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POWER AND UTILITIES

Power SectorDevelopment in

Europe – Lenders’Perspectives 2011

A survey of banks on the prospects for

power infrastructure financing in Europe

kpmg.com



Power Sector Development in Europe – Lenders’ Perspectives 2011 | 3

Preface by KPMG

According to recent estimates by the International Energy Agency (IEA)1,the European power sector will require approximately EUR 1,900 billion(USD 2,700 billion)2 in investment over the next 25 years in order to supportthe increasing demand for power, de-carbonization of its generation portfolioand replacement of aging infrastructure. The commissioning of new powerplant capacity will absorb 68% of these funds, accounting for someEUR 1,300 billion (USD 1,700 billion), while investments in transmission anddistribution grids are expected to amount to EUR 600 billion (USD 900 billion).

Financial institutions are expected to play a major role in realizing these

investments in the European power markets, with the financing of largeinfrastructure projects being increasingly done through Project Financingarrangements. As such, proper project structuring is becoming ever moreimportant in ensuring that individual projects are bankable on a standalonebasis. Based on our recent and ongoing discussions with financial institutions,the principal concerns are sponsor creditworthiness, project commercial viabilityand appropriate risk allocation, while further topics like a stable regulatory system,merchant risk mitigation with Power Purchase Agreements (PPA), and applicationof mature technology are also seen as key points to financing.

This paper is designed to reflect the views of project finance market leaders onthe future of power sector financing in Europe. Understanding financiers’ mainconcerns and expectations for the future of the European power market is of key

importance to all project stakeholders, and we hope that this report will facilitatethis discussion on our path towards reaching these ambitious targets.

We hope that you find this study interesting, and invite you to contact us ifyou have any further questions or if you wish to participate in a more in-depthdiscussion.

Peter Kiss

Global Head ofPower & Utilities

Darryl Murphy

Partner,Global Infrastructure

KPMG in the UK

1 Source: IEA World Energy Outlook 2010, Capacity and

investment needs in power infrastructure by region in the

New Policies Scenario, Europe, by 2035.

2 1 EUR = 1.3825 USD, ECB rate of 1 March 2011



4 | Power Sector Development in Europe – Lenders’ Perspectives 2011

Survey Methodology

This study aims to provide European power and utilitymarket participants with insight into lenders’ perspectives onthe future of financing power and utility projects in Europe.

Lead arrangers active in the Europe, Middle East andAfrica (EMEA) region were interviewed using a structuredquestionnaire prepared by KPMG’s Power & UtilitiesKnowledge and Resource Center, regarding lenders’ viewson the main aspects and perceived/actual risks of financingpower and utility projects in Europe. These issues include,

but are not limited to, technology, environment, regulation,construction, operation and maintenance, and publicacceptance.

Information collection for the survey was carried out throughpersonal interviews with project finance professionals fromleading financial institutions, and took place primarily in late2010 and early 2011. Participating banks were selected fromthe top 30 lead arrangers by deal value, as given in the 2010league table of PFI (Project Finance International).

The interview results are presented as follows:

• banks’ readiness to finance the increasing demand

for power infrastructure;• main aspects of their lending activity;

• actual environment and participant related issues; and

• current barriers to funding.

We are grateful to the survey participants for their valuabletime and insights. Our work has resulted in a clear picture ofthe current situation and the future challenges.




Executive Summary

The European power and utility sector will requirea substantial amount of investment during the next15 years, in order to manage increasing demand, while alsodecarbonizing its generation portfolio and replacing aginginfrastructure. Investment will be needed in both generationand network assets, including conventional power plants,renewable generation, as well as “smart” transmission anddistribution grids.

The IEA’s estimates are that the amount of money required

for the implementation of the necessary investments isclose to EUR 1,900 billion (USD 2,700 billion). Financialinstitutions are expected to play a major role in securing thisfunding through loan facilities, with project finance expectedto account for at least 60% of the total investment value.

KPMG has surveyed leading European financial institutionsto gain a lender’s view on what conditions need to be metby projects in order to obtain financing. Through thesepersonal interviews with leading professionals from theselected banks, the preferences and concerns of lenderswere mapped in relation to power infrastructure projectfinancing, covering issues such as technology, the regulatory

environment, the experience and financial commitmentof project sponsors, project structure and other factorsinfluencing their financing appetite. Although the numberof selected banks has been limited, based upon the sizeand experience of the interviewed banks, we believe thatvaluable conclusions can be drawn, with regard to lenders’main expectations and concerns when it comes to financingpower infrastructure projects.

Most of the interviewed banks seem to have a generallypositive outlook on the future of the debt financing market.They expect a steady growth in their energy books over thecoming year, and insist that there is no shortage of liquidity

on their side. As one bank has openly stated: “projects should be well prepared, and the money will be there” .

The most important issue for project developers to tackleseems to be the securing of long-term electricity off-takeagreements. As one might expect, lenders generally avoidhigh exposure to merchant risk, or tend to see this type ofoff-take structure as not being feasible from a bankabilitypoint of view, since they would prefer to see deals withlong-term Power Purchase Agreements (PPAs). Securing thedesired long-term off-take is, at the same time, increasinglydifficult for project developers to achieve, according to thebanks’ experience. A quality EPC (Engineering-Procurementand Construction) turnkey contract, and a good relationshipwith a credible management team are the two othermost important factors that can help give banks greaterconfidence in a project.

The interviewed banks have expressed other concerns aswell, which cannot be solved solely by the proper structuringof projects. Stable regulation is of key importance forsuccessful project financing, which is a key criterion amongbanks when selecting target countries. When regulatorychanges occur, it should be done in a planned and well-communicated way, while retroactive regulation has thepotential to ruin projects and market confidence, as hasbeen experienced in some European markets within thepast year. For renewables, Feed-in Tariff (FIT) systemsare preferred by banks than GC (Green Certificate) or ROC(Renewable Obligation Certificate) systems, due to thehigher security of FIT revenues.

