Rod Morrison, PFI: Welcome to the Refinitiv Project Finance International (PFI), Financing Japanese Offshore Wind Farm Projects, webinar sponsored by Fitch Ratings and Linklaters. I’m Rod Morrison, editor of Refinitiv PFI. I’m joined this afternoon by a distinguished panel of experts from the legal, rating agency, bank and developer community to discuss this exciting new market. I say new, this market is relatively new to Japan, but of course offshore wind has become a topic of great interest across the world and Japanese companies are some of the leading players in the global market. What is new is the development of schemes inside the Japanese market.
Precedents have been established overseas in Northern Europe and closer to home in Taiwan and how these precedents will be taken forward into the Japanese market will be one of our discussion points today.
Japan is one of a number of major new markets where schemes are now emerging. The US is perhaps the other new major standout opportunity for offshore wind. But each market will have its own unique characteristics. This will be explored this afternoon in relation to Japan.
I think it’s fair to say progress in developing the offshore wind sector in Japan has been slower than initially hoped, but this year we have seen major progress. The first deal, Marubeni’s 140 Akita project reached financial close. The tender for the 21-megawatt (MW) Goto floating wind scheme has been launched with bids due soon. The auction for the next phase of the Round One programme is due to start shortly. Four fixed-foundation 300MW to 400MW projects are up for grabs off Noshiro, Choshi and two sites off Yurihonjo. So, this is an ideal time to discuss developments in the sector. This market is starting to emerge and floating offshore could also be a very exciting development for Japan but, at the same time, challenges are emerging, too. Some of them localised and some already familiar to global players.
So, now I’d like to start our discussion by asking each panellist to briefly introduce themselves, then we’ll move on to our two discussion points: the market opportunities and challenges; and financing the projects.
Hirofumi Taba, Linklaters: Thanks Rod. I’m Hirofumi Taba and I’m a partner at Linklaters focusing on energy and infrastructure transactions.
We have been looking at the offshore wind sector in Japan since 2017 and I am very, very excited about its progress. I personally think the industry is heading in the right direction. Our thinking is that all players, international and domestic, should be on a level playing field to maximise the prospects for this market and so we have produced three offshore wind reports in English, which have received very positive feedback. That’s also the reason for this discussion. I hope you enjoy it and find the roundtable very useful.
Rod Morrison: So next, Sajal Kishore is the senior director of global infrastructure ratings at Fitch Ratings.
Sajal Kishore, Fitch Ratings: Thanks Rod. Yes, I’m Sajal. I’m based in Singapore. I head Fitch’s Asia-Pacific infrastructure and project finance rating’s group. We at Fitch have been rating renewable transactions in the capital markets space for quite some time now. I think globally, the first solar ratings that came out were in 2011, but in Asia we started looking at renewables ratings from 2015 onwards. Renewables is clearly a huge and significant growth opportunity in Asia-Pacific. Its potential has benefitted from the pandemic given the increased demand for green and sustainable infrastructure. We expect to see a lot more renewables transactions hitting the capital market space in future. So, in that sense, Japan holds out good prospects for us in the next few years.
Rod Morrison: Moving on to Daniel Mallo, managing director and head of natural resources and infrastructure, Asia-Pacific for Société Générale.
Daniel Mallo, Societe Generale: Thank you Rod. My name is Daniel Mallo. I run the energy finance practice at SocGen here in Asia Pacific. It’s very exciting to be talking about this young industry - offshore wind in Japan. Over the last couple of years all the talk has been about Taiwan, but it’s great to have this opportunity to discuss the prospects of the market in Japan. At SocGen we’ve been very involved in offshore wind all across Europe: in the UK, in France, in Belgium, in Germany. Closer here to Asia-Pacific, we financed all four projects in Taiwan to date, that’s about 1,700MW of capacity. We also financed the Akita Noshiro project with Marubeni earlier this year that you referred to earlier, Rod. I think what’s going to be exciting to discuss today are three things. A: the opportunity. Japan is seven times the size of Taiwan in terms of the power metrics, and Japan is accelerating its energy transition, so that should be a land of opportunity for us.
