US offshore wind financing update
The lead finance people at three large offshore wind projects planned off the US Atlantic coast talked about a range of finance-related topics at the annual American Clean Power Association offshore wind conference in Boston in October.
The topics included the recently concluded financing for Vineyard Wind, the financing plans for the other two projects and how the "Build Back Better" plan under debate in Congress will affect the projects.
The three panelists are Álvaro Ortega, chief financial officer of Vineyard Wind, an 800-megawatt project off Massachusetts, Joris Veldhoven, commercial and finance lead for Atlantic Shores, a 1,510-megawatt project off New Jersey, and Justin Johns, chief financial officer of Mayflower Wind, an 804-megawatt project off Massachusetts. The moderator is Keith Martin with Norton Rose Fulbright in Washington.
MR. MARTIN: Vineyard Wind is the first large offshore wind project in the United States to reach financial closing. Cape Wind came very close in 2014, but did not make it across the finish line. Block Island, a five-turbine project off Rhode Island, was financed in 2015, and Dominion Energy has two turbines operating in the water off Virginia.
Vineyard Wind said in a press release in September that it closed on a construction and term loan for $2.3 billion. The press release said the financing was led by nine banks, and the trade press is reporting that the loan is already in syndication.
Álvaro Ortega, is there anything you can say publicly about the terms of the financing?
MR. ORTEGA: [Microphone not working].
MR. JOHNS: Maybe that is all he can disclose. [Laughter]
MR. ORTEGA: What can we say about the financing? It is a construction loan first, followed by a mini-perm term loan with principal amortization over the term of the PPA plus a short tail. We cannot disclose the terms, but the rate is similar to what we see for wind farms on land.
MR. MARTIN: Can you say the length of the term loan?
MR. ORTEGA: Seven years.
MR. MARTIN: Seven-year debt after construction. Nine banks. The interest rate spread is similar to what is available on land. Is there anything else you can say?
MR. ORTEGA: That is all I am able to say.
MR. MARTIN: The most interesting thing is how quickly the bank market has warmed to offshore wind. It is a new asset class in the US, but there is so much interest in financing such projects that the spreads have already moved immediately to roughly the same level as a more mature market.
Why did you end up with bank debt, given all of the other options available for projects of this kind? You could have borrowed from export credit agencies or in the project bond market, for example.
MR. ORTEGA: We explored all of the possibilities. We began the process in 2019 with probably 60 institutions. We narrowed down to a group of nine banks. The project had to be put on hold for a period while the federal government deliberated about whether to issue construction permits for any offshore wind projects off the Atlantic coast. We came back in 2021 with the same bank group. We wanted to close as promptly as possible this year after receiving the permits, so we decided to do this form of financing.
MR. MARTIN: Is the plan to refinance with longer-term debt—for example, project bonds?
MR. ORTEGA: At the end of the mini-perm, we will have to refinance. We have seven years to evaluate options.
Other Project Timetables
MR. MARTIN: Joris Veldhoven, how are you thinking about the financing options for the Atlantic Shores project? You have very big sponsors, as does Vineyard. Are you planning to use all equity? Or are you going into the debt markets?
MR. VELDHOVEN: Our sponsors are likely to look closely at a similar structure as Vineyard, but everything is on the table. Our current plan is to rely on project financing for as much of the capital stack as possible.
You mentioned export credit agencies. That is an avenue that we have not ruled out, but in all likelihood, we are going to talk a lot over the next two and a half years until our financial close with banks.
MR. MARTIN: That was going to be my next question. You are two and a half years away from closing on the financing. Álvaro Ortega, how long were you in discussions with the banks? When would you recommend that Atlantic Shores start negotiations?
MR. ORTEGA: As soon as possible. We started our debt discussions in 2019. They took more than two years, although we had to put them on hold in the middle because of the freeze on construction permits. We were able to build on the effort that was done in 2019, so that is why we were able to close in a relatively short period of time once the negotiations resumed.
Most of these projects are owned by joint ventures. These are big, multi-party financings. There is a lot of back and forth among all of the parties involved to get to a loan commitment. The earlier you can start, the better. Engage early with the banks, but not too early because conditions can change over time in the financial markets.
MR. MARTIN: The Vineyard project has two owners.
MR. ORTEGA: Avangrid and Copenhagen Infrastructure Partners.
MR. MARTIN: The Atlantic Shores project also has two owners.
MR. VELDHOVEN: Shell and EDF Renewables.