The interviewees generally agree that new technologiesand large projects with an installed generation capacity ofover 1000 MW (for both hydro and nuclear power plants)cannot be considered without government support. Theseprojects constitute a high level of risk (primarily constructionrisk) that banks are not comfortable with. According to thevast majority of the interviewees, governments shouldnot necessarily participate in projects with direct funding;

rather, they should facilitate risk mitigation by establishingloan guarantees and by ensuring that regulation is clear andsupports those projects that have a substantial investmentneed, high risk profile, or extended payback period.

Overall, it seems that financial institutions are quiteoptimistic and are ready to provide substantial amountsof funding to finance the necessary power and utilityinvestments that will be required within the Europeanmarket. The debt market remains tight, and the procurementof funding will not be easy, but based on the interviewswe can claim that well-structured projects that addressthe following risks/concerns of financial institutions will,

in general, be better-placed to receive funding.




Capital investments in the European power sector are beingdriven by several factors, namely steadily growing powerconsumption, aging of power plant infrastructure, securityof supply, and decarbonization of the power sector. Giventhis backdrop, the capacity gap is expected to becomemore pronounced, and will need to be addressed in a timelymanner. The replacement of these aging power plants willnot only ensure stable and secure supplies of electricity, butthey will allow for reduced generation costs as more modernand efficient technology is utilized.

Increasing demand

Demand for power in Europe is expected to follow itscurrent growth rate, as described below. Historically,electricity consumption and overall economic developmenthave been closely correlated. Consequently, the financialcrisis which started in 20083 has caused a slight drop inEurope’s power consumption. As the continent show signsof economic recovery, bolstered by an improving investmentclimate and increased consumer confidence, so too is thedemand for power.

According to the Economist Intelligence Unit (EIU),electricity consumption in Europe is envisaged to increaseby 23% until 2025, which translates into an expectedaverage yearly growth rate of approximately 1.4%.

Source: ENTSO-E, KPMG, EIU CEE Western Europe

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

TWh

2 00 5 2 00 7 2 00 9 2 011 2 013 2 015 2 017 2 019 2 021 2 02 3 2 02 5

+23%

+36%

+21%

Figure 1: Electricity consumption forecast (2005-2025)

As depicted in the graph below, most of the growth isexpected to come from the Central and Eastern European(CEE)4, which given higher economic growth potential, isexpected to see consumption increase by 36% over thenext 15 years, equivalent to an annual growth of 2.1%.

Consumption of the Western European countries5, on theother hand, is expected to follow a stable annual growth rateof 1.3% per annum, resulting in total growth of 21% over theanalyzed period.

Aging power plant infrastructure

In addition to growing demand, aging power plantinfrastructure is creating the need for the replacement ofexisting capacity and hence, adds to the total investment needin the European power sector within the following 15 years.

Source: Datamonitor

350

300

250

200

150

100

50

0<10 10-20 21-30 >30

TW Nuclear

Coal

Gas

Oil Wind

Other

renewables

Hydro

Figure 2: Power plant structure by age (2010)6

Based upon the age of the current installed capacity inEurope, KPMG estimates that approximately 267 GW 7

of generating capacity should be replaced through 2025.

Soundness of Power Investment Targets

3 Financial Crisis here and after is referred to as financial crisis of 2008.

4 Countries under CEE category include: AL, BiH, BG, CZ, EE, HR, HU, FYRM, KO, LT, LV, ME, PL, RO, RS, SI, SK.

5 Countries under Western Europe category include: AT, BE, DK, FI, FR, DE, GR, IR, IT, NL, PT, ES, SE, UK

6 Countries included in the analysis: EU 27, AL, BiH, FRYM, HR, KO, ME, RS.

7 Power plant replacement is estimated based on the following power technology useful life assumptions: coal-fired: 40 years, gas-fired: 30 years, nuclear fusion: 60 years, hydro:

80 years, wind, solar and other renewable: 25 years. Source: OECD, KPMG

8 Alternative scenario contains mainly proven projects while Best Estimated scenario includes less certain projects and those in their early development stage.

9 “Conservative Estimate” is based on “Alternative” capacity development scenario of ENTSO-E. “Best Estimate” is based on “Best” capacity development scenario of ENTSO-E.




Planned capacity additions in Europe

As a result of growing electricity demand, a large amountof investment will be required within the Europeangeneration sector. The European Network of TransmissionOperators (ENTSO) has prepared two scenarios for capacitydevelopment over the next 15 years: Best (B) and Alternative(A) Estimates8. Altogether, the European power generationasset base is anticipated to add capacity in the range of128 to 355 GW for the examined period.

Source: ENTSO-E

1,400

1,200

1,000

800

600

400

200

02010 2025A 2025B

GW

877

1,232

1,005

Nuclear

Lignite Hard Coal

Gas

Oil

Renewable

energy

(exc hydro)

Hydro

Figure 3: Forecast of installed capacity in Europe per fuel type

+15% +40%

Europe’s generation capacity is expected to be dominated

by conventional technologies in 2025. At the same time,renewable energy is also envisaged to play an increasinglyimportant role, assisting countries across Europe in decreasingtheir carbon footprint and improving security of supply.

Estimated investment need

In order to undertake such a large investment program, atotal of EUR 700 to EUR 1,000 billion will need to be investedin the European power sector over the next 15 years.

This estimate covers both investments in new capacity,and the replacement of existing infrastructure.

Figure 4: Estimated investment need in the Europeanpower sector for 2011-20259

Technology CAPEX(EUR/kW)

Conservative Estimate Bes t Estimate

Capacity(GW)

Investment(EUR million)

Capacity(GW)

Investment(EUR million)

Nuclear 3,500 - - 5 16,100

Coal 1,600 126 201,044 147 235,343

Gas 800 122 97,775 178 142,678

Oil 800 2 1,735 2 1,735

Wind 1,400 107 149,576 170 237,622

Solar 5,000 24 121,200 36 180,050

Other renewables 3,500 21 73,558 25 87,838

Hydro 2,500 35 88,568 46 116,243

Total 437 733,455 609 1,017,608

Source: ENTSO-E, OECD, KPMG analysis

Concerning nuclear power, a substantial amount ofdevelopments may be possible above the official estimates,

however the implementation of these developments seemto be uncertain at this time. These projects previouslyfaced problems with financing and in the post Fukushimaenvironment their implementation has become even moreuncertain.

