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Cheap debt, emerging private credit market to shape power finance in 2020

SNL Image

A Tesla battery system storing solar generation on the Hawaiian Island of Kauai. Storage, primarily storage added to power assets, will becoming increasingly common in 2020.
Source: Tesla Inc.

Cheap debt is abundant in the project and acquisition finance markets for power generation assets, a trend that has persisted for several years and one that bankers and lawyers expect will continue through 2020.

However, the power finance market has changed, with deals involving renewable storage and wind repowerings becoming increasingly common. Meanwhile, traditional lenders face competition from private placement providers.

"I'd rather be a borrower than a lender in this environment," said Roger Wood, managing director in Moelis & Co.'s power group. "There's a lot of supply of money from banks and you see that, in high-yield land, there has been an erosion of covenants. That also applies generally to investment grade debt as well. Underlying rates are relatively low, spreads are relatively competitive."

"You have a lot of dollars chasing too few deals" in power, said Chadron Edwards, counsel in Mayer Brown's project finance group and a former vice president in Deutsche Bank AG's transportation, infrastructure and energy group. Edwards noted that he sees that same trend prevailing in all subsectors of the energy and infrastructure space.

"Costs are going to continue to go down," Edwards said, predicting that demand for renewables will stay strong. "There's a ton of interest in things like energy storage, transmission projects, so things like that are big possibilities for moving forward and seeing how those can all be financed."

Allan Marks, a partner in law firm Milbank LLP's project finance practice, agrees that storage is an increasingly important factor in project financings across generation types, though he noted that generation-plus-storage is likely to remain a more attractive model than standalone storage deals for the time being.

"I think you'll continue to see that most of storage will be coupled with something else, whether that's solar-powered generation or wind or natural gas-fired generation," Marks said. "Storage is most attractive when it is coupled with some kind of a generating asset."

The questions for storage lenders, and ones they are more comfortable addressing, according to Edwards, is, "What is actually the stream of revenues for an energy storage facility, other than just doing arbitrage with the power price, and can investors get comfortable with that and is that bankable?"

Meanwhile, there will continue to be production tax credit and investment tax credit-related deals from developers that have safe harbored equipment.

The rise of private placements

A "large, emerging private credit market" is rising as a serious rival to traditional bank debt in power deals, Wood said.

"Five years ago you'd pick up the phone and talk to a bunch of banks" to finance an acquisition financing, Wood said. "Now you'd be crazy, particularly further down the credit spectrum, if you didn't pick up the phone and talk to a bunch of private credit managers."

"In terms of financing we're seeing more institutional investors," said Madeleine Tan, partner in the energy and infrastructure group at Eversheds Sutherland, noting that insurance companies are particularly active in buying into privately placed debt as they try to diversify their investments.

"It's a significant volume and in some ways they are a competitor to your typical bank debt," especially for wind and solar deals, Tan said.

Peak gas?

The growing aversion to natural gas in parts of the country is also catching the attention of those who strike deals related to power generation.

"As you look at mandates for new home construction in California, as you look at some of that bleeding into the East Coast, there is a risk that we may be at 'peak gas,'" Wood said. "It's too early to say that it's happening today, but there are reasons why you may be more cautious about natural gas than you would about electric utilities."

Marks remains fairly optimistic on gas-fired generation, however.

"As coal plants need to be repowered, you'll see gas replacing a lot of those. As long as gas prices stay low, gas is going to be a really, really good supplement to renewables," Marks said. "And until we have widespread battery storage, we need it."

Wood agrees that gas-fired generation still has a major role to play: "For large parts of Texas, the Midwest, Midcontinent, natural gas isn't going anywhere anytime soon."