1 December 2009
Energy financing in 2009 – a UK snap-shot
Background
Getting towards the end of 2009, it would be hard to argue that it hasn't been a tough year for many of the banks.
We have seen significant numbers of banks re-trenching from long-term debt, others have substantially re-priced risk and the terms on which debt can be provided as well as certain funders stepping back from particular markets, whether in terms of a specific sector or a specific geography.
With Lloyds Banking Group and RBS still largely Government owned, there is undoubtedly political pressure to meet lending targets of £11bn and £16bn respectively by next March. However, the banks are struggling to meet these targets and we have seen little in the way of "new" money being lent – hardly surprising given the conflicting requirements to lend more and re-capitalise at the same time.
In terms of lending policy, the banks have, in general, indicated that the energy sector is somewhere that they want to allocate their capital. In particular, UK banks are committed to lending into UK based borrowers and UK deals.
Strangely, while funding of renewable energy projects on a global basis has continued, very few deals have closed in the UK. The increased cost of debt, combined with currency fluctuations and the decrease in leverage have meant a number of deals have needed to be reconsidered, as sponsors bide their time in the hope the market stabilises.
Some big deals have been done in the oil & gas sector – most notably Tullow Oil's US$2bn facility – but the lower oil price has made funding assets more difficult.
General features
- Banks are unwilling to underwrite large commitments and we have seen an increase in "club" deals
- Margins have increased in all sectors
- Banks are looking for a greater equity investment
- In addition to looking at the financial standing of the borrower, banks are increasingly concerned with the credit ratings of each other, insurers and hedging providers
As with every sector of lending at present, a long-standing relationship between borrower or sponsor has proved key to finance being available on any terms.
While club deals help to bring together sufficient capital to meet funding requirements, club deals bring their own problems for borrowers and sponsors. Different members of the club will often be allocated to different roles (e.g. documentation bank, technical bank, insurance bank), but it is rare to see a lead bank empowered through that role to take decisions on behalf of the club. Understandably, each credit committee will need to be happy with every aspect of the deal. But this will always make the process more cumbersome and there is a risk for borrowers and sponsors that the end result is the "lowest common denominator". The frustrations of borrowers are obvious, perhaps driving a desire to postpone leveraged transactions or investments until a time where banks will take some underwriting risk – that time may not be far away.
Oil & Gas
The dip in oil price has had an inevitable impact on reserve based lending. Banks are using a more conservative oil price assumption in the financial model when assessing new deals, which has the knock-on impact that certain developments do not currently stack up for senior debt. These developments will not support senior debt unless and until the oil price settles at an increased level and the banks are prepared to use a higher oil price assumption in their modelling. Any borrower that signed its borrowing base facility when oil price was high may have seen the amount it can actually borrow fall below its original expectations.
As well as concerns over the financial standing of other financial institutions, banks are looking at the covenant of off-takers and operators to get comfort that financial difficulty of others will not impact on their borrower. Every aspect of a deal and every counterparty is being stress-tested – additional reserving mechanisms, further collateral and altering risk profiles are all tools used to minimise risk of a deal being left in the lurch in unprecedented times.
At the height of the lending boom, banks were prepared to lend to pre-production assets. Banks are now more reluctant to fund assets that are not producing and will look for a proven cash flow in addition to proven reserves before they fund. This has taken away a source of cash for smaller exploration companies and small to mid-size E&P companies have instead turned to the equity market or opted for farm-out agreements to generate cash.
Renewables
The commitment to renewables and green energy didn't translate to financed projects – only 2 wind farm deals reached financial close in the UK by mid-November, although debt funding has been provided for operational projects, for example, Centrica's refinance of its operational wind farms portfolio.
The European Investment Bank (EIB) (which has a target of injecting US$70bn into Europe's economy this year) has identified wind farm funding as an area in need of liquidity. To this end, the EIB and a group of commercial banks – BNP Paribas, Lloyds Banking Group and RBS – have committed to lending £1.4bn to new UK on-shore wind farm projects. EIB will provide half of the £1.4bn debt, but the risk will be borne, and credit analysis carried out, by the commercial banks.
The involvement of EIB will reduce the borrowing costs for those projects fortunate to obtain one of the 3 commercial funders on their project – the size of the market means that not all will be lucky, but it offers a glimmer of hope in a world where costs only appeared to be going one way. The anticipation is that the EIB/commercial bank funding solution will only be available for deals requiring over £20 million of debt funding.
But it is not a simply matter of liquidity that has prevented renewables projects reaching financial close. Sponsors are encountering difficulties with thorny issues in the planning permission process, finding a place in the grid connection queue and working out which technology to use. The prospect of a change of Government (and the theoretical alteration to the ROC structure) does not help.
Outlook for 2010
As 2009 draws to a close, there are good reasons to be cheerful about 2010. We should see many more deals in the energy sector and energy has become a significant political issue – wind farms, waste, nuclear, carbon capture/clean coal…these are all doorstep issues for the political parties but at least there is consensus that the focus should be on sorting out the UK's security of energy supply.
Bank pricing seems to have stabilised (albeit at a higher level than in the past) and may even be on the way down (slightly) – whilst long-term interest rates remain low, it would be a good time to get a deal locked in to decent all-in rates.
Offshore will be the interesting space in 2010 – the prospect of Round 3 awards for wind farms, the bidding surrounding the offshore transmission network and the need for substantial external finance to fund the bids (depending on who wins) – energy funds and infrastructure funds will hopefully provide the equity, and the banks should, once again, be in a position to provide the debt.
If you have any questions please contact:
Gillian Frew
Senior Associate, Banking & Finance
McGrigors
Tel +44 (0)131 777 7026
Email gillian.frew@mcgrigors.com
Stephen Tobin
Partner, Banking & Finance
McGrigors
Tel +44 (0)207 054 2789
Email stephen.tobin@mcgrigors.com
Iain Macaulay
Partner, Banking & Finance
McGrigors
Tel +44 (0)131 777 7022
Email iain.macaulay@mcgrigors.com