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How to keep on financing wind farms when banks have no money left.

by Jerome a Paris Tue Dec 23rd, 2008 at 08:43:56 AM EST

Earlier wind diaries: Windpower series

Banks are engaged in a massive deleveraging exercise right now. One part of that has been much described and commented upon: the elimination of bad assets, either by taking the losses or by dumping them on the tax payer. The other part of the process is much more devious, as it means choking off new activity, even when sound, to avoid any new build up of assets. Debts that mature and are paid help shrink the balance sheet; giving new loans goes against that process and is thus avoided as much as possible by banks right now.

New lending activity is therefore much more scrutinized from a risk perspective, sees its conditions made much less favorable than they used to be, and is especially frowned upon for long term commitments, as long term liquidity is scarce and expensive.

In my case, working in a bank that suffers from a huge gap between its predominantly long term assets, and its short term liabilities, was basically bankrupt earlier this autumn, had to be bailed out via nationalisation and has not yet announced its forthcoming strategy (ie I still don't know yet if my ativity will be a "core business" or not), funding has been especially restricted.

The wind sector requires long term funding in order to spread out the initial investment over a long enough period (so that the levelized cost per MWh is low enough) and it was a massive user of debt finance to get investments done. This means that it is an industry particularly vulnerable to the credit crunch. And indeed, expectations are that the fourth quarter will show a severe drop in new activity. Construction will still be at a record high, as projects which got their financing in the past year and a half get built, but new funding is drying up and next year is thus likely see a significant drop in actual building activity as those investors that relied on debt finance have more difficuly finding it and have to delay their plans.

In this context, I must admit that I'm especially pleased to be able to announce that we closed the financing of a new wind project, with a $60 million loan to build, over the next 12 months, a 30MW wind farm in the Caribean island of Aruba (part of the Kingdom of the Netherlands).


The project makes particular sense as the island gets its electricity, right now, exclusively from oil-fired power plants, and it has an incredibly good wind resource. The wind farm, which will have a capacity factor in the 50-60% range (better than European offshore, and almost triple the German onshore figure) will replace about 15% of the island's electricity generation, thus saving on oil consumption, limiting pollution and emissions. The local utility will buy the power at a fixed price over 15 years, ensuring a steady revenue to repay the debt and hedging it, for that part of the island's consumption, from the variations in oil prices. The breakeven for the wind farm is at roughly $50-55/barrel, which means that it's rather likely to be a good investment over the duration.

The interesting question is: how did we find $60 million in December 2008 for a project in what is hard to call a priority location for any hard-pressed European bank (and with clients who are small developers - while highly experienced and competent, they could not be described as strategic customers, an increasingly strict requirement these days for banks to commit any funds)?

The answer is simple: we did not. My bank is not actually lending a cent of its own. The ways this has been possible is thanks to the involvement of two other entities - one is the export credit agency (ECA) of the country of origin of the turbines, and the other is a Scandinavian bank which has accepted to provide funds - but not for the project: only for the government of that Scandinavian ECA. So that bank is notionally the lender to the project, but it actually only takes government risk, being fully guaranteed for all sums by the ECA, which is a government-backed entity. My bank could then join the project by counter-guaranteeing the ECA for a share of the project risk. This is a deal where those that take the risk and those that do the funding are almost completely separate, and where a government provides the vital link, in a smart way (they take the risk on my bank, but it is as a backup to a project risk which they are also taking, which they would have taken in any case in normal times, and which is not a bad risk per se). For the client, it is slightly more expensive than usual, as, in addition to the usual margin to cover project risk, they have on top of that to pay the funding cost of the other bank (based on the price of that scandinavian government debt), plus a fee to compensate that government for taking the risk on my bank. But from their point of view, it is a price worth paying, as they could not build the project without debt funding.

The project has sound economics and can bear that additional financing cost; if markets change for the better in the future, they will also be able to reduce the funding costs via a renegotiation or a refinancing (in addition, by then, the project will be built and operating and will be seen as an even smaller risk).

