The U.S. power industry once epitomized stability, with long-term, low-risk financing for coal-fired power plants that could operate for half a century. However, in today’s “disrupted” energy sector, asset-based lenders face the challenge of reassessing risk related to technology, demand, regulations and the creditworthiness of borrowers. In comparison to when coal was king, deals involving the likes of wind, solar, bio-gas or battery-storage generally feature shorter terms and substantially altered risk profiles. Asset-based lenders need to account for this in the appraisals, loan structures and due diligence methodologies they employ moving forward.
Gone are the days in which the majority of energy deals involved 30-year loans to public utilities for the construction of coal or nuclear plants. Uncertainty has supplanted what once was a seemingly safe assumption—namely, that the power business would stay the same save for the fluctuation of regulatory enforcement under different political administrations.
The revolution in natural gas is a prime example of the shifting nature of the energy market. Twenty years ago, when energy buyers and sellers negotiated a contract, the price of natural gas was $15 for a million BTUs of energy. Today, it has plummeted to $3. In earlier eras, gas companies would routinely sign 20-year contracts with utilities in which the price was locked in. Now those contracts have shriveled to five years or less in length. Thanks to rising global demand and continued investment in LNG export infrastructure, gas companies understand that today’s price could easily double or triple in a few years.
Under the old model, lenders could count on all-requirements contracts to guarantee stable revenue streams for borrowers. Under these agreements, buyers agreed to pay a single energy producer to meet all of their energy needs. Now the capital markets are watching closely to determine the extent to which this will give way to flexible, multi-party agreements. Instead of purchasing power exclusively from a public utility, for example, a corporation might secure 15 percent of its energy from solar sources, or 25 percent from a startup that employs a combination of battery-storage, wind and solar technologies. Buyers might also want contracts that give them the freedom to leverage new, unregulated markets offering day-ahead, load following, frequency control and other purchase options.
Other factors, such as state regulations, are growing in importance as well. Energy demand in states such as California and New York, which have adopted aggressive renewables targets, is quite a bit different than in, say, Georgia, where no renewable portfolio standard applies. One Nebraska utility recently built a micro-grid and ramped up its ethanol production, not to meet demand locally, but to help a buyer in California hit its renewables targets. The buyer in question, per the California mandate, added $5 per gallon to the price it paid to the Nebraska utility. Likewise, in Kentucky and West Virginia interest is growing in converting closed coalfields into solar arrays and then selling that energy into the Northeast where rates are higher.
The corporate policies of energy customers also matter. Users like Amazon, IKEA and Google have aggressive targets for renewables. As they enter into flexible power purchase agreements, this will create opportunities for asset-based lenders to work with startups supplying renewable energy to these corporate giants. Alternately, some retailers and other companies with huge distribution or manufacturing facilities are rolling out rooftop solar in a large-scale way. To finance these installations, they, too, represent potential customers for asset-based lenders.
With respect to terms, lenders need to mirror their practices to the shorter-term contracts and higher-risk levels that are becoming the norm. Premium loans will in many cases be warranted. As more startups enter the picture, the ABL community may also need to ferret out potential credit problems with these neophyte market entrants. Among appraisers, substantial expertise in evaluating fast-changing technologies is a must. Moving forward, combinations of battery storage and renewables promise to provide cheaper and more consistent energy around the clock—but these systems need to work as advertised. What is the quality of the asset? Is it a Tier 1 solar panel or lower grade? Will the off-taker sell into an open power market or directly to the utility? Both affect the risk on the transaction.
Other strategies could range from refinancing the remaining term on legacy assets, to paying closer attention to the nature of interconnection agreements and regulatory trends. Like so many American industries, the power business has moved from stability to a state of flux. Coping with these changes—and capitalizing on the opportunities—requires adaptation on all fronts.