MR. MARTIN: The Mayflower project is also owned by a joint venture.
MR. JOHNS: Mayflower is owned by Shell and Ocean Winds, which is a joint venture between EDP Renewables and Engie. Shell owns 50% and the EDPR-Engie joint venture owns 50%.
MR. MARTIN: Justin Johns, how are you thinking about financing, and when will the Mayflower project be in the market for financing?
MR. JOHNS: Mayflower is similar to Atlantic Shores in the sense that it has partners with strong balance sheets and existing banking relationships. The partners are funding the work themselves during development. Their balance sheets give us a lot of flexibility as to when and how we execute any financing.
We expect to use nonrecourse project financing ultimately, similar to what has been done in Europe. Our goal is to find the most competitive terms on offer in the market, building on what Vineyard has done and making it incrementally better.
MR. MARTIN: When will you be in the market?
MR. JOHNS: Sometime around 2024.
MR. MARTIN: Mayflower is slightly ahead of Atlantic Shores, but not by much.
MR. MARTIN: Álvaro Ortega, a lawsuit challenging the permits in Vineyard was filed just days before the banks closed on the financing. That usually disrupts a closing, yet the banks closed over it. How did they get comfortable?
MR. ORTEGA: Any major infrastructure project always faces litigation. We hired law firm experts with expereince in this kind of situation. They reviewed all of the documentation that was available to us, and then we shared both the documentation and the analyses with the banks. The banks felt comfortable closing.
MR. MARTIN: There was more than one lawsuit pending at the time, correct?
MR. ORTEGA: Yes, three.
MR. MARTIN: The Cape Wind project also faced one lawsuit after another. There was talk about getting the US Department of Energy loan guarantee program effectively to bear the litigation risk over permits. You did not have to go to that length. The banks looked at the lawsuits and decided they were comfortable enough to close over them.
MR. ORTEGA: The lawsuits were not against Vineyard. They were against the various federal agencies that were involved in granting a permit to Vineyard to build.
MR. MARTIN: What percentage of the Vineyard capital stack will be debt?
MR. ORTEGA: Around 50% to 60%. The rest will be a combination of sponsor equity and tax equity.
MR. MARTIN: The 50% to 60% seems to be not only the percentage of the capital stack after term conversion, but also the advance rate during construction.
Joris Veldhoven, do you have a sense yet of how the capital stack will look for Atlantic Shores?
MR. VELDHOVEN: We are not advanced enough yet to give detailed percentages, but our goal is to get to as high a percentage of nonrecourse debt as the market will allow and improve on the capital stack in Vineyard.
MR. MARTIN: "Improve on the capital stack" means get to higher leverage than Vineyard was able to achieve?
MR. VELDHOVEN: We should all try to stand on each other's shoulders in this industry.
MR. MARTIN: The amount of debt that you can borrow is a function of the debt service coverage ratio and that, in turn, is a function of how certain the cash flows are. Coming back to Vineyard, what percentage of the offtake is contracted?
MR. ORTEGA: 100%.
MR. MARTIN: How long are the power contracts?
MR. ORTEGA: Twenty years.
MR. MARTIN: Joris Veldhoven, how long is the offtake contract for Atlantic Shores, and does it cover the entire output?
MR. VELDHOVEN: We have an OREC contract with New Jersey for 20 years. Atlantic Shores is a 1,510-megawatt project. The contract covers 100% of the output.
MR. MARTIN: Under the OREC program, electricity from an approved offshore wind project is sold into the PJM spot market. New Jersey then gives the project ORECs—offshore wind renewable energy certificates—that the New Jersey utilities are required to buy for pre-agreed prices. The utilities pass through the amount paid for ORECs to their ratepayers. The actual revenue the project receives from PJM spot sales is turned back to the ratepayers. Cutting through everything, the project exchanges revenue calculated at spot prices for revenue using a fixed contract price.
MR. VELDHOVEN: The value of the OREC credits starts in the mid-$80-a-megawatt-hour range and escalates from there.
MR. MARTIN: Justin Johns, what do you think the Mayflower capital stack will look like?
MR. JOHNS: We plan to use as much nonrecourse debt as the project can support. Having sponsors with strong balance sheets means we have the luxury of waiting until the debt terms on offer are most opportune. Then it is just a question of how much tax equity we can raise or how large any direct cash payments will be in place of tax credits.
MR. MARTIN: Are you far enough along with banks to know whether they would be prepared to go above the 50% to 60% advance rate that we just saw in Vineyard?