I literally had to harass my senior management to get them to agree to do the deal; I'm not sure if getting noticed by the top management is what you should do when your employer is preparing a massive plan of layoffs, but to me this project just had to be done. It' a good risk that would have been a no-brainer at any other time, it's the kind of activity that banks should support now in so many ways: it promotes economic activity at home, it's a good deal for the buyer of electricity, it's good for the climate, it's good if you worry about peak oil, the risks are understood and thus it's nicely profitable for everybody. And we found a way to do it without requiring my bank to come up with its own funding. So if we could not do it, I did not see much future for my activity in the bank anyway - the confrontation at senior management level was worthwhile as a way to force an answer on that, even if it does not tell me what the decisions will be like on future transactions.

I'm not sure yet if this is a lesson that the kind of banking that focuses on its actual core business (risk analysis and allocation) will survive the crisis, or a sign that even the most reasonable transactions will face tremendous hurdles. We'll see. Right now I'm just very happy that I pulled it through.

Display:
Excellent news, well done!
by In Wales (inwales aaat eurotrib.com) on Tue Dec 23rd, 2008 at 08:51:11 AM EST
I'm not sure if getting noticed by the top management is what you should do when your employer is preparing a massive plan of layoffs,

Well maybe being noticed for doing the dependable things might be a good thing.

Any idiot can face a crisis - it's day to day living that wears you out.

by ceebs (ceebs (at) eurotrib (dot) com) on Tue Dec 23rd, 2008 at 08:57:39 AM EST
http://www.dailykos.com/storyonly/2008/12/23/84033/609/271/676052

Thanks for your support to give it visibility.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Dec 23rd, 2008 at 09:03:20 AM EST
... checking out my hotlist, so even though it is probably far too late to help, I put in a sprinkling of comments wherever I could see an opportunity to crank up the comment count without being too obvious about it.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue Dec 23rd, 2008 at 12:51:10 PM EST
[ Parent ]
Congratulations on pulling off the deal and on having had the courage of your convictions to confront your senior management.  (I hope they aren't reading this).  

In my experience such courage generally works out for the better provided there is no loss of face for any of the senior people involved.  They will be able to congratulate themselves for still engaging in some of their core activity.  Sometimes you have to push the boat out to get a new policy, or a new approach to banking, accepted as within the established norms and risks of doing business.

What use is a bank to anyone if it doesn't want to bank any more?  Senior management are making themselves redundant if they no longer have the courage to engage in quantifiable risks at a profitable price.

Accounting isn't my field, but it should be possible to put a value (in the balance sheet) on future cash flows with a known risk attached to them.  On that basis the deal is either Bank assets value enhancing, or it is not.  Since it is the role of management to add value, this one sounds a no brainer.

In fact, if I were managing the ECA, I would be questioning why we cut the bank in on the deal at all...

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Dec 23rd, 2008 at 09:25:59 AM EST
Hope this means you'll have to go oversee the project a bit...

Would you find direct state funding of such initiatives, either through a state-owned bank where you would do the same work, or through some other financing mechanism, objectionable?

by redstar on Tue Dec 23rd, 2008 at 09:39:03 AM EST
the easiest way to do lots of wind would be to have EDF as a monopoly provider and investing in a coherent national plan to put as many wind farms as possible, finding the least objectionable sites to do so, and imposing, at the same time, that the manufacturers put their factories in France as a quid proquo for getting large guaranteed orders over the next several years.

Barring that, public support via (i) feed-in tariffs and (ii) consistent and stable permitting procedures are enough, in nomal times, for the industry.

In today's market, if funding is still an issue, then a public entity to provide funding to banks (which would keep project risk) would certainly help and would be very simple to set up - that entity would simply take bank risk (which we're doing by the shitload already anyway) and the banks could continue their business or wind risk assessment normally.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Dec 23rd, 2008 at 10:08:46 AM EST
[ Parent ]
What's an EDF?

paul spencer
by paul spencer (spencerinthegorge AT yahoo DOT com) on Tue Dec 23rd, 2008 at 10:28:08 AM EST
[ Parent ]
Electricité de France: the State-owned, formerly monopolistic French utility.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Dec 23rd, 2008 at 10:57:25 AM EST
[ Parent ]
It would seem that if all Banks do is take on some project risk (for a large fee?) and use public money to fund projects of definable public benefit - then their whole role in the whole  process is so small as to be largely dispensable.  

