European project finance is being buffeted by political headwinds, sudden shifts in policy and roiling, economic unpredictability. Brexit is of course a major concern, but so is populist groundswell in many countries on the Continent. Added to that are questions about the future of one of the most active project finance-related sectors – renewable energy.
“In a time of political changes, like there is currently, the project finance market is in flux as well,” said Aaron Konrad, senior analyst project finance ratings for the Berlin-based Scope Ratings.
Scope predicts new project finance issuance this year in Europe to decline, especially during the first two quarters.
West European project finance issuance during the first half of 2016 totaled €39 billion and estimates the entire year put the total at about €70 billion. The rating agency predicts 2017 will total €50-60 billion.
UK Project Financing
The UK is by far the biggest single European country for project financing. In the first half of 2016, it amounted to 30% of the total. The collective Scandinavian countries were second. Power was by far the single-biggest infrastructure-related sector for project financing.
Some investors are taking a wait-and-see approach to potential projects, at least until the contours of Europe become clearer. There are elections scheduled this year in France, the Netherlands and Germany. The EU and Britain must negotiate the terms of Brexit. And the continent is bracing for the possibility of new Brexit-style referenda.
Renewable energy has provided an extremely active arena over the past several years. During the first half of 2016, for example, the financing of two massive offshore wind projects in the UK accounted for €4.4 billion, or almost 40% of all the country’s project financing during that time period.
Renewable energy project financing is now under threat, however. For one, there’s concern about subsidies for being either lessened or removed completely. That’s happened before, when new governments in Spain and Italy came to power and cut incentives for solar and wind.
Secondly, European countries have pledged to generate 20% of energy needs through renewables by 2020. Some countries such as Spain are close to that target so the mandated need for more projects becomes less as the deadline approaches.
“As countries already reach the political objective, this political momentum may be slowing,” said Carlos Terré, Scope’s executive director, head of project finance ratings.
To lessen these kinds of energy-related risks, some projects are beginning to offer long-term power purchase agreements directly to corporate and industrial users, as opposed to selling only to utilities.
Transformation in Project Finance
That doesn’t mean European project finance is necessarily in steep decline. But it is transforming.
Project bonds, for one, are gaining popularity. In Europe, some 80% of project finance is through bank lending, while bonds are at best supplemental, a stark contrast to the US. That’s beginning to change, Konrad said, because of institutional investor demand. Institutional investors are seeking diversification and yield.
“There’s growing interest and project bonds will become a higher share of project finance,” Konrad said.
Pan-European infrastructure represents another emerging front for project finance. The European Investment Bank and the European Fund for Strategic Investments are two institutions pushing private investment in infrastructure such as transmission and inter-country roads.
Certain infrastructure is losing its financing luster. One example is high-speed rail. France has been a leader in using project finance for this, but increased cost has dampened both public ardor and private appetite.
There’s an upturn in airport privatization, on the other hand. Part of this is supply: Many European airports are still government owned. Part is demand: Air travel is increasing.
Terms of project finance are shifting as well. Toll roads provide one example. Before the global economic crisis of 2008-2009, it was common to see private investors assuming some of the risk for the number of vehicles traveling on a particular road. After the crisis hit, most investors refused to take on this risk. But recently, some investors have relented. One example is the Passante di Mestre project in Italy, a green motorway that enables motorists to avoid a congested part of Venice. Last year’s €830 million issuance was termed Italy’s largest ever project bond, evidence that this kind of financing will continue, even in times of uncertainty.