Banks will play a major role in financing such projects,contributing up to 60% of the required capital.




Overview of Power Project Financing in Europe

Over the last five years, financing activity in the Europeanpower sector has shown a steady and positive tendencyboth in the number and value of deals. The global economicdownturn has had a relatively short-term impact, mainlyaffecting transactions in the CEE region. At the same time,the number of closed deals has been steadily increasingover the investigated period.

At the same time, the power industry is also expected tobe an attractive sector for investments, due to the growingneed for new generation capacity, which may be expectedto fuel the financing appetite of lenders in the future as well.

As a result of the financial crisis and the ensuing lack ofliquidity, 2010 again saw weaker project finance activitywithin the Western European power sector, as comparedto 2008 levels. A total of EUR 16.4 billion worth of financingwas closed during the 2010 calendar year, with WesternEuropean deals accounting for 92% of the overall dealvolume, while CEE countries contributed just 8%.

Investors’ focus has shifted towards renewable energyduring the past few years owing to the adoption of varioussupport schemes and investment incentives in severalEuropean countries. While renewable energy sourcesaim to ensure a low-carbon future economy, conventionaltechnologies such as nuclear, coal and gas generation willcontinue to form the basis of the generation mix, owing totheir reliability, comparatively lower generation costs, andability to supply flexible power generation.

10 Source: Infrastructure Journal Online

11 2005 was an exceptional year in value of deals, due to three simultaneous large-scale

projects, uncharacteristic for the market.

Source: Infrastructure Journal

Waste-to-energy

Biofuels

Biomass Coal

Co-generation

Gas

Geothermal

Solar

Wind

Figure 7: Financial closes of 2010 in Europe

38%

50%

EUR 16,446 millionSource: Infrastructure Journal

Number of deals Deal value

Western Europe200

150

100

50

0

N u m b e r o f d e a l s

25,000

20,000

15,000

10,000

5,000

0

D e a l v a l u e ( E U R mi l l i o n )

2005 2006 2007 2008 2009 2010

Central and Eastern Europe14

12

10

8

6

4

2

0

N u m b e r o f d e a l s

2,000

1,500

1,000

500

0

D e a l v a l u e ( E U R mi l l i o n )

200511 2006 2007 2008 2009 2010

Figure 5: Overview of project finance deals in the power

sector of European countries (2005-2010)10

Source: Infrastructure Journal

Renewable energy Conventional

Western Europe25,000

20,000

15,000

10,000

5,000

0

E U R m i l l i o n

2005 2006 2007 2008 2009 2010

Central and Eastern Europe2,000

1,500

1,000

500

0

E U R m i l l i o n

2005 2006 2007 2008 2009 2010

Figure 6: Financing of power projects in Europe by type of

technology10




Geographical focus of banks within the energy sector

The vast majority of the interviewed banks have identifiedthe energy sector as a priority segment, with most havinga special energy division within their project financing unit.At the same time, these energy teams do not differentiatetheir activities by technology, since in most cases, bothrenewable and conventional technologies are handledtogether. The banks we interviewed are generallyorganized by geography, which implies that they place

a strong emphasis on understanding and monitoringcountry-specific risk.

Attractive or peripheral? – Technology types

We have found that most banks are involved in, or opento, financing various renewable technologies, such aswind, solar and hydro, as well as conventional technologiesincluding mainly cogeneration, CCGT (Combined-Cycle GasTurbine) and coal-fired assets. Several banks have claimed,however, that hydro generation assets currently have aperipheral role within their loan portfolios, while biomassand nuclear seem to be significantly less attractive financing

targets, as compared to wind, solar or cogenerationtechnologies.

Transition countries seem to be out of the comfort zone

The responses of most banks reflect a rather stronggeographical focus on Western Europe, the US, and Canada;one of the interviewed banks specifically stated that outsidethe UK, lending is challenging, unless really short tenorsare structured. As such, the majority of banks seem to behesitant to lend in small markets, although several bankshave expressed a commitment to “follow” their key clients.At the same time, a smaller group of banks considers

the Middle East, Turkey or Central Europe as attractivegeographies.

Lenders: leadership or nothing

As large banks in the market, the interviewed banks have allexpressed strong interest in taking a leading role (preferablyas Mandated Lead Arranger, “MLA” ) in any transaction theyparticipate in. The majority stated that they would not accepteven a second tier role, while a minority of respondents wouldbe open to non-leading participation if their return criteria aremet, or there is another substantial advantage to participation,such as limiting risk when entering a new market.

In light of the above, the preferred minimum deal sizes ofthe interviewed banks hold no surprises. While the smallestdeal size among the interviewed banks ranges betweenEUR 20 and EUR 60 million, the majority of banks haveset their limit above the EUR 50 million threshold.

Preparedness of banks Banks’ lending activity

Range of preferred project size

Bank specific optimal project size

Aggregate average optimal project size

Some of the banks have chosen not to disclose the size of

their average/optimal projects

Source: KPMG Research

200

150

100

50

1 2 3 4 5 6 7 8 9 10

EUR million

Figure 9: Preferred project size for interviewed banks

0Banks




Banks are optimistic – growing energy books

The current portfolios of the respondents show a significantvariance in size. While a number of banks have portfoliosof EUR 2-4 billion, some of them have much more sizeableenergy portfolios of EUR 10-25 billion.

Most of the banks reported a healthy pipeline of possibleprojects under consideration, while they have ambitioustargets for the energy sector, with a particular focus onrenewables and CCGT assets. None of the banks have

indicated any decrease in their lending appetite, while mostof them envision a dynamic increase in their loan portfolioin the near future. Several banks mention renewables asthe key area for further growth.

