Rod Morrison: Sajal, we heard the discussion earlier about the possibility of institutional debt.
Do you see the long-term debt market evolving for these projects?
Sajal Kishore: Yes, but I think it will be a bit challenging right now given the unique risks that sit with these projects. Offshore wind is a lot more complex from a construction point of view, but equally, even in the operating phase there are additional layers of complexity if you were to compare it to other forms of renewables. And then it has issues about the balance of plant equipment sort of risks, as well as undersea cable risk, et cetera. So, there are additional layers of risks that sit uniquely with offshore wind.
We rate over 70 renewable projects globally and, at the moment, we have a handful of offshore winds that we rate in Europe. So, it’s not that it cannot be rated, it can be rated, and it can be rated investment grade as well.
But for Japan, I think the need for ratings is still some time away. The early-stage financing, in my view, is an equity financing or a recourse finance by the corporate sponsor supported by financing from the bank market. This is something that we’ve seen in other jurisdictions in Asia, like in Taiwan or Vietnam, where the evolution of financing of renewables in those markets is more from the bank market. As and when these projects get de-risked and move into the operating phase, they will start to seek more capital markets issuances. And hopefully by that time, the regulatory regime would also be more settled to attract the long-term institutional investors, who would be reluctant to take an additional layer of merchant risk at this stage alongside the other risks with these projects. Besides, I guess there are also issues on curtailment on these projects, which have been spoken about as well.
Rod Morrison: In terms of cable risk, is that something you’ve seen as well. Has that been a major concern in terms of insurance?
Sajal Kishore: Not so much for insurance because of the projects that we rate in Europe, some of the cable risk sits with the project and for others it doesn’t. There are a number of offshore transmission companies, which deal with the cables and so this is outside the project’s scope. For offshore wind, the issue comes down to the scope of the project. Whether the cable is part of the project or not. We’ve had sort of a mixed bag of projects.
Rod Morrison: Daniel, obviously SocGen, along with some of our other banking panellists have been involved quite heavily all over the world.
How do you see your experience globally, but also how it will develop in Japan? In terms of financing these projects?
Daniel Mallo: So, in terms of capital, maybe we can draw an analogy with Taiwan and see what’s different. So, when the industry started in Taiwan, two things stood out. No domestic equity. There were no local power companies that invested in the sector, all the equity came from overseas. We had Macquarie from Australia, WPD from Germany, GUA from Japan, Northland Power from Canada, etc.
But there were no domestic equity capital providers in this sector.
And then on the debt side. Today around US$9bn equivalent in Taiwanese dollars has been raised, but only about 20% or 22% of that money came from the local banks. All the rest came from international banks and sometimes ECAs. And again, we had a situation where the local banks, while they were flush with liquidity in local currency, just didn’t have the knowledge base or the credit skills for offshore wind. None of the Taiwanese banks have ever invested in an offshore wind farm in the UK or in Germany, or in Belgium, or in France.
Now we move to Japan. A completely different landscape. In Japan we have sophisticated equity investors that have a track record in offshore wind: Marubeni, Mitsubishi Corp, etc, have invested in the European markets. They have that knowledge. On the lending side, on the debt side, it’s similar. SMBC, Mizuho, and MUFG have all been participants in offshore wind in Western Europe. So, the knowledge base exists. The liquidity exists. And those large banks have the ability to bring in a second tier of regional Japanese banks in syndication. So, it’s a very different landscape in my mind between Taiwan and Japan. That’s the first thing.
The first transaction has occurred; it closed in February. What happened with that transaction? We had about a dozen equity investors in Akita Noshiro, all of them Japanese, although two of them own more than 10% of the equity, all the others have very small or relatively small equity stakes. But it’s a consortium that’s formed purely of Japanese investors for this first project. That’s interesting to note. On the debt side, there’s about a dozen or so financiers. All of them except one, SocGen, are Japanese. We were an outlier, everybody else is a Japanese bank or a Japanese institutional investor. That’s the first transaction. A billion dollars, US$200m equity, roughly US$800m debt.
So, what will the future now be made of? Clearly, there’s a lot of interest among international equity investors to find their way into this large market. Ray is very interested in that market, so are all of the international investors, Equinor, etc. Or they’re looking for a way to come into that market. Will that happen? Will it happen in the first round? Will it happen over time? Will there be partnerships being forged between some of the local investors and the internationals? I think it’s possible and likely, and it’s going to be a function of what you bring that adds value. Capital is not in short supply in Japan. There’s a lot of capital available. So, that is not the issue. For a third party and international player to come in, they have to bring something in addition to just capital: knowledge, skillset, experience in floating offshore. Those things would be valuable.
