Financing sustainability

IFR Environmental Finance 2008
11 min read

In 2004, when Tom Whitehouse, CEO of London-based Carbon International, first launched his environmental investor relations/public relations consultancy, most private sector investors had little or no interest in committing money to environmental projects or renewable energy undertakings.

“They viewed the entire field of environmental finance as ethical, and therefore not profitable for them,” Whitehouse said.

“Private sector investors – venture capital, hedge funds, institutional investors and even private wealth – have dropped their prejudice and realised that you can make money in environmental finance,” Whitehouse said. “Even large corporations that had no track record of acting ethically are realising they have to invest in clean energy technologies if they want to be profitable in the future.”

In some markets wind project financing can prove to be something of a trip down memory lane, with old elements of project finance being revived to solve problems which rarely arise in more developed sectors – especially absent or unclear regulation and high political risk associated with the likely lack of continuity between changing governments. This sometimes forces bankers to be creative or bring back elements they used in project finance deals in the early 1990s, when several sizeable emerging market power projects were funded with project finance, said Clara Alvarez, group head of ING’s utilities and power finance team in London.

The tenors on alternative energy projects also tend to be longer than those on traditional power deals: 15-16 years, on average, for traditional projects, compared to up to 20 years for wind and 22 years for solar projects, said Alvarez.

What is really driving the money into environmental initiatives of all kinds is the universal realisation that there is simply no other way forward. Even as the high price of oil and gas is forcing companies to look at alternative ways of generating energy, renewables are a political priority in just about every part of the world, said Lionel Fretz, CEO of London-based Carbon Capital Markets, a fund manager and trader specialising in carbon and clean energy markets. At this stage in the game, Fretz said, the dynamic looks irreversible.

“Oil may be king but even if prices do trend down again, there is still a huge supply/demand imbalance,” Fretz said. “The high price of oil has got everyone to think more deeply about alternative energy, which is what we need in the long-term.”

Of course, the uptake is still relatively slow and alternative energy is not high on the list of most banks’ or investment funds’ priorities. The private sector still prefers to invest in alternative energy sectors that have been around for a while, such as wind and solar power, because investors are looking to deploy funds quickly, said Connor McCoole, head of project finance for Asia at Standard Chartered Bank. Therefore existing projects in developed countries are an obvious attraction.


Certainly, Europe is ahead of the curve when it comes wind and solar energy – not just in terms of the number of projects that are ongoing in Spain, Italy, the UK and elsewhere, but also with respect to the regulation that supports these. The markets are very different either side of the Atlantic, in terms of tenors, structures and pricing – with Europe being less demanding than the US, both in terms of margins and fees. “Before the credit crunch the US was approximately twice as expensive for these kinds of deals,” said Alvarez. However, “markets are also quite different within Europe,” Alvarez said. “Each country is a different market, with different financing parameters and different regulation.”

However, the sheer size and scale of projects in a country such as China, together with the will to get them done, means that it is catching up rapidly with the west, both in wind and solar energy technology as well as in other areas.

Standard Chartered, in fact, recently closed two biomass and waste-to-energy – a very new alternative energy area, experts said – projects in China. And in 2007, the bank completed a US$300m financing for the Wayang Windu geothermal power project in Indonesia – the first independent power producer project of its kind to be financed in that country since the 1997 Asian financial crisis.

An economical green solution for Indonesia’s power sector, Wayang Windu was designed and structured to meet world environmental standards. It is a project with a long-term horizon and was funded without the use of political risk insurance. “The impact of a geothermal project such as Wayang Windu is enormous and a great source of pride for all its stakeholders,” McCoole said.

In each country it operates in, Standard Chartered looks to focus on projects that make use of those resources that deliver the most cost-competitive renewable energy, McCoole said. Since it first started financing alternative energy projects in 2004, the bank has completed 10 transactions and is working on many more, he said.

“Looking at the project development activity around Asia, we are confident the forces driving renewable energy are many and relentless,” he said.

Despite the current pace of activity and the increased level of interest from banks and other private sector parties, it has still taken a number of years to make environmental finance in general a commercially viable sector. The main problem was the relatively small size of most alternative energy projects; even now, the greatest impediment to financing renewable energy projects is the high per-unit transaction cost that results from the smaller size of a lot of projects, said Russell Sturm, sustainable energy team leader of the environmental and social development department of the International Financing Corporation (IFC) in Washington, D.C. This is why wind and solar power remain the most attractive areas for alternative energy investment by the private sector: “They lend themselves to the kinds of big, chunky investments that the private sector – and also the IFC – like,” Sturm said.

This has created opportunities for niche players, able to cater to smaller financing projects: Triodos Bank does financing for renewable energy projects from €50m and down, and has an aggregate of around €900m investments in environmental projects globally, collectively generating around 1 gigawatt. Many of its investments are in small projects, producing less than 20 megawatts. This experience will be invaluable as larger projects come to market in greater numbers, as small deals are often just as complex – sometimes more so – than larger ones. With its understanding of planning and policy issues, and experience in pricing renewables deals, the bank believes, balance sheet permitting, it can step up to multi-million euro financings – either on its own, or part of a syndicate with larger banks.

Larger projects are coming to market increasingly frequently in a range of renewable areas such as hydropower, geothermals and biomass. Technologies that harness wind power and thin-film solar power are also at a stage where they are really maturing, Sturm said, and this lends an even greater appeal to investing in them on a large scale.

Many experts believe that the carbon trading market is set to benefit the most from private sector interest and funding going forward. Forecast to trade at a whopping US$30trn in 2020 and supported by legislation in different countries, putting a price on carbon and providing incentives to reduce carbon emissions has really helped create a win-win situation for all, said Fretz.

A victim of its own success

However, there is also a downside to the billions of dollars that are now flooding the alternative energy sector: “It’s been easier to raise money than it has been to find investments that are worthy of putting that money into,” Sturm said. “As fund managers run after projects, they get bid up and suddenly, the returns are no longer what they promised their investors, so they might end up not investing. This to me is a real risk, even if it hasn’t happened as yet.”

The other issue that could, ironically, cause problems in Sturm’s view, is the pace of subsidies, funding and government-sponsored incentives for environmental projects in many countries around the world and particularly in emerging markets. “There is a role for subsidies but they have to be used with care otherwise you undermine the market in the long-term,” Sturm said.

Many governments are, for instance, committing billions of dollars to greenhouse gas reduction funds. If this money is being given to subsidise a particular kind of technology without there being a long-term plan on what money will replace those funds, this can outpace the scope and the meaning of any potential commercial funding. This creates a sort of moral hazard problem.

Still, the pace of governmental support around the world is nonetheless encouraging and it will allow for a greater and more diverse range of environmental projects to take place. Even as some countries like the US, India and China need to commit to less emissions so that renewable energy can then be more viable, others such as Chile – which has a regulatory framework similar to the EU’s – and South Korea – which over the past two months has made a dramatic shift toward using solar power – are going in the right direction.

On a more technical level, environmental projects have bucked the global credit market crunch, which will further enhance their appeal, Whitehouse said. “Banks are going through a rough time but because this is a stable sector with predictable returns, there is no credit risk as such.”