“Projects should be well prepared, and the money

will be there”

The interviewed banks are unanimously positive towards thequestion of liquidity. They say that liquidityis not a major concern; rather, the bottleneck is expectedto be the quality of projects and their level of development.Banks are willing to fund well-structured projects, and

are looking for opportunities with limited risk, such asinvestments in transmission or distribution network assetsthat have returns based on the Regulated Asset Base (RAB).At the same time, unproven or complex technologies likeCarbon Capture and Storage (CCS) will need governmentsupport in order to ensure financing, according torespondents. Lenders have also expressed the viewthat subject to significant improvement in internationalfinancial markets, the participation of international financialinstitutions such as the EIB, the EBRD, or direct governmentinvolvement or Export Credit Agencies (ECAs) may be required,so that such challenging projects can be implemented,especially in the light of the EU’s 2020 targets.11

Regulation is key for renewables

The Banks’ appetite for financing is limited by both externaland internal factors. On the one hand, banks strive to reachan appropriate level of diversification and to limit their overallrisk exposure. As such, the recent increase in renewableenergy projects constitutes a challenge for the banks,since they seek portfolio diversification. On the other hand,the Banks’ lending appetite is also affected by externalfactors such as the stability and credibility of the regulatoryframework, the level of country risk, as well as project-

specific issues such as construction risk, security packagethat is in place, project returns and cash cover ratios,as well as merchant risk.

Based on the Banks’ responses, the most importantdeterminant for a successful project financing is thepresence of a national regulatory framework that is capableof ensuring certainty over the long run. This is especiallyimportant in the case of renewable projects, since a stableregulatory background and attractive support schemeensure a substantial share of revenues for a given project.At the same time, merchant risk is a significant issue forconventional projects, which need to sell their output on

the market in the absence of a mandatory off-take regime.Outside of the Eurozone in Eastern Europe, currencyexchange risk remains an obstacle for financing as well.Another important consideration for banks is the properallocation of project risks and identification of appropriatemitigation measures, thus ensuring banks that a project willbe able to service its debt. Among renewables some ofthe surveyed banks noted that construction risk is an issuein the case of off-shore wind, as construction could takeseveral years, while the technology is somewhat less proventhan that of other renewable generation assets. Thesefactors lead to a bias towards shorter loan tenors being

offered by the banks.

11 Renewable share targets have been set in the 2009/ 28/EC Directive for 2020.

The EU targets the share of 20% renewables in total energy consumption including

power, heating and cooling and transportation by 2 020. Member States have varying

individual targets that together contribute to the intended 20% share by 2020.




No off-take contract – no bank financing?

From the lenders’ perspective, the “dream deal” includesa long-term (20-25 year long) PPA, which is backed bythe government and also supported by stable regulation.At the same time, based upon the respondents’ experience,securing a long-term PPA is becoming increasingly difficultfor clients. Still, lenders have been more than clear abouthaving limited to zero appetite for merchant risk; most ofthem are extremely cautious with such deals, and would notbe involved in any project with 100% exposure to market risk.

Some banks stated that they are able to structure aroundmerchant risk, but they expect a PPA to be in place for themajority of the output, for a period of more than 10 years.A minority of banks are open to deals with merchant risk,but only with a much lower gearing and tenor than usual.In those cases where a bank is open to taking a merchantdeal, the off-take counterparty of the project company isrequired to be a company with a favorable credit rating.

New technologies need government support

It is also clear that apart from merchant projects,commercially unproven technologies are also out of the

comfort zone for most banks, since banks prefer provenand reliable technologies. Some lenders are partially opento taking new technology projects, but the majority ofthe interviewees expressed their view that such projectsneed to be implemented with support from EU subsidies,governmental support, or from equity providers such asventure capitalists and private equity funds.

Construction risk is too much for banks in nuclear

Lenders are extremely cautious with nuclear financing.Their shared view is that nuclear projects are very difficult tostructure, due to the high level of construction risk, leaving

banks with little appetite for such projects. Most of themhave stated that they would only be open to participation inoperational projects that have PPAs readily available – unlessspecial risk mitigation measures are applied as follows.

The most significant factors that seem to have a negativeinfluence on lenders’ appetite for nuclear financing arerisks associated with cost overruns and delays duringthe construction period, which can easily deteriorate aproject’s economics and its ability to sustain a high levelof debt. As such, banks currently expect that the majorityof investment in new power generation would be financedon the developers’ balance sheet. Another peculiarity withnuclear projects is that decommissioning must be covered inadvance, which constitutes a substantial additional cash flow

requirement.Lenders have strongly expressed the need for governmentsupport in the form of guarantees for specific risks, whichcan substantially support risk mitigation and facilitate theparticipation of banks in financing. The participation of IFIsis also desirable, as well as that of well proven technologysuppliers; this can further reduce the risk for financing banksand through that, increase their appetite for the given projects.

The unfortunate events at the Fukushima power plant inMarch 2011 may overwrite many previous expectations.Recent events will likely cause banks to be even morereluctant to lend to nuclear projects due to their higher

perceived risk. Furthermore, nuclear projects can beexpected to face higher capex costs, due to higher securitystandards. As a result, raising both equity and debt financingfor such projects will be even more challenging.

At the same time, the future of nuclear cannot be easilydiscarded. Nuclear energy constitutes a stable generationsource that is a viable alternative to conventional energysources, while for Europe, nuclear will play an important rolein decreasing natural gas dependence on Russia. As such,the construction of new nuclear capacity will likely continue– especially in Eastern Europe. While it should also be notedthat the relatively long project development time will allow

existing nuclear projects to implement the lessons learnedfrom Fukushima without major delay to these projects.




