Investing in Central and Eastern Europe Webinar
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RenewablesMarket UpdateRecent announcements of proposed regulatory changes in Poland have spooked investors in Central and Eastern Europe's (CEE) largest onshore wind market. While the final version of these bills is debated in parliament, opportunities may be plentiful within cogeneration and operational transport PPPs in the region
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Central and Eastern Europe's (CEE) most active renewables market, Poland, has seen a series of recent policy changes which would significantly shrink the onshore wind sector in the country. Onshore wind currently has accounted for nearly 75% of deal activity in the region since 2010, according to dataLive.
However, according to panellists on inspiratia's Investing in Central and Eastern Europe webinar, there may be hope yet for those looking to get their feet wet in CEE.
On the energy side, cogeneration provides an attractive prospect as it seeks to address many of the challenges that renewables investors face in the region. Additionally, mature transport PPP projects are primed for refinancings and acquisitions in countries like Hungary, Slovakia, Poland and Turkey.
Polish policy woes
Observers of the Polish market will be familiar with the recent regulatory upheaval impacting the onshore wind sector within the country. Earlier this year, a private members' draft bill was introduced in the Sejm (Polish parliament) which, if passed in its current form, would see it next to impossible to develop new greenfield onshore wind projects in the country. As the most active renewables market in the Central and Eastern European (CEE) region, this is a distressing development for investors.
The day before inspiratia's webinar on the CEE region on Thursday, 19 May, talks on the contentious Wind Turbine Investment act resumed with a second reading in parliament, after having been suspended at the end of March. Subject to discussions with the Commission on Infrastructure, the second reading would introduce certain amendments that might make the act more palatable. A vote is understood to have taken place on Friday, 20 May with an outcome that will be decisive for the sector.
According to panellist Tomasz Janas, Warsaw-based Partner in the Energy and Natural Resources practice at Dentons, proposed amendments would most likely include removing the chapter on penalties which includes the penalty of imprisonment for wind farm operators who fail to obtain the additional operating permit. The provision relating to a maximum fee of 1% of capital investment for obtaining this operating permit will also likely be axed.
According to panellist Tomasz Janas, Warsaw-based partner in the energy and natural resources practice at Dentons, proposed amendments would most likely include removing the chapter on penalties which includes the penalty of imprisonment for wind farm operators who fail to obtain the additional operating permit. The provision relating to a maximum fee of 1% of capital investment for obtaining this operating permit will also likely be axed.
The minimum distance requirement has also been proposed to be amended to a more palatable 600 metres, added Janas.
At the same time, draft amendments to the Renewable Energy Sources (RES) law which were posted on the Polish government's website earlier this month also had their first reading on 19 May. The amendments would see the auction system significantly modified, creating six separate technology baskets focusing on generation efficiency rather than technology type.
"The authorities are interested in promoting technologies that generate in a stable and predictable manner. This implies priority will be given to co-firing, biomass, biogas and energy-from-waste," according to Janas.
Additionally, the statutory obligation to offtake energy from renewables would no longer apply to developments over 0.5MW – the majority of utility-scale projects with PPAs. And while previously, projects were guaranteed support for 15 years, this is now capped at a maximum of 15 years, at the discretion of the Minister of the Economy.
While the auction is expected to take place this year, the amendments to the RES law will need to be debated and voted on in parliament before then. An ordinance will be issued by the end of August 2016 which will lay out the order in which the auction will take place, as well as reference prices.
"It is important to point out that both pieces of legislation were proposed by MPs, which means the legislation path looks different than if they were official governmental proposals. It allows for fast-tracking and does not require the government to carry out any public consultations," Janas added.
Winds of change
All this could spell trouble for investors like EnerCap – a CEE-focused renewables investor.
EnerCap has had relative success in building and even selling projects in Poland over the last few years despite significant regulatory uncertainty. Its regional wind fund was fully deployed in 13 projects across four countries in the CEE with an average gearing of 70:30 in most cases.
In March 2016, Geo Renewables, in which EnerCap has a 25% stake, sold its 54MW Lubartow wind farm in Poland to Ikea. In such a volatile environment, this is one of the only M&A deals to have taken place since 2014, as others such as EDPR and John Laing are taking a wait and see approach. Founding partner, Ewan Gibb, clarified that the sale was agreed in 2014 when the green certificate market was relatively stable and that it isn't a reflection of any particular deal structure.
We have faced even more severe pressure in Romania [than Poland] in terms of regulatory changes.
Ewan Gibb, Founding Partner, EnerCap
Of the four countries in which EnerCap has operational assets – Poland, Romania, Czech Republic and Croatia – only returns in the latter two have exceeded expectations. Gibb attributes this to the fact that Croatia and Czech Republic have been "materially unaffected by regulatory change."
He added, "We have faced even more severe pressure in Romania [than Poland] in terms of regulatory changes." EnerCap was one of three, alongside the Marguerite Fund and EP Global Energy, to invest in the 80MW Chirnogeni project, one of the largest in the country.
Cogeneration in CEE
In an effort to increase yields, EnerCap has been looking increasingly at cogeneration opportunities in the region in the last few years. "Collectively, you can get much more attractive returns with utilizing that asset for two separate applications," said Jim Campion, another partner at EnerCap focusing on CHP, biomass, and thermal sector investments.
Using Germany as an example, Campion illustrated that during peak wind speeds, energy generated by wind, which is given grid priority, displaces other technologies very quickly and at a significant level. 10-15GW of thermal power on an average day can be displaced by wind and up to 40GW on particularly blustery days. This is shown in figure 2 below.