Secondly, what needs to happen to have this industry mature. To me the topics that we could discuss are cost, the grid, curtailment, and environmental and social approval processes. Then thirdly, where will the capital come from? Debt capital, equity capital, domestic capital versus international capital. So, I’m looking forward to the discussion. Thank you.
Rod Morrison: Moving on to Manabe-san, joint general manager in the structured finance department at Sumitomo Mitsui Banking Corporation, SMBC.
Takehisa Manabe, SMBC: My name is Takehisa Manabe. I work for SMBC and I’m acting as a joint general manager in structured finance Tokyo where we have covered offshore power projects from 2010. Globally we have supported over 60 offshore power projects in UK, Europe, Asia including Taiwan, the US, as well as Japan. Now, we are seeing the development of offshore wind power project financings in Japan. We are excited to contribute to the development of Japan’s offshore power industry from a financing point of view as well as from a capital and structuring perspective. Thank you very much.
Rod Morrison: Next is Ray McLaughlin, head of capital markets at Mainstream Renewable Power.
Ray McLaughlin, Mainstream Renewable Power: Thank you Rod, it’s a pleasure to be here today and I’m looking forward to bringing the developer’s perspective to the table. Mainstream Renewable Power is one of the world’s leading developers of offshore wind, one of the world’s leading privately-held developers of renewable energy. We have a 12-gigawatt (GW) development portfolio on five continents. We’re also still the owners of the largest offshore wind development currently in existence, the Hornsey blocks in the UK, and we’re very excited to enter the Japanese market and explore new partnerships to investigate how we can bring our extensive expertise and experience in the fixed ultra-wind market, and introduce the innovation that will be required to grow the floating offshore wind market to efficiently capture Japan’s true potential in hitting its 2050 net zero targets.
Rod Morrison: Moving on to Okubo-san, manager at Tokio Marine and Nichido Fire Insurance.
Soh Okubo, Tokio Marine and Nichido Fire Insurance: Thank you very much, Rod. I’m the manager of Tokio Marine and Nichido Fire. Tokio Marine is one of the leading insurers in Japan. We have the capability of underwriting many projects and we have already underwritten 45 projects worldwide, including the projects in Taiwan. So, we would like to provide any insurance advice, and also the insurance coverage, to all the Japanese wind farm projects. We can probably give you a lot of feedback from the lessons learned from our previous losses. So, thank you very much for inviting me today, and I hope my information can be useful to the audience.
Rod Morrison: And finally, introducing Yasuda-san, senior vice-president of the structured finance department at Development Bank of Japan (DBJ).
Shinichi Yasuda, Development Bank of Japan: Thank you very much for letting me join this conference and I’m happy to discuss our insight of offshore wind projects. DBJ is a unique organisation, wholly owned by the Japanese government. Our main involvement in the process is as a member of the working group as part of the bidding process. Our general director is one of the members of this type of working group.
DBJ has, so far, invested in four UK offshore wind power projects and one Taiwanese project with ordinary equity and mezzanine equity. We are excited to see the new opportunities for Japanese offshore wind power development and we welcome the liquidity brought into the market by foreign sponsors and investors.
Rod Morrison: We start the first part of our discussion, looking at the market opportunities. It’s obviously very exciting, but every opportunity comes with challenges. Linklaters has produced a few reports over the last couple of years on offshore wind. So, perhaps if we start with Taba-san, he can run us through not only the exciting potential for this market, but also some of the challenges. Taba-san.
Hirofumi Taba: We’re seeing a lot of interest in the sector. There’s a lot of activity, not only in the Round One auctions, but up to a potential round five auction process. In terms of an update, I would like to divide it into three key developments: one is around longer-term discussions; the second is the Round One auctions and the third is the recent amendment to the feed-in-tariff (FIT) act.
Of the first one, the long-term discussions, green recovery and digital transformation are two growth areas that have been on every government’s agenda. Prime Minister Suga has announced Japan’s commitment to be carbon neutral by 2050 and offshore wind is expected to play a major role in the energy policy. This debate started on October 13 with discussions focused on its longer-term energy-mix plans. It remains challenging to restart/commission new nuclear reactors and, in the absence of further technical innovation, it falls on offshore wind as the alternative. The Ministry of Economy, Trade and Industry (METI) and Ministry of Land, Infrastructure, Transport and Tourism (MLIT) indicated earlier, in terms of goals, that they wanted to auction one gigawatt per year of approximately 200MW projects each. They have reiterated that this is not a cap.