Source: European Commission Report 2011, miscellaneous sources

Figure 11: Operational subsidies for renewable electricity

in Europe

Quota obligation

Romania

Sweden

Poland

FIT and Premium

Spain

Czech RepublicEstonia

Slovenia

FIT and Quota

obligation

Italy

Belgium

United Kingdom

Premium

Denmark

Netherlands

Only investment

subsidies

Finland

Norway

FIT

Albania

Austria

Belarus

Bosnia and

Herzegovina

Bulgaria

Croatia

Cyprus

France

Germany

Greece

Hungary

Ireland

Kosovo

Latvia

LithuaniaLuxembourg

Macedonia

Malta

Moldova

Montenegro

Portugal

Serbia

Slovakia

Switzerland

Ukraine

Stable regulation is key for project funding

The interviewed banks see regulation as the mostimportant factor behind granting approval for a deal.One bank representative even expressed that it internallyfilters projects based upon both the sponsor and the qualityof national regulation, in equal proportions. As such, it is akey requirement among lenders that governments shouldprovide clear guidance on the basis of their support for aspecific sector or technology. The Banks’ main concern is

retroactive legislation that undermines current economicassumptions, which can potentially ruin projects that arealready in the pipeline. Therefore, assurances that therewill be no retroactive legislation would significantly increaselending appetite, to the extent that they can be made.Furthermore, governments need to communicate potentialex ante changes in order to further ensure trust among lenders.

With regard to government support, banks strongly favorthe Feed-In Tariff (FIT) system, due to its simplicity and thesafety it provides project owners. At the same time, projectdevelopers prefer Renewable Obligation Certificates (ROCs)due to the higher revenue they can potentially achieve with

it. However banks dislike this system as it is too complicatedand, as such, brings additional risks into a project. A keymessage to legislators is therefore that they should ensurethe stability of off-take prices, as this is crucial for projectsto obtain funding from banks.

Governments should help with risk mitigation

rather than direct funding

According to the views of the interviewed banks, thestate should play a key role in cases where technologyis unproven, where projects are extremely large, or incases where substantial commercial risks are present.

Governments should not necessarily be involved in directfinancing (such as investment grants), but instead inrisk allocation measures. Several banks have pointedout that loan guarantees, export credit support, and clearregulations (as mentioned earlier) are the key areas inwhich governments should support these types of highrisk projects. In terms of regulation, governments need toestablish consensus around their national energy strategy,and support technologies that need substantial investment.On this basis, a favorable project environment can beestablished, in which commercial banks can take only thoserisks that they are familiar with, or that they are accustomed to.

Project environment and participants



Quality EPC contracts and a strong management

team build banks’ financing appetite

The interviewed banks place great emphasis oncounterparty risk management as well. Based upontheir responses, lenders carefully look at the consortiummembers in a project - both on the lending side (if providingfinancing with other lenders), and the project developer’sside. At the same time, some of the banks are morecautious with the financing partners they choose, ruling out

new lenders or lenders with limited experience; while otherbanks are more cautious in choosing the parties involvedin project development. At the same time, many banksseem to be open to working with new entrants in projectdevelopment, provided that they have a good relationshipwith the given developer.

Interestingly, the interviewed banks do not have highexpectations towards the participation of technologyproviders. In general, technology suppliers as investorsare perceived as being more committed to their project,although in most cases, banks do not seem to requirethat technology providers take an equity role as well.

Many of the banks stated that the quality of the EPCcontract and their trust in the management team arethe most important factors in committing to a deal.At the same time, if the technology involved inthe project is of a novel or highly complex nature,equity participation of the technology provider isdefinitely seen as being important.

Banks see the participation of institutionalinvestors in financing projects as being quiterare due to the fact that institutional investorsusually invest in operational assets with arating (in regulated sectors), as they have an

aversion to construction risk. At the sametime, many banks have stated that bondissuing might be a good way to attractthese players into financing energydeals. In this case, banks see distinctdifferences between technologies:they say that among renewables,onshore wind could be matureenough for the bond market, butoff-shore wind, biomass andCSP (Concentrated Solar Power)technologies might be immature

for this.




Market prices will stay above 100bp

Bankers are uncertain about the development of marketprices over the short term, owing to high market volatility.About half of interviewees have indicated their expectationthat pricing will remain stable in the short term. At the sametime, 2010 pricing is believed to not reflect the marketproperly due to low deal flow, increased competition amongbanks and, as a result, lower pricing.

During the course of 2011, debt pricing is anticipated togradually increase, reflecting the expected improvementin deal flow on the market. Over the long term, however,market leaders expect debt pricing for generation projectsto drop below 200bp. Although projects are priced on anindividual basis, bank funding rates will be the key to lowerpricing. Pricing is predicted to come down by the banks invarying degrees; at the same time, banks are unanimousin stating that price will probably not drop below 100bps.Further tightening is foreseen by banks in the capital costsdriven by the looming Basel III regulation.

Basel III: higher pricing, shorter tenors

The effects of the implementation of Basel III regulations arestill uncertain. Driven by the additional capital requirements,banks are anticipating a potential increase in funding costs,which will result in an increasing impact on market pricing.Moreover, the new regulation is expected to affect loantenors and result in shorter tenors to be offered by banks.

The ultimate impact on project sponsors will be a reductionin returns on invested capital, which will thereby push theattractiveness of certain projects down.

The majority of lead arrangers have adopted the

Equator Principles

Financing institutions are increasingly concerned with thesocial and environmental impacts of the financed projects.Energy efficiency projects and those associated with climatechange are taking a higher profile among banks. The vastmajority of interviewees have indicated that their institutionshave adopted the Equator Principles (EPs),12 while othershave indicated that they have similar internal policies in place.

When considering financing, banks are assessing projectson an individual basis in relation to their compliance with theEPs. Non-compliant projects may be rejected in financing.Project sponsors should be prepared to comply with EPrequirements when they expect to acquire financing fromEP-compliant banks.

Barriers of funding

12 The Equator Principles constitute a financial industry benchmark for determining,

assessing and managing social and environmental risk in project financing. Many

banks have signed up to be EP compliant, which means that they make their financing

dependent on the compliance of the given project with the Equator Principles.