MR. JOHNS: Not specifically, but we see a very strong interest among the banks in financing US offshore wind projects. Mayflower will probably be the second or third such project to hit the bank market. The market seems quite competitive as to the amount of leverage and other debt terms.
MR. MARTIN: Álvaro Ortega, tax equity was not part of the Vineyard capital stack from the start. Why not?
MR. MARTIN: We expect the project to be in commercial operation by the end of 2023. We do not see tax equity committing that far in advance in the onshore wind market. Tax equity also requires high commitment fees that are a function of how long the commitment remains outstanding. We reached financial close on the debt without having tax equity committed, and we are confident that next year we can get there with tax equity.
MR. MARTIN: Did potential tax equity investors tell you how far in advance they would commit?
MR. ORTEGA: They could have probably committed this year if we had put a tax equity bridge loan in place and been prepared to pay the commitment fee.
MR. MARTIN: For how high a commitment fee were they asking?
MR. ORTEGA: That's confidential information.
MR. MARTIN: I see now why the advance rate during construction was only 50% to 60%. The banks were not willing to lend more without a tax equity takeout at the end of construction to repay the construction loan down to the level that the project can support as term debt.
Joris Veldhoven, is Atlantic Shores planning to have tax equity in from the start?
MR. VELDHOVEN: Our financial close will be in 2024, so anything I say today is not so valuable. Congress is considering a direct-pay alternative to tax credits. We will see how the world looks early next year and take it from there.
MR. MARTIN: Álvaro, do you have a sense for how much tax equity can be raised on your project?
MR. ORTEGA: Not yet. It depends partly on whether the export cable to bring the electricity to shore qualifies for the investment tax credit.
MR. MARTIN: The export cable can cost $300 million or more. A 30% investment tax credit on it is a substantial number.
We are optimistic that the IRS will treat any export cable that is inside the perimeter of the offshore wind farm as part of the generating equipment and, therefore, as eligible for the tax credit.
The "Build Back Better" plan being debated currently in Congress would also allow a 30% investment tax credit on new transmission lines. However, any such line would have to be 275 KV or higher and have a capacity of at least 500 megawatts to qualify.
Some offshore wind farms plan to have more than one export cable to shore. The combined capacity is more than 500 megawatts, but each separate cable is not. Hopefully the IRS will allow the megawatts to be combined in such cases.
Álvaro, do you expect any complications from slotting in the tax equity after the debt has already closed?
MR. ORTEGA: Not at this point.
MR. MARTIN: Surely the lenders will have something to say, because you are going to insert tax equity ahead of them in the capital stack. It is like two farmers along a river. The tax equity farmer would have first claim on the water before it reaches the lender farmer downstream.
MR. ORTEGA: That is correct, but the lenders understand that this is going to be like any onshore deal. The debt will become back-levered. They feel comfortable with the typical terms in such arrangements.
MR. MARTIN: There are a lot of other offshore wind projects in line hoping to tap into the debt and tax equity markets. These are behemoths; they are all multi-billion dollar projects. Is there any sense, starting with you, Justin Johns, that the market has limited capacity?
MR. MARTIN: Europe has a handful of projects that go to the financing market each and every year, and they are able to raise nonrecourse financing. The US market is still in its infancy. I understand there was strong demand for Vineyard. I expect that there will continue to be strong demand for Mayflower and Atlantic Shores, driven by quality PPAs, backstopped by quality revenue structures and managed risk.
Tax equity is an area where you have to look at market capacity for tax equity, but as long as we bring good projects, we are optimistic.
MR. MARTIN: Joris Veldhoven, what sense are you getting from the tax equity market about its interest in doing this type of project?
MR. VELDHOVEN: Our sponsors, EDF and Shell, have lots of experience raising tax equity for onshore wind projects. It is still early for us to have engaged fully with the tax equity market. The Atlantic Shores project is not expected to be in commercial operation until 2027. The initial interest is there, but tax equity investors are not able to forecast tax capacity six years in advance.
MR. MARTIN: Two banks, JPMorgan and Bank of America, have seemed recently to have endless tax capacity. Their main constraint is people. They are a little over 50% of the market.
Álvaro Ortega, remind us how many banks expressed an interest in financing Vineyard.
MR. ORTEGA: We started with probably 60, narrowed it to 20 and then ended up with nine. We had plenty of banks that wanted to participate, and now they will have a chance through the syndication.