In terms of the longer-term discussions, the first public/private council was held in July, which was meant to be a forum to discuss longer-term targets. At this forum, it was reported that the aim was to create a virtual cycle of continuous investment and growth. It is part of the de-carbonisation plan. Other policies of decarbonisation include coal-fired phase-out in the domestic market and heightened requirements for supporting coal in other countries. It was repeated by Minister of Economy, Trade and Industry Kajiyama that offshore wind is a key industry in terms of scale, cost-effectiveness, economic impact and job creation. Emphasis was also placed on predictability. A necessary requirement if they are to invite and attract investments into the centre.
Moving on to the Round One auctions. As Rod mentioned, the Akita Noshiro project achieved financial close in February. This was a port project. And the Round One auctions, which is an auction for a thirty-year permit and a feed-in-tariff, started earlier this year. Goto is the first one, it’s a 21MW floating project. For the three remaining projects, Noshiro, Yurihonjo and Choshi, the auctions are expected to be launched sometime soon. In July, another four promising areas were announced: two in Aomori, one in Akita and one in Nagasaki. These are expected to be Round Two projects. The Round One auction was delayed for COVID reasons, but it’s likely that there will be two rounds of auctions in the next 18 months.
I have had some direct interaction with METI and MLIT officials, who have been very open to discuss their auction guidelines with market participants. In fact, there has been an extensive exchange of opinions with the market, and while their responses may not have satisfied everybody, it is clear that they have given some consideration to the feedback and responded thoughtfully.
Some issues in the auction guidelines I would like to highlight, and I think some of the issues will also be touched upon by other participants. The ceiling price. METI has opted to disclose the ceiling price for the three fixed-bottom projects. It’s ¥29. That announcement sent shock waves through the market as a drop from ¥36 to ¥29 seemed a big one. It demonstrates however, that METI and MLIT are willing or expected to reduce the tariff.
The second point is around the scheduled commercial operation date (COD) and any delay in construction risk. It is clear that that is a bidder or a project risk. So, any delay will result in a shortening of the revenue period and means the bidders will need to take that into account when they bid, and propose the scheduled COD.
Fishing communities and local communities. There is a requirement to establish a fund to address these issues. The details of the terms of the fund, how it’s going to be used, and the amount will not be certain at the bid period, that will be subject to discussions, post-award.
Decommissioning costs for the fixed-bottom projects has been set. It’s not part of the regular evaluation. It will be 70% of the marine construction costs. Feedback is that it’s too high, something recognised by METI and MLIT. Therefore, there are expectations of further discussions and amendments, if necessary, to the occupancy plan, post-award.
Eligibility and evaluation criteria: the no-foreign investment restrictions. There are some questions about how the track record in other parts of the world is taken into account. I think this is important and something about which I personally had some discussions with officials as to how to evaluate and to take into account the track record in other places in the world. It’s not the shareholding, necessarily in other projects, it’s the role played and how that knowledge is going to be used, or deployed into particular projects in Japan.
There have also been some discussions about technology. While of course, for efficiency reasons, METI and MLIT will want the latest technology, at the same time, the reliability of the technology will be an important part of the evaluation. There is recognition that the natural conditions in Japan may not be the same as in Europe.
And share transfers. I think Yasuda-san will discuss this later on, but there has been some flexibility indicated in the auction guidelines, which would allow capital recycling and reducing the cost of capital.
So, these are the key issues. I think, in general, that whilst METI and MLIT have retained some discretionary rights, from my experience dealing with METI and MLIT I think that they will be reasonable in discussing any developments in the future and thoughtful in the exercise of their discretion in the auction guidelines.
Finally, amendment to the feed-in tariff act. In June, a piece of legislation was passed, which is expected to come into effect on April, 1, 2022. It consisted of three pillars. First, it’s an introduction of a market-driven subsidy regime, which is called the feed-in premium. The second is upgrading of the grid and associated financial support nationwide, not regionally. And requiring some reserve for the decommissioning cost. The market-driven subsidy, feed-in premium. The premium will be added to the market price with the idea to integrate larger-scale generation facilities into the wholesale market.