On the debt side. Again, we have a lot of liquidity domestically, and SMBC and DBJ I’m sure will talk about that, but there’s plenty of liquidity available. Large Japanese banks, second tier, regional banks, there’s a huge liquidity pool that can be canvassed. Will there be room for international banks? We think so. And that’s one of the reasons we tried really hard to be in Akita Noshiro, the first transaction, because we think the industry will grow very quickly. And the amounts of capital will be huge. When I say there’s US$9bn of debt capital in Taiwan to date, Japan is likely to dwarf that number. So, the numbers will add up very quickly and I think there will be room on the equity side and on the debt side for internationals to co-invest alongside domestic market participants.
Rod Morrison: I guess, Daniel, it’s also partly the size of the opportunity and how quickly it comes forward. I guess it’s a question of how big and how quickly the timetable is processed in terms of the need for external capital.
Daniel Mallo: That’s absolutely right. I think the numbers are large and they will add up quickly. Today, if we look back at Taiwan again, a number of international institutions have loaned to all four projects. We’re one of those. It starts to add up, right? You start to add up exposure. All those projects sit in the very same typhoon corridor, they sit in the exact same location, and they have the exact same off-taker. At some point you will reach a concentration issue, taking the same risk time and time again. Whether it’s weather risk, whether it’s off-taker risk, whether it’s sovereign Taiwanese risk for that matter. So, I think there will be a need for a variety of market participants and a deep market in Japan.
Rod Morrison: Can I just move to Ray McLaughlin next from the developer perspective? You had a couple of points from the previous comments. So, Ray.
Ray McLaughlin: I just wanted to go back quickly to Sajal’s reference to the Vietnamese market. We’re developing 1.9GW there under development licences at the moment and it really concerned me when Sajal mentioned that the beginning of the Japanese market may be similar to the beginning of the Vietnamese market. We’re an early-stage equity player, emerging markets specialists in offshore wind, so I’m hoping it’s the complete opposite in Japan because there is already that wealth of experience in Japan and, to echo Daniel’s comments, we have the usual suspects playing at the table at the same time. We’re not going to see the development banks participate in Japan as we have seen kick off the Vietnamese market, as in KFW’s example. Before KFW entered that market, nobody else looked at it. But in this instance, in Japan, we have SocGen, SMBC and MUFG, DBJ, big banks, established banks. One of the requirements that we’ve read into the current bidding process is it’s not just the developers or the partnerships that need to have a 10-year track record, but the lending banks have to show a project finance skillset in the market, either in Japan or historically elsewhere. So, there is going to be the same blueprint banks participating in the same projects time and time again, until that first round, second round brings stability. Syndications will happen and then the secondary transactions, like in the Taiwanese market, will happen.
I hope we see the capital markets evolve dramatically quicker than in the emerging economies, because the off-takers, the 10 regulated utilities, they’re all sitting with investment grade credit ratings. So, I’m hoping we see construction bonds come to the market a lot quicker than any of the other emerging market developments that we’re involved in in Asia at the moment. So, I think we’re going to see the deployment of both debt and equity expedited, not only driven by net zero targets, but also driven by the need to mobilise capital for ESG, for climate change, for the greater good. But only assuming the right partnerships with the right skillset are in place such as the SocGens, the SMBCs, and the local Japanese partners who complete that trifecta skillset. Together, with the large oil and gas players, like the Apexes of the world, in respect to having the risk appetite to go into these markets knowing that it’s no different than the UK market 20 years ago, then the foundation will be created. The market will go from US$300/MWhr in the next decade down to as low as US$40 or US$50/MWhr if efficiencies and innovation occurs across the technology set.
Rod Morrison: I just want to move on to Manabe-san at SMBC. We had a question from the audience. I’m not sure you can answer it, but what lending margins do you think will be on your projects? There’s a suggestion here of TIBOR plus 2%. I don’t know if you’re going to tell him the lending margins, it’s a fellow banker. Anyway, SMBC, obviously a big global player in offshore wind. How do you see the market develop in Japan? Similarities and differences to the rest of the world.