MR. MARTIN: How many tax equity investors?
MR. ORTEGA: We are looking at two or three.
MR. MARTIN: The renewable energy tax equity market could be about $20 billion this year. Multiply $3.5 billion for just one offshore wind project by whatever percentage investment tax credit you think applies, and you can see that a string of offshore wind projects could have a big impact.
MR. MARTIN: Álvaro Ortega, what practical lessons did you take away from the financing negotiation?
MR. ORTEGA: The paperwork was huge for this deal. There were a lot of banks and two sponsors on our side. That made for a lot of back and forth. One lesson was the need to start early. Another was the importance of putting in place early hedges or derivatives. We have two sponsors. They have two different risk profiles and goals. The accounting implications of the derivatives take time to work through.
MR. MARTIN: What were you hedging?
MR. ORTEGA: We hedged the interest rate and some foreign exchange exposure for the components during construction.
MR. MARTIN: Your debt is in dollars. What percentage of the project cost is not in dollars?
MR. ORTEGA: Around 30%. We were able to lock in the exposure in some cases with the suppliers directly.
MR. MARTIN: What will you do differently the next time? I know that Vineyard has some other projects teed up.
MR. ORTEGA: The Vineyard Wind project will remain a 50-50 joint venture between the sponsors, but we are in the midst of reorganizing the remaining projects so that each will have only one sponsor. Each sponsor will decide on its own how to finance its projects.
MR. MARTIN: Is there nothing you would do differently the next time?
MR. ORTEGA: I think it went pretty well. We are very happy with the result.
MR. MARTIN: One of the lessons from Cape Wind, which came very close to securing financing in 2014, was that the politics of individual offshore wind projects can change rapidly if there is a change in governor in a state. It is important not to waste time arguing about small issues. Move rapidly through the financing process.
All three of you have been in the energy industry for a long time. What other lessons are there for people trying to develop offshore wind?
MR. VELDHOVEN: It is extremely important that we actually deliver and show real-life examples of where jobs are created. We talked about the local supply chain. This industry talks about local content. We need to show a lot of progress in the next 12 to 24 months to maintain momentum and political support.
MR. MARTIN: So build political support by creating jobs on shore to build parts of the project. The projects have also moved farther offshore so that they are not as visible from land, which helps dampen opposition from property owners along the coast. Justin Johns, any other lessons?
MR. JOHNS: I guess I would call it a reflection about how much more complex offshore wind development is in the US than in Europe. In the US, you have multiple levels of federal, state, county, city and community involvement, even down to the fisheries. You have so many stakeholder groups. You have a supply chain that is only beginning to develop. You have permitting issues with transmission. It is not so simple to apply skills learned in Europe to the US market.
MR. MARTIN: Another challenge for Cape Wind, which of course did not make it across the finish line, although it got very close, was the sheer number of contracts to build parts of the project. There was no one overall prime contractor who wrapped everything and guaranteed it would work once everything was assembled. How did you get past that in Vineyard?
MR. ORTEGA: We have multiple contracts, but we are doing the construction management in house. The banks felt comfortable with that approach. The due diligence went extremely well.
MR. MARTIN: Joris Veldhoven, Atlantic Shores has a 10-megawatt hydrogen project tacked on the back end. The conventional wisdom is that hydrogen does not yet make economic sense. Why is this a benefit to Atlantic Shores?
MR. VELDHOVEN: It is a pilot project. We are not doing it for the return on capital. We are working with a local partner in New Jersey and plan to test different use cases. We have a primary use case, which is injecting green hydrogen into natural gas pipelines up to approximately 15% blending. That can be done without any additional infrastructure costs, either on the gas company or on the customers of the gas company.
This is our first project in New Jersey. Our partner is the local gas distribution company, South Jersey Industries. Congress is considering offering up to a $3.00-per-kilogram tax credit for making green hydrogen, which would help with the economics.
MR. MARTIN: What are you projecting currently it will cost to make a kilogram of hydrogen?
MR. VELDHOVEN: I don't have those numbers.
MR. MARTIN: For those of you interested in hydrogen, there is a very good briefing in The Economist magazine this week at the start of the issue.
Changing Tax Laws
MR. MARTIN: Álvaro Ortega, your financing played out against the backdrop of a debate in Congress about changing the tax law, including possibly having the IRS make direct cash payments to owners of new renewable energy projects in place of tax credits. If that happens, will you still raise tax equity?