The basic framework is established in the legislation, but the details remain under discussion. There have been two meetings of the government committee, in August and October, and nine issues are being discussed. To give you an example, the type of technology that will be subject to the feed-in premium, how you calculate the feed-in premium, what is the market price, how do you refer to a market price? Curtailment and battery storage are also key issues that are under discussion. So, despite the issues with the COVID-19 pandemic there have been significant milestones achieved. These are very interesting and exciting times.
Rod Morrison: Thank you Taba-san. That’s an excellent laying out of the groundwork for our discussion today. Moving on to Sajal Kishore, if you’d like to talk about the opportunities and challenges from a credit rater’s perspective. Sajal.
Sajal Kishore: I think there is obviously, as Taba-san mentioned, a lot of potential from a resource point of view in Japan and elsewhere in Asia. Taiwan has made a lot of progress in this space from an offshore wind development point of view but, equally, we see similar prospects in Vietnam and China as well. So, there is abundant and good resource potential for offshore wind in the region, including in Japan.
From a capital markets issues perspective, there are still some challenges for renewables in various countries. We’ve only seen capital markets deals come out of the Indian market and some private discussions on Chinese renewables. But we haven’t really seen any renewable issuances come out of any of the other countries. Now, for offshore wind, given where it is in its evolutionary stage, it’s more an equity and bank debt story currently and probably a few years away before its ready to tap into the capital markets. In this sense, I see Taiwan would probably be one of the first countries to come to the capital markets in offshore wind, given it’s an early starter in this space in Asia.
Japan still has a fair way to go. That’s not just due to the evolution of how these projects are typically funded, but also from a regulatory and bankability or investability perspective, which is something we focus on: really the PPA; the curtailment risk, as Taka-san mentioned; and there are a few other regulatory or contractual issues which will need to be looked at. And those would need to be mitigated in a sufficient manner to give comfort to long-term investors, invested in these projects.
As I said, there is a lot of potential out there, but it’s really about getting the framework right, and I think that is always a challenge in the initial stages. We’ve seen that happen in markets like Vietnam, which again from a solar and wind development perspective, has been more advanced, but continue to face challenges in terms of accessing long-term capital in the capital markets space so far.
Rod Morrison: Daniel, you mentioned a couple of points in your introduction, and I also know you’ve been looking quite closely at the turbulence in the floating offshore wind market. Daniel.
Daniel Mallo: So, a couple of comments on the opportunity. Look at the sheer size of the opportunity. The power system in Taiwan has just under 50GW, whereas the power system in Japan is around 330GW. The market in itself is seven times bigger. So, Japan has the potential to dwarf Taiwan over time.
The second thing to say is, what is offshore wind? Offshore wind, in my mind, is an accelerator of the energy transition process because you can do big projects, and this is particularly relevant for a country like Japan where land is expensive, land is scarce, and there’s only so much you can do in terms of onshore wind or solar. So, offshore wind has the potential to jumpstart, to accelerate, to leapfrog other countries in terms of the energy transition.
In terms of the opportunity, it is the size. Now what needs to happen to realise the potential? And I want to pick up on a couple of comments that Taba-san made on the ceiling price, for example, as costs will matter. Akita Noshiro, the first project, it was a great start for the industry. It’s 140MW and cost a billion US dollars. It’s relatively expensive, but that is not abnormal, right? I mean, it’s the first of a kind. Serial number 001. So, there are a number of costs there that have to be incurred just to get the industry started, but over time, costs should come down. And we’ve seen that in other markets. We’ve seen that in Western Europe, and we are seeing it in Taiwan for that matter. Costs will come down through two things: economies of scale, the projects will get bigger and that will help bring costs down; and then secondly, non-additional costs that are getting incurred, will be spread over a larger industry. So, that’s one factor to keep an eye on, in terms of the industry to develop.
The second thing that would help the industry accelerate is a streamlined environmental and social approval process. Japan has very stringent environmental and social laws, which is a good thing. It’s a good thing from an investor perspective, but sometimes the process can be a little bit lengthy. I think Taba-san is in a much better position than I am to comment on that, but we are talking several years to complete the environmental and social approval process. It’s good to be meticulous, it’s good to be thorough, but this might delay a little bit, progress in the industry. So, there’s maybe some merit to think about fast-tracking some of the approval processes in order for the industry to develop even faster.