Figure 12: Focus areas of Basel III

Main objectives of Basel III

• to strengthen global capital and liquidity regulations with the goal

of promoting a more resilient banking sector

• to improve the banking sector’s ability to absorb shocks arising

from financial and economic stress

Main addressed areas of the reforms

• capital reform

– increase quality, consistency and transparency of banking capital

– increase quantity of banking capital

– complete risk coverage

– reduced leverage through introduction of backstop leverage ratio

– introduction of capital conservation buffers and a counter-

cyclical banking capital buffer

• liquidity reform

– increase short term liquidity coverage

– increase stable long term balance sheet funding• other elements relating to general improvements to the stability of

the financial system

Basel III regulation will expectedly result in an increase in pricing and

a decrease in loan tenors as banks need to adhere to an increasingly

strict set of regulations.

Source: KPMG Study: Basel 3 Pressure is building…



Expectations Concerns

P r o j e c t s t r u c t u r e / p a r t i c i p a n t s

• Projects should have a quality EPC contract and a trustworthymanagement team

• The presence of technology suppliers as investors builds trust, as

they are perceived as being more committed to their projects

• If the technology involved is of a novel or highly complex nature,

equity participation of technology providers is definitely a positive

• Bank liquidity is not a problem; the bottleneck to financing isexpected to be the supply of well-structured low-risk projects

• The main project concerns are construction risk, covenants in place,

return / cash cover ratios and merchant risk

• Higher perceived risk leads to a bias towards shorter loan tenors

• Banks are cautious in choosing their financing partners, and the

project developers that they work with

• Projects should be prepared to comply with environmental and other

Equator Principles related requirements

T e c h n o l o g i e s

• Proven and reliable technologies are strongly preferred

• Commercially unproven technologies are out of the comfort

zone of banks

• Unproven or complex technologies need to be implemented using

EU subsidies, governmental support, or equity providers such as

venture capitalists and private equity funds

• Most banks are only interested in financing operational nuclear

projects with PPAs, as they have limited appetite for the

construction risk involved with nuclear

• In nuclear, the participation of IFIs and well-known technology

suppliers is desirable

• Banks strive to achieve an appropriate level of diversification, whichmay limit their willingness to take an increased amount of renewable

projects

• For renewables, the availability of a stable national regulatory system

is important, as government support can secure a substantial amount

of revenues

• For coal and gas projects, merchant risk is still not seen as an

acceptable commercial structure

• For off-shore wind power, construction risk is an important risk factor

• Delay risk and cost overrun risk in nuclear construction can easily

deteriorate project economics and compromise a project’s ability tosustain a high level of debt

• Decommissioning has to be covered in advance for nuclear projects,

which constitutes a substantial additional cash flow requirement

A l t e r n a t i v e fi n a n c i e r s

• IFIs should participate in nuclear projects, as a means of helping

to reduce risk by bringing it down to a level that is acceptable for

commercial banks

• On-shore wind could be mature enough for bond issuance and the

subsequent attraction of institutional investors

• Depending on future changes to the lending environment,

the participation of IFIs and Expor t Credit Agencies (ECAs)

could be crucial for reaching the 2020 targets in renewables

• Institutional investors tend to prefer operational projects with

a credit rating

A rather clear picture emerges from the Banks’ responses to the survey, especially when they were asked how an “ideal” power infrastructure project should be structured in order to successfully obtain bank financing. Banks have also expressedspecific concerns relating to the current regulatory and market environment, which are of great importance to them, sincebanks are only open to taking risks that they are familiar with. Please find below a short summary of the main expectationsand concerns of the interviewed banks, related to the financing of energy projects.

Conclusions – expectations and concerns




Expectations Concerns

G o v e r n m e n t / R e g u l a t i o n

• The ideal deal for banks is backed by the government and

a stable regulatory environment

• Governments should provide clear guidance on the basis of their

support to a specific sector or technology

• Assurance on no retroactive regulation would increase project

appetite

• Governments need to communicate potential changes ex ante to

ensure trust from banks

• Regulation should ensure the stability of off-take prices in supportregimes

• Banks favor the Feed-in Tariff (FIT) system due to its simplicity

and the safety it provides

• Commercial banks need an environment in which they only have

to take risks that they are familiar with

• State participation might be necessary for mega projects to be

implemented

• Banks feel that regulation is a constant issue to be tackled;

they say they need to structure projects around it

• The most important requirement for projects is a national regulatory

framework capable of ensuring certainty over the long term.

• The main concern of banks is the threat of retroactive legislation;

this may undermine current economic assumptions and can

potentially ruin projects already in the pipeline

• Project developers, in contrast to banks, prefer the Green Certificate

(GC) or ROC (Renewable Obligation Certificate) systems as these

can provide higher revenues; however, these instill extra risks intoprojects and are therefore disliked by lenders

• Governments should rather help with risk mitigation rather than

direct financing; loan guarantees, export credit support and clear

focus of support on technologies are the most beneficial areas for

support of mega projects

• The state should take a role where technology is unproven or there

are substantial commercial risks – such as nuclear projects, where

governments should guarantee against specific nuclear risks

O f f t a k e r s / M a r k e t

• The “ideal structure” includes a long-term (20-25 year long)

Power Purchase Agreement (PPA)

• Interviewed banks have been clear about having limited to zero

appetite for merchant risk

• In a deal with merchant risk, the off-taker should be a well-known

company with a favorable credit rating

• The experience of banks shows that i t is increasingly difficult for

projects to get long-term PPAs

• Some banks stated that they are able to structure around merchant

risk, but they still need a PPA that covers most of the output for at

least 10 years

• Some banks seem to be open to deals with merchant risk,

but only with a much lower gearing and tenor than usual

• From the second half of 2011, debt pricing is anticipated to

increase, reflecting decreasing competition among banks due

to an increased deal flow

• On the long term though, debt pricing is anticipated to drop

below 200bp

• The Basel III regulation, which would bring stricter rules for bank

financing, is expected to also contribute to the increase of pricing

and the shortening of loan tenors

Limitations of the survey

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we ende avour to provide accurate and

timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such infor-

mation without appropriate professional advice after a tho rough examination of the particular situation.