MR. ORTEGA: Let's see what Congress enacts, including any haircut, the timing and other details. At least for now, tax equity seems to make more economic sense for the project.
MR. MARTIN: There is no haircut in either the House or Senate bill. Of course, we don't know where this will land or whether the bill itself will be enacted, but if it is enacted with no haircut, how will you think about whether to do tax equity?
MR. ORTEGA: Tax credits are only part of the tax benefits on offshore wind projects. There is also accelerated depreciation. As long as there is no direct-pay option for depreciation, it will probably still make sense to raise tax equity.
MR. MARTIN: Justin Johns, if there is a direct-pay alternative to tax credits, will Mayflower raise tax equity?
MR. JOHNS: It depends on what the final bill says, whether there are any time limits on when direct payments are available and what other requirements will apply.
MR. MARTIN: We are down to the last five minutes.
The "Build Back Better" bill would restore federal tax incentives for renewable energy to the full level and extend deadlines, but it comes with fine print. One bit of fine print is the need to pay the same Davis-Bacon wages that the government pays on federal construction projects and use qualified apprentices for 10% to 15% of total labor hours, both during construction and for five to 10 years after the project is completed on later alterations and repairs.
Is this already playing into your contract negotiations?
MR. VELDHOVEN: Yes. The supply chain in offshore wind is still emerging, but a lot of the suppliers that we are talking to are already paying prevailing wages. We will be interested in the eventual IRS guidance.
MR. MARTIN: Is there a prevailing wage for offshore projects? The US Department of Labor publishes them for the different locations onshore.
MR. VELDHOVEN: I am not sure. Another issue is how far down the supply chain the requirement applies. For lack of a better term, the jury is out. That said, I think overall, as an industry, we can pay good, living wages.
MR. MARTIN: Justin Johns, how are the wage and apprentice requirements playing out in your current planning?
MR. JOHNS: Mayflower certainly intends to pay a prevailing wage. I think the point was eloquently made.
MR. MARTIN: Álvaro Ortego, another bit of fine print is a domestic content requirement. You would have to use 100% US-made steel, iron and manufactured products. The domestic content requirement is both a carrot and a stick. The carrot is an additional tax credit if you comply. The stick is inability to qualify for a full direct cash payment in place of tax credits. The stick will not apply to Vineyard because the project is already under construction. There is a haircut in the potential direct payment for projects on which construction starts in 2024 or 2025 and no direct payment at all for projects on which construction starts in 2026 or later.
Is this starting to play into your planning for your future projects?
MR. ORTEGA: We are following it closely. The exact requirements are still taking shape in Congress.
MR. MARTIN: I gather at the moment offshore wind projects will have a hard time satisfying any requirement using 100% domestic content, but perhaps this will influence how the local supply chain develops over time?
MR. ORTEGA: That's correct.
MR. MARTIN: Has anybody looked enough to know whether his project can meet the requirement currently?
MR. VELDHOVEN: We are not constructing currently. As we proceed to construct in 2024, could we meet it as is? No. However, I think we all are very bullish on what the US market can do given enough time to adjust.
You talked earlier about hedging. One of the benefits of a local supply chain is that there is less need to hedge. I think that is the goal. Atlantic Shores has committed major facilities on land in New Jersey as part of our project.
Offshore wind developers have been having meetings about how to get to the stage where we can confidently say the steel and iron come from the United States. I don't think anyone can really say today even with 2024, 2025 or 2026 construction you can make it.
MR. MARTIN: My last question is this: offshore wind projects already qualify for a 30% investment tax credit as long as construction starts for tax purposes by the end of 2025. The bill may end up with a corporate tax increase, and it has the fine print we just discussed in the form of wage, apprentice and domestic content requirements. Is the bill a net benefit or net detriment for offshore wind? [Editor's note: At the time of the panel discussion, the House bill increased the corporate tax rate to 25%, but the increase was later dropped from the bill before it passed the House in late November.]
MR. JOHNS: It depends on the particular facts of each project, but it should be a net benefit.
MR. MARTIN: What is the benefit?
MR. JOHNS: The benefits are a potentially higher tax credit and the possibility of being paid the amount in cash rather than having to go into the tax equity market.
MR. MARTIN: Only if you satisfy the domestic content requirement.
MR. JOHNS: It all depends on how the bill is implemented at the agency level. There is definitely potential, but it needs to be done right with recognition that US offshore wind is at a much earlier stage of development than other types of renewable energy.