A large Utility like EDF, or a Government agency charged with promoting wind power would be just as capable of taking on project risk - seeing the state is proving the funding in any case - so why not just cut out the banks who are acting as little more than (a poorly funded) insurance company in this case.

Unless you are arguing that Banks have some specialist consultancy expertise in project evaluation that no one else has or can develop, what use is a bank as a bank if it doesn't provide capital?

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Dec 23rd, 2008 at 11:29:40 AM EST
[ Parent ]
Frank Schnittger:
Unless you are arguing that Banks have some specialist consultancy expertise in project evaluation that no one else has or can develop, what use is a bank as a bank if it doesn't provide capital?

Correct.

J would not need to work for a bank to bring his unique knowledge and experience to bear. In fact, he'd probably make a lot more as a metaconsultant. But it's not exactly a secure existence...

I find the project structure most interesting for the potential it will have for refinancing once built.

I've been doing some really interesting stuff re Iran and Ecuador (in the context of a South American clearing system - Chavez's Banco del Sur concept, and the recent Ecuador debt default).

In the case of Aruba they could unitise both oil production and electricity production.

Refinancing with unitised oil production (ie selling forward units redeemable in oil or the energy equivalent) gives them an interest free loan.

Unitising and selling the electricity forward gives them a domestic pool of investment capacity, and the beginnings of an "Energy Pool"

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Tue Dec 23rd, 2008 at 11:59:28 AM EST
[ Parent ]
Thus my suggestion for EDF to go ahead and do it directly. But as long as we have markets in place then bank finance plays a useful role (helping smaller players, among other things).

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Tue Dec 23rd, 2008 at 12:07:00 PM EST
[ Parent ]
Jerome a Paris:
then bank finance plays a useful role

But bank finance is the one thing you are currently unable to provide?  I presume this is a momentary blip while the Bank works out a new strategy for its core business - but were the Bank to decide that it will in future also no longer provide such finance, I suggest your skills would be better employed by EDF or some Government agency promoting wind power - or a Bank which will provide such finance.

Once banks cease to provide such finance there is no reason why anyone would go to them for any expertise whatsoever.  Why not work directly with Government agencies or banks which DO provide finance and with specialist technical/implementation consultancies which can estimate risks and quantify returns on investment.  The project management/risk mitigation role effectively follows the money...

notes from no w here

by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Dec 23rd, 2008 at 06:39:56 PM EST
[ Parent ]
Congrats, Jerome!  This may be how a lot of what gets done is done over the next year.  Governments will have to assume larger roles by default.  Banks and private businesses will grumble and resent those who enable them to turn even small profits.  Drying out is never pretty.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Dec 23rd, 2008 at 12:29:54 PM EST
Congratulations, Jérôme. It was a toughie, and you pulled it off just in time for Christmas.
by afew (afew(a in a circle)eurotrib_dot_com) on Tue Dec 23rd, 2008 at 12:51:31 PM EST
It spilled over into my holidays, given that it was supposed to be done and over on Friday and that we still had to tie a few loose ends over the past two days. It's been a pretty intense few weeks for me to negotiate the whole package. The big break was earlier this month, when I finally got the approval to do the deal, after a tough internal fight, but then getting the deal done still required a lot of time-intensive work.

Now I need to negotiate a bonus from a taxpayer-funded employer...

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Tue Dec 23rd, 2008 at 01:16:47 PM EST
[ Parent ]
1% of the deal = 600K seems reasonable...

notes from no w here
by Frank Schnittger (mail Frankschnittger at hot male dotty communists) on Tue Dec 23rd, 2008 at 06:41:59 PM EST
[ Parent ]
Congratulations on getting this complex funding mechanism for the wind project to work. It's amazing!

What I don't understand is why the Scandinavian government has to borrow money from the Scandinavian bank to fund the project through its ECA. What confuses me is why the Scandinavian government could it not just fund the project directly (print money) without borrowing its own currency?

by Magnifico on Tue Dec 23rd, 2008 at 01:34:45 PM EST
That may have something to do with the domestic politics of the Scandinavian government in question...

I don't know which one it was and I'm not too terribly familiar with the policies of the Swedish and Norwegian governments, but the Danish government has stuck tightly to a no-public-spending policy essentially since it was elected. No exceptions (well, except for the banks, of course - wouldn't want to let the banks down...) and even to the point of being ridiculous about it.

