For example, if you start to have too many changes of contracts, you can right size the loan to a place where the banks are comfortable. But with all the issues that get in any of these deals, you still look at FICO scores and expected default rates. And you still have to do due diligence and make sure you can get comfortable with the different types of contracts. Plus you still have to look at tax equity. So these are very complicated financing. But we are seeing more and more of these types of assets come to market and lenders getting comfortable. I see it in the pricing, it's getting painful for us to continue to follow and do. You know I mean?

Ren: Absolutely. There’s a lot more interest in the non-conventional access for sure. I think we've covered a lot of this, but just highlighting some of the expected activity. Residential commercial is becoming a bigger part of the story. Utilities are still there as a baseline. And the idea is that we're going to have to get comfortable with different types of models to be able to address the entire market.

Moving over to emerging wind, a couple of major areas where there is new activity is offshore generation. Development and specific projects are still on the horizon. There are a couple of them. There are plenty more in development and leases that are being made available to developers. As a result, we expect a lot more activity over the next five years or so. One of the issues around offshore, in particular, is that it's been very successful in Europe, but hasn't been done on a large scale in the US. However, it’s starting to emerge. Many European developers are interested in this market, which is good. There's a lot of experience coming in. We do have issues like the Jones Act that we have to figure out because there isn't a lot of infrastructure to support that bill. That also opens up opportunities around resources that support wind development. So we think there's certainly an opportunity there.

Ralph: In the US, it's all regulatory. In Europe it's super popular. And the spreads on the bank debt financing are continuing to tighten to almost mainstream levels for Europe. So there's a lot of expert European banks, on these structures and the technology, that are very comfortable with the risk. The question is, is that going to transfer over to the US? And when we see some players, I think Copenhagen is in the market talking about something like that right now. So let's see. But it's certainly an area I think we should follow.

Ren: What do you think about onshore without PPA and hedge risks — more of a merchant profile?

Ralph: I think people are so interested in renewables, and looking to diversify their portfolio, that I think merchant renewables would get done tighter than merchant gas. And we see it. I mentioned that Carlyle's got one in the market. BlackRock's got one in the market. Is this a trend? Let's see these two get done. Obviously, if it's going to be done in the bank market, I think the lenders will take a conservative view of both production and forecasted merchant power price. But certainly, I think it's very doable, and I think there's a strong appetite in the market for these types of deals. We certainly would do it.

Ren: We're definitely looking at this market very closely, and we're in the middle of some transactions in this space.

Ralph: The question is price.

Ren: Right. Well, there're two ways to look at that. On one hand, people that are looking at utility rate credits, high rate credits, they're looking for a little yield but still want to be in renewables. That's a great trend in terms of quality portfolio diversity and a little bit better yield. If you're used to gas fire deals, maybe it's not something that works, so it depends.

Ralph: One argument a European bank gave me of why he'd rather do merchant renewable versus merchant gasses is that the power is free. You can't beat free

Ren: Makes sense. Then some of the risk there, we’d have to get our heads around basis and price risk. They are very specific. There're region-specific and site-specific aspects to assess, especially if we're looking at merchant. Again, main areas that we're focusing on are offshore wind development. That's an up and coming space. Also non-utility and merchant wind development and financing.  Storage is one of those areas where the conversation is far in excess of the deal flow.

Ralph: And I would say the liquidity out there. Availability is far in excess of the current level of supply.

Ren: And there's a good reason for that. I think generally there's a market consensus that storage has a role to play, especially with the growth of renewable assets, intermittency and the grid. There is enabling legislation, and specific initiatives that are being rolled out. So it's certainly a hot area of focus and there's good reason — it will play a role in the grid.

As we look at the market, we’re primarily focused on lithium-ion because that's where we see the most potential in the short term. That doesn't negate flow batteries, hydro and other sources of storage. We think there will be a role to play. At the moment, lithium-ion just seems to have the upper hand, and that's where we're seeing a lot of the activity. Within that, there're a variety of remedy models, and I think that's going to be the key. Take your perspective, Ralph. In terms of technology risk, I'm not sure that's the main factor in people's minds, but we'll talk about that in a little bit.