Figure 2: Electricity production in Germany in week 30 2015
Source: EnerCap, German Federal Ministry for Economic Affairs and Energy (Energiewende)
"Germany has a very evolved balancing market, but there are similar issues particularly in Romania," Campion elaborated.
"We started to look at solutions of how to develop cogeneration that would deliver modest returns on delivering heat to the district heating systems, but trying to design them so they were flexible enough to also provide this balancing service."
Cogeneration which is largely underutilised in the region, particularly in countries like Romania, provides a significant opportunity. Campion supported the flexible cogeneration model powered by gas-fuelled systems (as opposed to coal or nuclear), which allows for a fast response power plant. This allows the power producing part of the plant to choose when to run and when not to, thus curbing grid instability from surges in renewable generation.
"This flexible cogeneration is quite an attractive proposition from an investment point of view. It can provide very low cost heat, because you're not just recovering your investment over the heat pricing and can be the lowest cost provider of the balancing services," added Campion.
There is a big opportunity for cogeneration in the CEE, especially in Romania where support schemes are in place until 2023. "But if you are able to serve this balancing market, you can make these projects investable without relying on that support," said Campion.
Infrastructure M&A – right place, right time
Meanwhile, on the infrastructure side, institutional capital may find a home within operational transport PPPs. While the level of M&A deals in the region until present have been minimal, as shown in figure 3 below, the EBRD's Marcos Martinez drew attention to the number of PPP deals that have been identified as prime assets.
Originally, many of these greenfield projects had been financed at a high cost, including larger equity commitments, higher pricing, and more stringent debt terms from lenders. "That was obviously because the market was not mature at that time and there was a perception of high risk," explained Martinez. This was further exacerbated by the fact that there was and is still a lack of investors in the region, particularly for small to mid-size projects.
"When there is a big project in the market, like the Bratislava Ring Road [D4/R7], you will see big players from around the world bidding and being very aggressive. But when we look at projects that are €100 million or less, it is very difficult to get interest from international bidders," said Martinez.
Additionally, across Europe, bond financings are largely underutilised for infrastructure PPPs. According to Martinez, capital markets particularly within emerging European markets should be tapped much more often because the market is in dire need of that extra source of funding.
"As a result, there is a dysfunctional market with attractive brownfield opportunities but with constraints on the supply side – lack of deals and a lack of investor interest."
In particular, Martinez pointed out transport PPPs that have been operational for several years. "Much of the risk has been eliminated for projects that are now completed and operational, and market perception of risk is much lower," he said.
Firstly, the current low-interest rate environment means that these projects can be refinanced at much more competitive costs.
Additionally, many of the original developers of these projects who hold long-term concessions may benefit from selling their equity stakes to institutional investors and infrastructure funds and investing into new projects that require construction and development.
However, according to Martinez, many institutionals view infrastructure assets with an associated risk that they often do not have the capacity to assess. Nor do they often have the capacity to carry out proper due diligence. For these reasons, they need to rely on infrastructure funds who charge management fees, providing less value for money than other areas in which there is more in-house expertise.
There are approximately 30-35 projects in the region identified by the EBRD as attractive for secondary market investment. These operational assets, most of which are in Turkey, Poland, and Hungary are valued at around €600 million each, making them a good size for institutional capital.
This is where the role of international development finance institutions (DFIs) such as the EBRD can facilitate by mitigating political risk and leveraging their understanding of and relationships in the market.
Martinez elaborated on the EBRD's new framework for investing in secondary market transactions targeting transport and municipal and environmental infrastructure (MEI) projects. The framework can see the bank take a minority stake (up to 25%) in an asset alongside private investors, but also facilitate refinancings on the capital markets. Martinez pointed to the 20-year bond issue of over €1.2 billion (£928m $1.35bn) for refinancing the R1 in Slovakia which was supported by the EBRD and KfW in 2013 as an example.
There are approximately 30-35 projects in the region identified by the EBRD as attractive for secondary market investment. These operational assets, most of which are in Turkey, Poland, and Hungary are valued at around €600 million (£464m $673m) each, making them a good size for institutional capital. Stakes in the M6 toll roads in Hungary, which were sold to the EBRD, Aberdeen Asset Management and Intertoll in December 2015 are a prime example of the type of assets identified.
A smaller but ample market of municipal infrastructure, including assets such as wastewater treatment plants, also exists, according to Martinez.
In the coming days and months
Until more clarity emerges on the final versions of the WTI act (expected this week) and the RES law in Poland, as well as on the structure of the auction, it is difficult to say what the M&A market will look like in Poland in the next 6-12 months.
Regardless, according to a poll conducted during inspiratia's CEE webinar, 50% of respondents believe that the country will still see the most activity within wind M&A in the region.
On the infra side, the privatisation of the Llubjana Airport will be an interesting one to watch. It is still in early stages, and it has not yet been fully conceptualised. It may involve a full privatisation, simply a concession, or even some hybrid between greenfield and brownfield. Serbia does have a higher risk profile than countries in which similar deals have been done – namely Slovenia and Hungary. The hope is that the government, who is being advised by the likes of KPMG and Linklaters, would create the right risk balance to attract international investors while DFI involvement could facilitate this as well.
Interestingly, however, poll respondents believed that whether more M&A activity will take place in CEE will depend largely on what happens in more mature European markets.
Slides from inspiratia's Investing in Central and Eastern Europe webinar
Panel:
Tomasz Janas, Partner, Energy and Natural Resources, Dentons
Ewan Gibb & Jim Campion, Partners, EnerCap
Marcos Martinez, Principal Sector Specialist, PPP, Infrastructure Policy and Project Preparation, EBRD
Moderator:
Irmeen Khan, Head of Data, inspiratia