London

Johannesburg

Calgary

Tokyo

Melbourne

Hong Kong

Dallas

Sao Paulo

Paris

Budapest

Essen Moscow

KPMG’s vision: We aim to maintainour position as a leading advisor tothe power and utilities sector bycontinuously developing strategicthought leadership and practicalstrategies that help our firms’ clientsmeet their challenges. Our industry-leading initiatives include KPMG’sGlobal Energy Institute, KPMG’s GlobalEnergy Conference in Houston and

KPMG’s Power & Utilities Conferences.

KPMG’s reputation: Throughour firms’ national practices andKPMG’s Power & Utilities Centers ofExcellence, we constantly strive toprovide services of the highest qualityand the best available advice to clientsaround the world.

KPMG’s commitment: Ourunderstanding of the demands

and challenges power and utilities

companies face enables our firmsto develop services, methodologiesand original thinking that specificallyaddress the needs of this sector.We look at industry challengesfrom multiple angles, pooling ourknowledge and resources to developholistic services that are designed tofit our firms’ clients’ ever-changingrequirements.

About KPMG Global Power & Utilities Practice

KPMG member firms offer globalconnectivity. We have 12 dedicatedPower & Utilities Centers of Excellencein key locations around the world,working as one global network.

They are a direct response to the rapidlyevolving power and utilities sector andthe specific challenges that this isplacing on industry players.

Located in Budapest, Calgary, Dallas,Essen, Hong Kong, Johannesburg,London, Melbourne, Moscow, Paris,Sao Paulo, and Tokyo, the centers

support companies in the upstream,downstream and service industriesaround the world, helping them toanticipate and meet their businesschallenges.

In each center, there are professionalswith practical, in-depth power andutilities experience. They draw onour wider global network of power andutilities practitioners to provide ourclients with immediate access to thelatest industry knowledge, skills,resources and technical developments.

Our Centers of Excellence also enableus to transfer knowledge andinformation globally, quickly and openly.With regular calls and effectivecommunications tools, we share

observations and insights, debate newemerging issues and discuss what is onour clients’ management agendas.The centers also produce regularsurveys and commentary on issuesaffecting the sector, business trends,changes in regulations and thecommercial, risk and financialchallenges of doing business.

Power & Utilities Centers of Excellence

We have 12 dedicated

Power & Utilities Centers

of Excellence in key

locations around the

world, working as part

of our global network.




Modelling

Program Management

Accounting / reporting issues identification Transaction-related accounting standards, understanding /

interpretation (international)

Audit

Tax efficient exitCreation of tax efficient

deal structures

Tax due diligence Post transaction integrationTax

Project management support, transaction

impact analysis (stakeholders, etc.),

organisational impact assessment,

change management, public sector and

infrastructure sector knowledge

Project management and change

management support, operational due

diligence support, organisational design /

restructuring, contract management

process design, performance metrics

Analysis in support of contract compliance

and dispute resolution, analysis in support

of renew / dispose decisions

BusinessPerformance Services

Risk analysis and assessment, retained

risk / technical risk analysis, advice on

risk-sharing issues, advice on valuing risk

for inclusion in pricing mechanism options,

regulatory / legislative compliance assessment

Information management / security

assessment, privacy protection issues

advice, risk mitigation / monitoring

Monitoring of major programmesRisk Management

Upfront corporate intelligence,

counterparty integrity due diligence,

conflict of interest management

Counterparty risk assessment

(fraud / criminal risk)

Contract compliance and governance

–royalty review

Forensic

Commercial due diligence, market

assessment feasibility

Strategic CommercialIntelligence

Initial financial / commercial / counterparty

solvency due diligence

Detailed due diligence, investigation

of negotiating issues

Restructuring: On-going contract compliance

and performance monitoring (covenants,

financial metrics / gain sharing, capex)

Transaction Services/Restructuring

Strategy planning / support, financial

modelling / model integrity review (demand

planning / financial forecasts), assess delivery

options / funding / pricing / risk sharing,

develop procurement / transaction s trategy,

initial transaction valuation support

Support vendor / partner evaluation and

selection process, finalise business case,

support developing negotiating positions,

support fulfilling closing conditions

Support to subsequent contract changes,

dispute resolution, annual investment

valuation / review and refinancing

CorporateFinance

Infrastructure

Strategy

Transaction

Strategy

Implemen-

tation Plan

Procurement Negot iat e

and Close

Implement Monitor and

Control

Renew /

Dispose

New Investments

KPMG Services (Primary Market)

Across the globe, KPMG member firms provide clients with offerings in relation to the following services:




Modelling

Program Management

Systems optimisation, IT governanceInformation RiskManagement

Accounting / reporting issues identification Transaction-related accounting standards,

understanding / interpretation (international)

Audit

Creation of tax- efficient deal structures Tax due diligence Post transaction integrationTax

Project management support, transaction

impact analysis (stakeholders, etc.),

organisational change management, public

sector and infrastructure sector knowledge

Project management and change

management support, operational due

diligence support, organisational design /

restructuring, contract management

process design, performance metrics

Performance improvement / value

realisation, merger integration, ongoing

performance monitoring, analysis in support

of renew / dispose decisions

BusinessPerformance Services

Risk analysis and assessment, retained

risk / technical risk analysis, advice on

risk-sharing issues, advice on valuing risk

for inclusion in pricing mechanism options,

regulatory / legislative compliance

assessment

Information management / security

assessment, privacy protection issues

advice, risk mitigation / monitoring

Design of governance, compliance

and controls

Risk Management

Upfront corporate intelligence,

counterparty integrity due diligence,

conflict of interest management

Counterparty risk assessment

(fraud / criminal risk)

Contract compliance and governance

– royalty review

Forensic

Pre-deal strategy Commercial due diligenceStrategic CommercialIntelligence

Initial financial / commercial /

counterparty solvency due diligence

Detailed due diligence, investigation

of negotiating issues

Restructuring: ongoing contract compliance

and performance monitoring (covenants,

financial metrics / gain sharing, capex)