And then thirdly, I think the other thing that needs to happen is the grid needs to be able to manage this influx of offshore wind. The grid infrastructure needs to be able to accommodate the hundreds of megawatts that will be developed at a time. Curtailment is a little bit of an issue in Japan for other asset classes like solar, for example.
Those are risks. They are risks for equity; they are risks for debt. They will have to be managed properly. And then I would just like to maybe make another comment on Sajal’s line of reasoning around issuance in the capital markets. I think the capital markets are a great tool for those assets, those offshore wind farms, the long-term, long economic life assets, 25 years, maybe longer. The capital markets are ideally suited to fund those assets. They’re even more suited when those assets are operational. It’s a little bit harder to fund some of the construction processes in the capital markets, as they can be a little bit lengthy, and there’s just a little bit less flexibility in terms of drawdowns over time. But, as some of those projects move into COD, as some of those turbines start spinning, I’m confident that there will be opportunities for the capital markets to become a refinancing market for some of those operating assets, particularly in a country like Japan, which has a deep institutional investor base in Japanese yen.
Rod Morrison: Can you discuss the dominance you’ve seen there, Daniel, in the floating offshore wind market?
Daniel Mallo: Absolutely. So, on the floating side, and that is maybe a key difference between Taiwan and Japan, Taiwan is blessed with very easy conditions from a construction standpoint. A lot of the sites are relatively close to shore. Sometimes it’s as close as a couple of kilometres away and in very shallow waters of 15m to 20m in depth. So, it’s ideal conditions to develop offshore wind from a technical standpoint. It’s a lot less challenging than other jurisdictions. In Japan, the seabed drops much faster. The water depth actually increases relatively quickly, so the industry is likely, as it develops, to be pushed further away from the shore into deeper waters. And that will become more challenging from a technical standpoint.
So, over time, I think the market would be well-suited to floating offshore wind solutions, just given the topography of this country. And we have done some work on bankability around floating offshore in Scotland and the industry. The floating offshore industry is still young, but I think Japan could potentially be at the forefront of those developments, given its unique typography.
Rod Morrison: Manabe-san, if you’d like to talk through what you see in terms of the opportunities, but also some of the challenges that I know you see. Manabe-san.
Takehisa Manabe: I think the opportunity, as has already explained, is very good for offshore power in Japan. Currently we are trying to develop up to 10GW, up to 2030. But as Daniel said, Japan has over 300GW capacity, so if we assume 30% of future power will be renewable, we would have 100GW in potential. So, I think the 10GW target is just the initial stage. And after that, we will have more opportunities for offshore wind. For this initial 10GW, we will develop the fixed offshore wind base, and floating base offshore wind will follow.
One important step in the development of the Japanese offshore wind market must be to work together with the authorities. As Taba-san said, our feed-in tariff is very well established, but at some point, it will be adjusted and/or amended. In order for investors as well as financiers to make confident investment decisions, a stable legal framework is very important.
The important aspect from banks’ perspective is, for example, the timeframe issue, i.e., COD date or operational date issue, which as Taba-san said, may potentially include a FIT reduction risk. I think these framework issues need to be clearly clarified and documented by the authority in the Q&A process.
Also, transactions are exposed to curtailment risk due to transmission line capability. For instance, we have good wind conditions in the Hokkaido and northern area of Japan, but our transmission line capacity is not good enough to utilize such electricity in the area where demand is strongest. It’s up to the utility companies to enhance their ability to accommodate sending electricity from the northern part of Japan to the Tokyo area, where the demand is. Therefore, we are exposed to a project-on-project risk. How can we evaluate this project-on-project risk? Who could assess this risk in a realistic model? This is a very important point for investors and banks.
Japan has a really expensive assumption for the decommissioning risk arrangement compared to other countries, such as the UK, France and Taiwan. So, we may be required to reserve, or put aside, around 10% of the project cost for the decommissioning arrangement. This potentially increases the tariff for sponsors to secure a principal return. This point needs to be addressed in order for offshore wind to provide competitively priced and stable power.
As I said, it’s very important to work together with the authorities and it’s very important for the Japanese megabanks to play their part in supporting the development of offshore wind power.
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