Funding strategy is critical to successful bids in the RESS auction
There is less than 3 months to the revised date for final submissions into the first RESS auction, so focus is now shifting to refining and finalising bid models in preparation for that main event. Funding strategy in relation to both debt structuring and hedging will be a key determinant in the final price bid and delivering on investor returns. There are a wide range of funders who have expressed their support to lend into the new RESS scheme but market uncertainty resulting from Covid-19 means that pricing and risk appetite may be subject to change over the pre-bid and implementation period. Centrus is working with developers and investors in refining the funding proposal that will underpin their final price bid submissions and enhance the delivery of same.
The auction timeline has moved
An important first deadline for RESS passed in the last week of April as qualification applications were submitted. Now that first step is out of the way and initial money has been put on the table in form of bid bonds, it is time for RESS hopefuls to focus on the main event, the auction submission.
Eirgrid recently released its revised timetable which showed limited slippage in the overall timetable given the uncertainty introduced by Covid-19, and includes the following revised dates for some key steps in the auction process. The source of this information from Eirgird can be found here:
Provisional results from the qualification process will be available in early June (9th) and with only a further seven weeks until the closing date of the auction submission at the end of July (28th), the real work on refining and finalising the details of auction bids needs to begin in earnest now.
Focus now on optimising the financing strategy
Bidders were required to submit a letter of commitment from finance providers (equity and/or debt funders) as part of the qualification package submitted in April. The level of commitment required to provide those letters was relatively low.
However, optimising the debt pricing and structure along with risk management of financial exposures (e.g. interest rates, inflation and foreign exchange over the implementation period and project life) will be key inputs into deciding the optimal price to bid into the auction. Therefore, there is a need to ensure that the proposed financing solution is optimised between now and July to produce auction bids that are as competitive as possible and remain viable for the period from auction submission to financial close.
In addition, deliverability of the proposed finance solution will be essential for achieving commercial operations and the flow of RESS funding within the timeframe assumed by bidders. Any unexpected credit / investor requirements or delays in getting the required due diligence to funders will result in delays to financial close and reduced RESS revenues with knock on impacts for investor returns.
Consider the wide range of options available
Our discussions with clients and the market reveal a range of debt solutions are under consideration, ranging from project finance on an individual project and portfolio basis, corporate balance sheet and in some instances short term / bridging facilities through the construction stage – with the appropriate debt structure being complemented with hedging solutions in respect to interest rates, inflation and foreign exchange in order to meet shareholders’ return and risk requirements.
Centrus works with the Irish and European banks who have been key funders of renewable projects in REFIT and all remain committed to continuing to support the sector under RESS. In addition, we have strong relationships with a range of bank and institutional funders from across Europe and beyond with experience of lending into renewable auction processes in the UK and Europe including established models for solar funding. Many are keen to build on that expertise to support developers in the evolving RESS support market and are actively seeking opportunities to build relationships with clients in Ireland. Given the range of funding options available, bidders should undertake a detailed review of the pricing and structures on offer to ensure the best fit in terms of their bid model.
…But beware of Covid impacts other than just the auction timeline
However, it is important to note the context in which the auction bids are being prepared as Covid-19 not only impacts on construction programmes and supply chain logistics in the short term (e.g. pricing for solar panels are likely to be impacted by supply-demand dynamics and USD exchange rates while turbine pricing is more likely to be impacted by increased supply costs) but is also significantly changing the financing landscape.
To date funders continue to confirm their strong preference for lending into the green sector and indicative pricing (if given) has typically referenced pre-Covid levels from February as a baseline. However, as elsewhere in the banking sector, existing relationships and/or large developers with strong pipelines could be favoured over new/smaller clients and pricing will be reassessed when term sheet commitments are required. Based on a substantial widening in credit spread movements and market volatility over recent weeks, pricing today would show that loan margins have moved wider while changes in risk appetite will feed through to the range of funding structures being made available. In addition, market expectations for long term interest rates and inflation, energy market forecasts and USD exchange rates are all in flux as the impact of the pandemic is felt in Ireland and elsewhere. All these changes in inputs will need to be understood and factored appropriately into the bid price model.
The auction process requires that the financing solution underpinning the bid price is deliverable in terms of both pricing and the risk appetite of the funder over the approximate 12-18 months implementation period. Allowing funders the necessary time to get approvals for projects in the new RESS support regime in the context of increased and ongoing market uncertainty due to Covid-19 means engagement with a range of lenders to get the most competitive pricing and fully committed termsheets in advance of final bids needs to start now.
Crucial next steps for a successful bid price
Achieving the appropriate balance between being as competitive as possible in an auction process and delivering investors’ required returns in line with their risk appetite is always a difficult task. In the context of the upcoming RESS auctions, this will be further complicated by (i) the need to develop a model that optimises the bid price into a “pay as bid” auction within the constraints of the RESS support structure (e.g. no inflation, zero floor in periods of negative pricing, etc.) and (ii) the Covid-19 context which is leading to concerns regarding the pricing and deliverability of funding solutions over the auction period as well as increased uncertainty around a range of key inputs from inflation to foreign exchange pricing, electricity market curves and the timing and costs of project delivery.
Understanding the full range of funding providers with an appetite to lend into the developing RESS market along with the debt structures and hedging solutions that can be deployed for risk management is a critical next step in the bid management process. Centrus is helping developers and investors in refining the funding proposal that will underpin their price bid submissions and enhance delivery of same through the following:
Financial strategy including optimisation of debt and equity structures
Debt funding options appraisal to ensure competitive pricing and deliverability
Negotiation of funding and commercial contracts alongside hedging strategy and benchmarking of debt and swap pricing
Interest rate and foreign exchange hedging to mitigate risks on capital costs and project returns