Transaction Services/Restructuring

Strategy planning / support,

deal criteria / objectives, initial

opportunity identification /

assessment, pre-deal

evaluation, financial modelling

Deal hypothesis, transaction

structuring, detailed financial

modelling / model integrity

review, demand planning /

financial forecasts, initial

transaction valuation, bidstrategy, bid preparation

Support bid analysis,

investigate / model issues,

incorporate risk analysis /

mitigations, develop negotiating

positions, fulfill closing

conditions

Support for subsequent

contract changes, dispute

resolution, annual investment

valuation / review

CorporateFinance

Acquisition

Strategy

Opportunity Identification

/ Assessment

Deal Hypothesis /

Transaction Structuring

Bid

Preparation

Due

Diligence

Negotiate

and Close

Enhance /

Operate

Renew /

Dispose

Acquisitions

KPMG Services (Secondary Market)

Across the globe, KPMG member firms provide clients with offerings in relation to the following services:




Most recent Power & Utilities sector relatedThought Leadership Publications

Green power 2011 – The KPMG

renewable energy M&A report

This annual report follows PoweringAhead: 2010, looking at changesand trends in the renewable energysector to provide insight on wherethe market is heading.

Offshore Wind in Europe – 2010

Market Report

KPMG`s report “Offshore Wind

in Europe – 2010 Market Report” in cooperation with the GermanOffshore Wind Energy. Foundation“Stiftung Offshore-Windenergie”

concludes that the growth targetsfor offshore wind are at risk due tolow returns.

Prospects for the Central and

Eastern European Electricity Market

The CEE region needs to up toEUR 144 billion in power sectorinvestment to meet demand overthe next decade. This report isbased on analysis by KPMG’s P&Upractice in Hungary compiled withthe cooperation of industry andfinancial experts.

Major Projects Advisory Statement

of Qualifications – Power and Utility

Public infrastructure and largeprivate projects are still movingforward and are creating a continualdemand on the national construction

industry.

Power and Utilities KPMG’s

Profile and Perspectives

This document combines ourservice offerings, client lists andprofessionals’ thoughts on industryhot topics from around the globe.

Central and Eastern European

Hydro Power Outlook

Hydropower offers extremelyvarying potentials in the CEE region,but provides a decent 23 per centshare overall in the capacity mix ofthe region, placing it far above allother carbon sensitive technologies.

Power Ahead 2010: An outlook

for renewable energy M&A

Powering Ahead is the 2010version of an annual publicationwhich discusses trends in M&A inthe Renewable Energy Industry.

Over 250 senior executives weresurveyed and supplementaryinterviews were carried out withkey industry players.




Think BRIC! India

India’s population, around 1.1 billionin 2009, is expected to surpassthat of China soon after 2020 –making it the largest in the world.To fuel growth, total generatingcapacity will jump, with an increasedemphasis on nuclear, clean coal &renewables.

Think BRIC! Brazil

Brazil’s electricity sector bearsenormous potential for growthand business development, butaccessing the possibilities requirestailor-made investment strategiesand careful planning.

Think BRIC! China

Long term estimates predict thatChina will need to invest US$2,765billon into the industry by 2030to cope with its power demand.How will this be spent, and what

opportunities will it offer investorsand suppliers?

Think BRIC! Comparative Study

This report sizes the investmentneeds of the power sectors in Brazil,Russia, India & China; includinghistorical analyses from 2000–2008& also projected investmentneeds until 2020 by assessing

socio-economical, technical,environmental & legal aspects.

Think BRIC! Russia

The global financial crisis, alongwith the fall in the price of oil, hashit Russia hard but the Russianelectricity sector is still a target forforeign investments.




KPMG member firms invest significant time and resources in deepening

and sharing our understanding and knowledge of the sector. This enables

us to provide our clients with strategic and insightful services that are

truly tailored to their specific needs and based on a real understanding

of their challenges.

Our key industry initiatives include:

2011 KPMG Global Power & Utilities Conference – Europe

September 28–29, 2011The Westin Paris Vendôme Hotel, Paris, FRANCE

Join industry leaders and international experts fromacross the globe for an intensive day-and-a-halfprogram consisting of keynote presentations, sixissue-focused sessions, and four parallel sessionsproviding insights into the strategic, financial,environmental and risk related issues that are topof mind for power and utilities executives.

To register or to learn more about how the 2011

KPMG Global Power & Utilities Conference can helpyou navigate the ever-changing economic, socialregulatory and technology environment, please visit:www.kpmgpowerconference.com

The KPMG Global Energy Institute (GEI)

The GEI provides critical insights and analyses to the energy sector, helpingfinance, tax and risk executives meet new energy challenges and maximize newopportunities. We do this by creating an open forum where peers can exchangeinsights, share leading practices, and access the latest KPMG thought leadership.These publications provide interpretations, insight and practical guidance, and

range from white papers, podcasts and surveys to opinion pieces and regulatoryanalyses that affect major companies in the power and utilities sector.

The GEI interacts with members through a variety of channels, includingwebcasts, podcasts, conferences, share forums and a web-based portal:www.kpmgglobalenergyinstitute.com to be a valuable resource for insighton key industry issues and emerging trends.

The KPMG Global Energy Conference

The annual KPMG Global Energy Conference is the premier event presented bythe KPMG Global Energy Institute, and is held in Houston, TX every spring.The conference brings together energy financial executives from around the

world in a series of interactive discussions with industry luminaries.www.kpmgglobalenergyconference.com

Investing in the sector



The information contained herein is of a general nature and is not intended to address the circumstances of any particular

individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such

information is accurate as of the date it is received or that it will continue to be accurate in the future. No on e should act on

such information without appropriate professional advice after a thorou gh examination of the particular situation.

The KPMG name, logo and “cutting through complexity” are registered trademarks or trademarks of KPMG International

Cooperative (“KPMG International”).

Contact us

Peter Kiss

Global Head of Power & Utilities

T: +36 1 887 7384E: [email protected]

Darryl Murphy

Partner, Global InfrastructureKPMG in the UK

T: +44 207 694 3041E: [email protected]

kpmg.com

If you would like to order further copiesof this publication please e-mail: [email protected]

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