Takehisa Manabe: Japanese markets are somehow unique from a liquidity point of view. As Daniel explained, Japan has plenty of liquidity to support at least the next 10 years of development. The Japan offshore wind market is unique in terms of almost all the Japanese and some of the foreign players coming into this market have experience in developing offshore wind projects in other areas of the world. So, some of the Japanese players will play a major role in this development. A second point is the position of the mega Japanese construction companies. They may have limited experience in constructing offshore wind projects but, given their strong track record with construction in the maritime industry, it would be reasonable to believe that they can deliver the projects efficiently once the EPC contract has been agreed.
A third point is the structure of the PPA, especially relating to the potential issue of tariff reductions with COD delay. For example, in case capacity is only being built up to the 80% of the agreed megawatt output there would be a risk that the PPA tariff will be reduced. I think fixing the legal framework on this issue is important for the banks, in order that they can provide a sustainable financing solution to offshore wind projects. But I think there is plenty of liquidity, so TIBOR plus 200bp would be a healthy margin for banks and sponsors.
Rod Morrison: Do you see institutional debt maybe coming in at a later stage for these projects? Or as a refinancing plan?
Takehisa Manabe: Institutional debt means an institutional investor with a bond. So, I think they would come after completion. But at this moment, the bank market in Japan is very competitive, and coming with a bond would be much more expensive. At some point, as Daniel said, we will reach the issue of concentration risk, but until then I think bank debt will dominate in supporting these transactions.
Rod Morrison: So, Manabe-san, just one quick question. We see firms, like the major insurance companies, joining deals already on the bank debt side. Some of these major Japanese life companies have actually joined project finance loan syndications. Is that correct?
Takehisa Manabe: That’s right. So those major life insurance companies already in the project finance business, and also financial investors such as Norinchukin, have experience in project finance. They can make an investment in a bond style but they are providing liquidity on the debt side which is another unique feature of the Japanese market.
Daniel Mallo: And I think that’s key. They can provide floating-rate bank debt and fixed-rate bonds. We see them on both sides. They complement the banks from that standpoint.
Rod Morrison: Thanks, Daniel. So, moving onto Yasuda-san.
Shinichi Yasuda: Another important thing is that Japanese local banks and other big banks have already provided large commitments and liquidity to Japanese solar projects. Solar projects started in 2012, and so there’s a long history. And, right now, some of the existing debt lent to solar projects has been repaid, so the outstanding debt provided by Japanese banks has already started to decrease. Offshore wind power projects provide another opportunity for the debt market. Therefore, I think that, except for institutional investors, the traditional banks and the commercial banks, might provide plenty of liquidity for these transactions.
I think Round One auctions will start soon, so by November 2021, we will see the winners and by 2025 or 2026 we will start to see construction. Therefore, until 2025, the lack of liquidity might not be a problem for Japanese market. On the other hand, after 2025, I think it will be a big problem. Therefore, it’s very important for us to work out how we increase liquidity for debt.
Rod Morrison: And lastly, Okubo-san, your thoughts on financing. Obviously, you’re an insurance expert, but could we have your thoughts on how you see the financing market develop?
Soh Okubo: Project financing is the key to the project, and from that point of view, insurance is an important aspect. For instance, there is a cover call for business interruption and blank start-up. It covers for the time when losses occur. So, if we have an accident and the whole project is delayed for 12 months, or 24 months, then insurance should cover the losses. And that is one of the requirements of all project finance. So, for project financing, the issues of start-up and business interruption will be the key insurance to be placed, not just property damage and certified liability.
Rod Morrison: Thanks very much, Okubo-san. I want to ask the panellists on the equity side. Do we see there being a Japanese flavour to the industry or will some of the global players such as Orsted, GIP, the Copenhagen Infrastructure funds of the world, enter this market?
Ray McLaughlin: I’d be happy to give that one a go, given the fact these guys are our peers. We sold the Hornsey three gigawatts, the ones that Orsted are currently developing, we sold them to Orsted. So, I see them coming into the market, and I see them exploring partnerships with local players.
But you have to remember that the skillset that is possessed by the development organisations, a lot of the time it is acquired. And I think there’s going to be undoubtedly roles played by the international developers, expanding upon the work that was executed in Taiwan recently. I think it’s a natural progression to move from Taiwan to Japan, or Korea.