The most tragicomic tale is that of a county had a footbridge destroyed by a careless truck driver. His insurance paid for reconstruction, but they had to postpone the reconstruction indefinitely, because - get this - they had already spent as much as they were permitted to on public works.

- Jake

Austerity can only be implemented in the shadow of a concentration camp.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Dec 26th, 2008 at 05:29:08 PM EST
[ Parent ]
Congratulations Jérôme!

(This is my first post in 3 weeks, I didn't expect to immediately find some good news on my return but there it was)

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Wed Dec 24th, 2008 at 07:47:28 AM EST
fascinating story, great victory,
Jerome.
I agree with those who suggest that, in deals like this one (or similar ones) one can envision several scenarios in which the bank becomes unnecessary--in fact, an impediment. Could some of the resistance you encountered relate to the realization on the part of management of this aspect of the deal?  


Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Thu Dec 25th, 2008 at 08:56:07 AM EST
Banks do have a role
  1. We still take the risk on the transaction, and do put our balance sheet at risk in it, just in an indirect way
  2. another banks was required to provide the funds, just on different terms
  3. the place to put the longer chain of funding/guarantees/risk still needs to be a bank, for it to be credible - you need to have "skin in the game"

In fact, one of the reasons why I dont think Chris Cook's model will work is that it has been proven by reality not to work: Mortgage-Backed Securities, repackaged and resliced and resold to other investors, with the initial dealers not taking any of the risk is exactly what his model is about.  And the result is what you would expect when the people that cook up the paper and those that hold it are so separated.

You need banks to assess risk - and to put their good name on the risk by holding it themselves.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Thu Dec 25th, 2008 at 06:43:16 PM EST
[ Parent ]
Jerome a Paris:
In fact, one of the reasons why I dont think Chris Cook's model will work is that it has been proven by reality not to work: Mortgage-Backed Securities, repackaged and resliced and resold to other investors, with the initial dealers not taking any of the risk is exactly what his model is about.  And the result is what you would expect when the people that cook up the paper and those that hold it are so separated.

You need banks to assess risk - and to put their good name on the risk by holding it themselves.

Eh? I'm absolutely gob-smacked. Where on earth do you get that from?

I see the future role of banks as service providers within partnership frameworks, and one of the key elements of this model is that at least part of their remuneration will be related to the outcome of the work that they do. This does not involve putting capital at risk (other than reputation) but it does involve putting future income at risk.

There are two types of work I see banks in.

(a) "Peer to peer" credit - managing the bilateral creation of "trade" credit necessary for the creation of productive assets, including the bringing together of risk-friendly investors with risky development;  

b) "Peer to Peer investment" - post-development, refinancing through "Peer to Peer" investment by risk averse investors in the "unitised" production streams - essentially monetisation through the creation of redeemable units.

When have I ever said I don't see banks as having any stake in the outcome of what I have always described as a partnership-based model?

I have had excellent feedback in respect of this recent lecture in Ireland

Unitisation: solving the Credit crunch - Quicktime file

Please take the time to view it, or if not, then take ten minutes to look the slides.

here

Then explain to me firstly, what is impracticable about what I am suggesting, and secondly, in what respect this service provider model bears any resemblance whatever to the structural faults of the MBS "originate and distribute" transactional model to which you refer.

How many times have I said that I think that intermediaries and the related "for profit" transactions have no future in a directly connected "peer to peer" economy?

And when have you ever addressed that point, whether to agree or disagree with it?

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Thu Dec 25th, 2008 at 07:54:51 PM EST
[ Parent ]
how this

(a) "Peer to peer" credit - managing the bilateral creation of "trade" credit necessary for the creation of productive assets, including the bringing together of risk-friendly investors with risky development;  

does not describe exactly what was done by investment banks when they put together groups of mortgages (risky development) with bond buyers (risk-friendly investors) - by setting up various tranches with different risk profiles, they allowed buyers to take exactly the risk they cared to; by making the market in MBS highly liquid, more house buyers were able to find funding for their projects.

It's conceptually substantially the same thing.

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Dec 26th, 2008 at 05:28:31 AM EST
[ Parent ]
It is a question of bringing together investors in the project with investment in the project.