Ralph: Yeah. I think lenders can definitely get comfortable with the technology. Lithium ion's been around. Obviously, you're still going to have to get comfortable around the warranties behind it. Because things do break and someone needs to fix it or pay for it. But it's all going to come down to a revenue model, like you said. Of the few pure battery storage deals that I’ve seen, you've got a capacity contract. There's some high-grade contract that guarantees a level of cash. For example, it’s going to go live at plus 125. Crazy price. We're not going live at plus 125! But if your revenue model is something where you rely on ancillary revenues, more of a volatile merchanty type of cash flow where it can go up and down, it requires some creative structuring to make it financeable. But, that's not going to be in a range within margins. People want to price that risk. And that's where I think it gets interesting for us.

Ren: And I think one of the key factors that will be relevant there is getting the markets' heads around the CNI risk unrated credits. Again, residential has a role to play there as well. That'll be a large portion of market. The question is — can we come up with a solution that works in terms of credit profile?

Ralph: I think there's so much hype and excitement over these battery deals that, just to get in, people are willing to buy them. And we're no different. But they’d be willing to buy the deal just to get it done and take the syndication risk off the table.

Ren: And that just goes to show that this scenario has a lot of potential. People are lining up to get into it. But, why? We have specific state energy-storage targets and mandates that are being rolled out. This is all happening real-time, with more on the horizon. FERC Order 841 is a major factor that should allow for battery resources to compete more effectively. That will be rolling out over the next couple of years, so I think we'll start to see more transparency and new revenue models that the market will be able to get its head around. That should enable some more development.

A key factor is battery costs. Here's where the electric vehicle market and the stationary storage market start to reinforce each other.  As Asti grows through EV batteries, the stationary market will benefit as well, and we'll start to see that price curve drop over time. That's where I think some of the alternative technologies, other than lithium ion, are going to have a tougher time competing. Since it's cheaper to deploy lithium ion, and also the players that are backing up that technology tend to be larger and provide warranties. That doesn't mean that other technologies don't have a role to play, but for the time being, lithium ion is certainly the short-term choice. And if you get into a little bit of technology risk, there are plenty of players looking to come in. The question is, can we finance producers other than the larger producers that can stand behind their product with a strong warranty? This remains to be seen, but with 160-odd lithium ion suppliers in the market, there are plenty of people looking to get in.

Ralph: At what point do I, as an owner of a gas keeper, get worried?

Ren: I think based on where we sit right now, I wouldn't say that you'd be worried today. But I think over time, in the next five years, you should start factoring that into your decision. If you're either acquiring, or you're looking to retain an asset, storage is on the horizon and is a competing resource. It will be and has to be factored into the conversation.

Ralph: Like coal is getting swapped for gas, do you think gas keepers get swapped for batteries?

Ren: Potentially, especially if those prices continue to drop. I think that'll be a major factor. That's a great point. If you look history, we have seen such a precipitous drop in coal, we predicted that, but here we are. And that's primarily because natural gas has been so cheap. So if we can see cheap alternatives, certainly that's going to be a factor.

In distributed gen., the technologies are fuel cells and small-scale thermal. Distributed gen can be a lot of different types of assets. Those are a couple that we've highlighted. And really the story here is that there's more of an ability to aggregate load, than there's ever been, for a variety of reasons including that the technology is much easier to integrate at this point. So we're starting to see large-scale acquisitions in this space, big players coming in and taking on distributed gen companies. NL and MG came in and made some big acquisitions. There's other companies that form similar functions in the market that are trading. So we do see that there is strategic interest as well as private equity interest in this space. And I think that this suggests that there's a view that the grid will become more distributed and some of these technologies have a significant role to play. So from our perspective on the financing side, how do you handle large portfolios and different credits?

Ralph: Just to emphasize the point, when we talk about distributed generation, we're talking about a portfolio of it, not a specific technology. Distributed generation can be all these small fuel cells or all these small solar farms or wind or even small tiny gas plants. So it's more of a model.

Ren: And it's interesting to see how this will play out because in certain markets, for example, it's tough to get your head around building out 800 megawatts at a time. Building out distributed loads to capture peaks might be a better solution. Just something to think about. So we're seeing that type of model rolling out in the market.

Ralph: For financing these types of assets, because each asset is so small an amount, the ideal financing solution is almost like a credit card. Give these guys credit cards so they can go in and finance these assets one at a time and then they can roll it all up when they're ready and do one big lump sum portfolio financier.

