Financing Energy Efficiency (EE) and Distributed Generation (DG) Portfolios with Project Finance (PF) and Asset-Backed Securities (ABS)

The international community has agreed to limit global warming to 2^oC. However, the IEA estimates that we are currently on a trajectory for 3.6 to 5.3^oC. Limiting global warming to the agreed target requires that investments in low-carbon energy technologies will need to at least double, reaching $500 billion annually by 2020, and then double again to $1 trillion by 2030. Accessing the necessary level of ‘Green Infrastructure Finance’ has been the subject of much study recently, and reports by the OECD highlight the importance that the US$83 trillion of private capital will have to play in a time when national governments and banks are seen as having stretched their balance sheets to the limit.

The study presented here investigates the application of structured finance techniques, project finance and securitisation specifically, to the development of a portfolio of investments in a proven low-carbon energy technology, cogeneration. Cogeneration, the simultaneous, and therefore more efficient, generation of useful heat and power, is a mature energy efficiency (EE) and decentralised generation (DG) technology. An additional 2,800 MWe of cogeneration is forecast to be deployed in the UK by 2030, estimated to require an investment of over £1.5 billion.

An important potential advantage of access to this capital is that it can be made available at costs which align well with the returns typically achieved by investments in energy efficiency (<15%). These are found generally to be lower than the hurdle rates typical users of cogeneration set for their own investments (>15%). Using these assumptions for lower cost capital, a detailed cash flow model has been built to test the hypothesis that a portfolio of cogeneration projects can both achieve the scale of investment required to warrant the use of structured finance techniques, and that the equity returns are greater than the cost of equity.

The study finds that for the set of scenarios investigated, the hypothesis holds. Equity returns are found to be high (>15%), and the levels of debt involved are in excess of £40m. However, this assumes perfect credit performance by the portfolio. A simple default model using a 15% default rate is applied to the portfolio to test its impact on equity returns, which are found to be modest. These promising initial results suggest further study is required in this area to develop a more robust default model for these kinds of investments. Additionally, the management of business development risk, and refinancing risk, are identified as challenges to the funding approach proposed.

Read the full study as an article: Structured Finance 4 Distributed Generation.