I am proposing a new form of investment, consisting of units redeemable in the production of the turbine as and when built. The proposition is simply to sell for value now Units which are redeemable in (say) Kilo Watt Hours. The proceeds pay for the development and construction of the turbine.

Part (proportional "Equity Shares") of the unsold stream or "Pool" of production would go to continuing "stakeholders", probably a land owner (but this could be the Community); part to an Operator; and the balance should IMHO accrue to the Community.

Once a turbine is built and operating, the risk is lower than when it is yet to be built, and investment in it is attractive to an entirely different constituency of risk averse investors to whom risk friendly development investors may "exit".

The art (your art) is to work out what price these units are "worth" pre-development, and this price reflects the development risk with which you are familiar.

The economic calculation in an economy where energy has been monetised in the way I advocate is entirely different to one in a deficit-based economy. Any energy project which is expected to create or save more energy than has been used in its construction and/or operation will be viable.

I believe that the way in which we can achieve the massive investment we need is initially to re-finance the existing secured debt through "unitisation". This will then "free up" the development capital needed to build new renewables and finance energy savings (the cheapest energy of all).

The key to successful development IMHO is a legal and financial structure whereby the interests of the stakeholders are aligned so everyone has the same interests - including the developer and financier, of course.

This is where partnerships come in, and I believe that such structures minimise development risk. They don't remove it altogether, and I have already come across a couple of transactions which did not stack up using any enterprise model. eg shipping biomass into an urban location for power generation, where the consultant recommended an LLP model over an ESCO but concluded that nothing worked at current prices.

And you still haven't said why credit intermediaries are necessary... :-)

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 26th, 2008 at 06:20:40 AM EST
[ Parent ]
the 'structuring' and 'risk minimization' and manage the 'investment' and 'exit' by investors.

Sure, this can be done by advisors that don't have a balance sheet behind them, but their credibility hinges on attracting players with the money and having a track record of successful structures. Putting up your own money usually helps in that respect; when you start doing this consistently enough, hey, presto, you become a "bank."

In the long run, we're all dead. John Maynard Keynes

by Jerome a Paris (etg@eurotrib.com) on Fri Dec 26th, 2008 at 06:31:17 AM EST
[ Parent ]
Jerome a Paris:
Putting up your own money usually helps in that respect;

Putting up your own money makes you an investor, alonsgside other investors, and not an intermediary.

That's fine.

It's when you start creating credit on the basis of your capital that the problem starts.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 26th, 2008 at 07:45:03 AM EST
[ Parent ]
Just to be clear, I have no objection to the form of banking/"credit intermediation" that you describe and aim to practise, since I see that as "service provision".

The credit intermediation I see as unsustainable mathematically - and I am not commenting on any moral issues - is the Basel I/II style creation of interest-bearing credit.

I am talking about banking reinventing itself as service provision, and I do not see that as inconsistent with your description of your profession of banking.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Fri Dec 26th, 2008 at 07:56:40 AM EST
[ Parent ]
Well, to the outside observer, you often seem to be in violent agreement.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Fri Dec 26th, 2008 at 09:03:05 AM EST
[ Parent ]
You told us a story about doing battle to secure unorthodox financing for a project-doing battle with your own bank. I applauded your victory, and suggested a possible reason why there might have been so much resistance from your own institution--a reason I did not invent. There is a reaction that is, at the moment, rather common in the world of banking-- a fear of the consequences of a major loss of credibility as a result of foolish and often corrupt behavior. Across the world, suggestions are being made as to how to reduce reliance on and restrain the behavior of banks.
My comment was in the nature of a question, and I would still like an answer. Why do you think they resisted your apparently very reasonable plan?

Capitalism searches out the darkest corners of human potential, and mainlines them.
by geezer in Paris (risico at wanadoo(flypoop)fr) on Fri Dec 26th, 2008 at 04:37:18 AM EST
[ Parent ]
did not mean not to answer that. But this is not it. There is little credibility loss involved in supporting a sound deal in a"good-looking" sector like renewables. The problem really is today that the banks are completely out of funds and are allocating whatever spare cash they can find very sparingly.

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Fri Dec 26th, 2008 at 05:23:26 AM EST
[ Parent ]


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