Ren: It's an interesting play and I think that comes into the next factor that's in the next sub sector as well. Whether it's distributed gen or starting to get into efficiency, where it's even more of an issue, because the individual projects are even smaller. From what I see, the companies that are the most interesting are the ones that have a bit of a credit function within their own company. So they can do some pre-screening, they can do some assessment, they can take a look at credits and say, "Okay we've done a lot of the work,” to your point about giving them a credit card. You don't want to give your credit card and your sports car to your 16 year old. You want to make sure that it's handled properly. So having those types of controls in-house is the factor that sometimes may be underappreciated. But to the extent that any company can start to build that capability within their own ranks, that helps from a lending standpoint.

We're seeing some of that, as well, where HVAC swaps, lighting retrofits and very large-scale build outs or roll outs that are individually very small projects. So you take a look at a portfolio. You want some rigor in terms of how you create the portfolio and the underlying contracts. But from a financing standpoint it's not practical to say we're going to review every project that comes in through this type of program, so we'd have to get more efficient about it.

Ralph: This is interesting; this whole energy efficiency. I haven't seen too many of them. Do you have a view on volume trend, what's this look like over the next year or two or three?

Ren: We're starting to see some grow — facilities in the range of 50, 75, a hundred million and in terms of funding requirement. So it's getting to the point now where we're dealing with the growth pattern. We're at the earlier stages for some of these ventures and companies, but we are seeing the growth is there and for example, HVAC swaps, a lot of that infrastructure nationwide is old. So there is a fundamental need and for the host that can do it efficiently, I think it's there.

Mobility is one that Ralph holds dear to his heart. He’s a big EV fan and in general this is going to be a big space. We look at it from a PF standpoint and say, "Okay, can we charge support the early build out? With respect to public transport, fleets and entities that have multiple vehicles that they're looking to charge, there’s a need to build out the infrastructure to support it. That starts to look more like a traditional project type deal where you've got a counter-party that needs the asset and is looking to service a fleet. We think there's opportunity in terms of all of the areas that we've outlined. It's still fairly early, but the point I would make is if you look forward to about 2025, that's the projection where there's parity in an automotive market in terms of the gasoline versus EV. Then start to work backwards and ask — where's the build back going to start? Before we get to that point, where are the mass market starts to adopt?

Ralph: Ren. You know me. I'm a big, big believer of EV vehicles. Just like the tube-TV transformed to flat-panel overnight. I think we're going to see that with electric vehicles in, who knows, maybe three to five years. I think you're going to see more and more switch over to electric vehicles. To make that happen, a lot of infrastructure has to get changed. Right now, if you think about how many gas stations there are in the US, they've got a lot of wood to chop to put in the EV infrastructure for charging stations. So this is certainly an area I think we should definitely focus on. The question is– really it's more equity dollars right now than debt dollars. And so it needs to get to the point where we can put structure in more debt dollars.

Ren: Yeah. It's a scale issue at this point. The question is, how early in the game do you want to invest in it? And can you invest, as an institution? What's the risk profile in this appetite? But in terms of bills, I think there's certainly going to be a lot of activity in the space. And looking forward, as far as planning for a team and planning for capital allocations and capital resources, what mix do you need as an institution? It's certainly something to keep in mind.

How does the financing market adapt?

Ren: Ralph will speak about the evolution, on the financing side, and sources of capital as well as how the market will need to adapt.

Ralph: I think when you look at all the debt players that are out there, I think of everything as a giant jigsaw puzzle. I mean, you have some guys that want super-safe loans, and they're willing to accept the low rate of return. And then you have some guys that are willing to take a little bit more risk, that want to load up more yield and so forth. So when we structure deals, we can tranche it out, or we can look at the credit profile and try to put something that works for the borrower. We structure it for something that we think would be appealing to a lender. When we're talking about these emerging asset classes, there's something for everybody. At Investec we're in a unique position where we can lend across the capital stack. But you have different players that focus on different areas. High-grade infrastructure is going to be your safest. If we have a contract, if you can show some stable level of revenue that lenders can hang their hat on, you can create a debt profile that relies on this. That's going to be your cheapest cost of capital. This middle tier energy and energy transition is going to be for more aggressive banks. Maybe some debt funds that are willing to add some leverage by taking on a little higher risk profile, and get paid for that yield. And it goes all the way down to equity.