And because there is a greater thirst for projects and an ability to deploy capital, you’ll see a lot of these vehicles coming to the capital markets, in Orsted’s case, for example, in Taiwan. But the other large managers, such as the CIPs who have raised new funds, they need to deploy those funds in areas where they can de-risk and target real returns. I think it all depends on how quickly the market gets comfortable with the equity IRRs on a levered basis in Japan, versus the equity IRRs in Taiwan, which I think are now as low as 70% on a levered basis in Taiwan’s perspective.
Undoubtedly, the international developers such as ourselves will play a role in this market. But as Daniel highlighted, it’s not going to be our capital that is necessarily required, it’s going to be our track record, our innovative approach in raising a new market making marginalised wind resource profitable and viable so that they can be financed, creating the cycles and the foundations of this market.
I am very conscious that a lot of the large Japanese players have huge exposure to both offshore and onshore wind whether it be in Latin America, whether it be in Europe, whether it be in Asia, as the markets developed locally. But I think it’s going to be imperative to form partnerships, and valid partnerships, with each of the partners, bringing complementary skillsets to the table.
And I think we need to commend the Japanese government on the legislative process, in that they are awarding a good points allocation for that international skillset in order to be part of the consortiums. It’s not just the development skillset that comes into play, it’s going to be the experience in establishing supply chains, the OEMs and the turbine supplier being comfortable with the developers that they are working with. That they know how to deliver projects through to financial close. And ultimately COD so that it further reinforces the market. I think it’s going to be exciting to see where those partnerships settle. Obviously, the Akita project that Daniel brought to financial close recently, it’s a consortium of over 10 Japanese counterparties. If I’m not mistaken, Daniel.
We’re going to need some of those parties to take a leap of faith and engage with international developers, such as ourselves, to say “let’s go on this journey together” and be able to transition, not only the development expertise, but the other skillsets that de-risk the supply chain, and de-risk insurance. That only comes from experience, and real, practical experience in market.
Daniel Mallo: If I can add to that point, Rod. They’re all opening up offices in Japan, so they’re very attracted by the market. Those investors, CIP, Orsted, Ocean Winds, they’re looking for two things. Growth and returns. They want to add megawatts, so they are attracted by the growth prospect that Japan can offer that.
Returns are going to be trickier. We see returns getting eroded in Western Europe, and those investors are looking for returns elsewhere. They found some returns in Taiwan early on, but Japan is not always known as the country of high returns. It will be very, very competitive. So, we will see if they’ll get the returns that they’re seeking, but they’re certainly attracted by the growth prospects.
Ray McLaughlin: That’s where the innovation comes in. Being able to differentiate. Finding some of those marginals, the ones that others cannot make work.
Rod Morrison: Maybe we could wrap up with Taba-san, and Sajal Kishore. We did have a question from the audience, Taba-san, although I’m not sure you could answer it because it basically says that developers with local partners tend to win concessions. Do you expect a similar trend for offshore wind projects? Although I guess around the world, local expertise is important, whatever market you’re in.
Hirofumi Taba: Of course, it’s crystal ball gazing. But I think there is a distinction to be made with previous concession auctions. Offshore wind is a different beast. You need real expertise to develop these things and I think it has to become a mutual partnership. It’s got to be of benefit to commercial developers and local developers. So, it’s a genuine partnership. I expect the outcome will be different from previous infrastructure concession auctions.
Rod Morrison: Taba-san, if you’d like to make a few concluding remarks from our discussions today?
Hirofumi Taba: Thank you very much. I think it’s been very, very productive, with some very interesting insight from all the participants.
I think, generally, it’s still a nascent market, and the government wants to progress incrementally. But it is a market with potential and, like all of us, we’re very committed to its development, and that’s very exciting.
Rod Morrison: And Sajal. A few concluding remarks.
Sajal Kishore: I would like to echo Taba-san’s remarks, that this is an exciting prospect. A new market with a lot of growth potential and there will be opportunities down the track from a rating agency angle. That’s a few years down the line, but it will come. And it opens up a new space in Asia that will benefit from the experience gained by developers have in Europe.
Ray McLaughlin: Rod, can I put one final request in? If possible, it would be great for the really key stakeholders in the market to consider priority dispatch for offshore wind. I appreciate that the mechanism from a feed-in premium is one that is being proposed, but if you’re going to build at scale, I’m surprised that there hasn’t been priority dispatch given to some of these new markets that have yet to amass any skills.
So, I think it’s something. Whether it be fixed or in the floating space, priority dispatch is something that is undoubtedly going to help de-risk and create the foundations for the future of the market.
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