So for all these asset classes that we've been talking about, the more proven the technology and the more stable the revenues look, we have put in tranches of bank debt. Then we’ve layered it on in case the borrower wants higher levels of leverage in their projects. So it doesn't have to just be one of these asset types. We can layer on one or two or three of these levels of leverage. So I guess that that would be the message for everyone who's looking to potentially finance these assets.

Ren: Generally, the industry is going to have to adapt. I think, in terms of liquidity, there's plenty. If you agree with that, Ralph. It's just what flavor does it come in and how you fit against the structure?

Ralph: Yeah.

Ren: Just to sum it all up, we do see a major shift in sources and business models, in terms of how the generation mix is going to evolve. In general, development activity is getting closer to the load, which suggests a more distributed model, larger portfolios and smaller assets. Revenue profiles are becoming more variable for a variety of reasons. I think generally we've looked at the continuing significance of natural gas in the mix. A lot of that is being done on a quasi-merchant basis. Then as new assets come in we're starting to look at C&I credits and different types of revenue profiles which we also have to take into account. Counter-parties are becoming more diverse on a similar point, and we'll need a more flexible capital toolkit to make it all come together. The bottom line is, we won't be bored.

Ralph: I like that. Future won't be boring. No, that's for sure. One thing I like about this business is that because of all the changes that are continuously happening in our sector. It's certainly very dynamic. Even with the lenders out there, it is super dynamic when it comes to who's coming in and out of the market. I think it's definitely an exciting time to be in this industry.

Infocast: Are investors showing a real interest in emerging power assets?

Ralph: I would say a profound yes. Right now there's a supply-demand imbalance. There is a lot of liquidity out there, chasing a small number of deals, and a lot of deals have already been done this year. The volumes, for the first three quarters of this year, have been in excess of around 60 billion dollars. Just to put that in a frame of reference, in 2017 alone there's probably about 50 billion dollars. So we've already exceeded volumes just compared to 2017. So there's a lot of capital out there chasing projects. Emerging power assets is interesting. That’s why we’re involved on this, because everyone's always looking for the next big thing. And even from the diversification of your portfolio perspective, it's a good thing to look at different asset classes. And so everyone talks about it but we just don't have the volume there yet.

Infocast: Is carbon tax coming and do you know if that will change things? There’s some bills floating around.

Ren: In as far as whether a carbon tax will make it, that's hard for us to predict. There's certainly a major push to make that happen. To the extent that it does, I think it's pretty clear when you look at the profile of the market how significant a role natural gas is playing and will continue to play. So to the extent that a carbon tax comes in, we would expect that natural gas power generation becomes more expensive. This means that power prices, in general, are likely to increase, at least in the short term. But that should open up opportunities for competing resources.

Infocast: Do you think long-term PPAs will make a comeback if reserved margins become strained through decommissioning?

Ren: I can take that one. Well, it could happen, sure. If there's an issue with supply we could certainly see that come back into the market — see these long-term PPAs push through the market again or maybe to support global generation. It's a possibility. We personally aren't counting on that, at least as an institution. When you look at gas power development, which is a large share of what's on the horizon, especially in terms of baseload, which definitely has been done without PPAs. They have the PPAs required but no lack of development in PJM. Ralph can speak to that.

Ralph: Yeah. What do PPAs do? Just give certainty of cash. If your reserve margins are thinning out, you as a system operator need to incent new developers to come into the market and build assets. PPAs is just one way to do it. Another way to do it would be to offer higher capacity prices.

Ren: And if we look at PJM as a model, to the extent that other regions are looking at solutions, it certainly has hampered development there. So would it be necessary? Probably not. Could it happen? Sure.

Infocast: Why do you think there are so few deals in the battery storage space while the conversation on storage has been so popular?

Ren: Well, for a variety of reasons. There's a recognition that, as we build up more renewable resources, storage would be very useful on the grid to get the full bang from those resources. Then we’d be able to take on off peak wind and solar and maximize the contribution of renewable resources to the grid. On a functional level, there's the understanding that it makes sense. Now, in terms of regulation and incentives, that’s a whole different story. So while we appreciate that there's value, or there could be value, the regulatory regime and some of the incentives are lagging. So that's the mismatch that we see right now. I think ultimately it will happen. It's just a matter of timing.

Ralph: There's three types of applications for UC storage. You could either A, have it on a stand-alone basis. B, you can combine it with another generation asset like a solar or a thermal gas asset. Or C, you can clip the storage, like a battery, to an application in some kind of vehicle such as buses, forklifts or some other application like that. Generally, they're small and if they're small, they get taken out. I mean, there's no lively syndicated deal. They’re so small and when they do come out, they usually get financed by one guy. So these are private deals. The stuff that gets tracked are the larger ones and we do get the larger ones, there just haven't been a lot for lenders to sink their teeth into.

Ren: As a matter of fact, there's cost. The battery prices have gone down quite a bit over the last couple of years and they continue to drop. Some of that is driven by UV fans and some is driven by efficiencies in technology. So as those resources get cheaper, that conversation starts to become much more viable. So all these things that are happening, they're not real time.

Ralph: But just to be clear, we've seen a number of RFPs come through. Sometimes they're just capacity placed, so it doesn't make sense for many institutions to lend to it because it's very cheap financing.

Infocast: Per our previous question on the PPA come back, can you explain your rationale for equating higher capacity pricing to be an equivalent to the revenue security that a PPA provides?

Ren: Sure. So just to clarify, so we're all on the same page. What a PPA does to an owner of a power plant, is assure them some level of cash, so they know they can increase all their power. So that's what incents a builder to build an asset — they know that they're going to make money and get a return on the equity they invest. The other way that they can be assured some cash flow, is capacity prices. So certain regions, let's say the most popular one like PJM, will tell you, if you qualify, that they’ll guarantee you a certain level of cash for your capacity. And they determine this three years out. So if you've bid in 100 megawatts, you know you're going to be paid a certain amount of cash, just for having the capacity available into the market. And when PJM lists the capacity price for qualified plants, it's a signal to the market that they want to incent developers to come and build megawatts — they need those megawatts. Now, it's not a perfect solution because it doesn't guarantee you long term. But it's certainly a strong indication that your asset would be valuable in that region. The only problem is, if it's like a gold rush, PJM might lift their capacity price one year and then there’s tons of developers coming out and putting assets down. Then it could fall because they don't need so much. But it's a double-edged sword.

Ralph: Those are all great points! One of the distinctions we should make is we've been able to crack the code in terms of merchants for gas-fired generation. So, if a regulator and a governing body doesn't need to sign long-term PPAs and pass that on to their rate base, then they don't. Then they'll probably save some money that way for the ratepayers. Now, making the distinction for renewables, it’s still to be tested that we can get renewables done without long-term PPAs. That's where the gas-fired market is much further ahead. Yet the renewables market is still trying to figure that out. Can we get there? It's all to be seen but generally, if there's no need for a long-term PPA, then we probably won't see them.

Infocast: Will we come to a point where traditional project finance (i.e., investment grade off-takers, long-term contracts, stable cash flows) where they will play a very limited role in the power market?

Ren: That's interesting. Look, anything's possible. My vote is it's unlikely. And trust me, we are not a player that plays just with fully contracted assets. I think there's a place for everybody. I mean, there's going to be a need for someone who wants the power on a long-term basis of regulator utility. If he's short power, he may enter into a PPA. Definitely, right now we see a lot of merchant plants being built and PJM has been a huge area for this. But do I see PPAs going away? I don't think so. I don't know what you think, Ralph.

Ralph: Yeah, I don't see them going away. I think in general, in terms of orientation, we have to be, as an industry, prepared to do things other than PPA financing. That would be part of the mix, but we're going to start to see a lot of revenue profiles. If you want to capture the full market, there's a lot of opportunities.

Ren: There's so many players out there and everybody has a different business model. Just like some people are risk-averse and some people are risk-on. So depending on what you're looking for, if you're risk-on, you might build a power plant.  Decide to roll the dice and see where the power prices take you. But other guys won't do that unless they can be assured some kind of return. So I think the market is so deep and so wide, I don't see PPAs disappearing. The counter price can be different. And just to be clear, it's not just investment grade off-takers. We see some investment grade off-takers, corporate off-takers and municipalities that may not have a rating. There's a lot of different people out there that could be a counterparty to a PPA or even a hedge, which isn’t mentioned here.

Ralph: We'll just see. We're expecting a market where the standard utility PPA is not the only way to get a project done. There's going to be a lot of different combinations.  [/read]

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