Effects of the Russian invasion

Effects of the Russian invasion

February 28, 2022 | By Keith Martin in Washington, DC

Leading project finance market participants were split as the NewsWire went to press about the effect the Russian invasion of Ukraine will have on renewable energy and the broader project finance market.

Some said they see little lasting impact.

Others saw potentially wide-ranging second-order effects, with the effects growing more pronounced the longer hostilities and sanctions last and if the fighting spreads beyond Ukraine.

Debt and Equity

Interest rates for bank project finance debt have not yet been affected.

Ralph Cho, global co-head of power and infrastructure at Investec, said that the bank market remains "business as usual aside from the shock of the invasion happening."

The institutional debt market tends to react more quickly than the bank market to events. Spreads have widened for term loan B debt with institutional lenders either pausing or pricing at the wider end of the range, Cho said. "I can only imagine it is a matter of time" before the effects are felt in the bank market.

Andy Redinger, group head of utilities, power and renewable energy at KeyBanc, said he has not seen any widening of spreads in the bank market and does not expect any currently, assuming tensions do not escalate beyond Ukraine.

Russian banks do not appear to have been involved in project finance transactions in North America, but have been in some transactions in Europe. "That will be directly problematic for obvious reasons," the head of infrastructure and energy finance at a global private equity fund said.

The invasion has added to volatility in the equity markets. It could delay launches of initial public offerings of a few renewable energy development companies, Redinger said.

Stock prices have been falling for weeks. The decline has been small when compared to recent gains. The S&P 500 index was in correction territory after a 12% drop so far this year, but that compares to a 114.4% increase in the period from March 2020, when the market hit bottom, through January 3 this year.

Ted Brandt, CEO of Marathon Capital, said Marathon has not noticed any slowdown in the private equity markets, "although a drop in public equity prices will have a negative effect on private firms who are always compared against public trading multiples."

European capital could eventually be diverted to fund a more rapid transition to renewable energy in Europe. The heavy dependence of Europe on Russian oil and gas has limited Europe's room for maneuver in the current crisis. Europe relies on Russia for nearly 40% of its natural gas supply. Roughly 8% of Russian gas supplied to Europe passes directly through Ukraine.

Gas prices shot up to $40 per mmBtu versus about $5 per mmBtu in the US. Prolonged higher prices would make a recession more likely in Europe as consumers struggle to pay bills and factories have to curtail production.

Michael Kumar, global head of project, commodity and infrastructure finance for Morgan Stanley, said he sees a "boom for US LNG and I expect numerous projects to be commissioned, the clear winner in this tragedy."

Kumar said he will be interested to see to what extent global policy shifts to "drill baby, drill" to try to replace Russian oil and gas supplies. Russia supplies 12% of global oil demand and 10% of petroleum products. About 60% of Russian oil goes to Europe and 30% to China. The prices for Brent crude surged briefly after the invasion to above $100 a barrel for the first time since 2014, before settling back into the $90 range. The US imports little Russian oil. However, the oil price is set in global markets.

There were indications as the NewsWire went to press that Russian oil was starting to trade at a discount, indicating buyers are trying to avoid Russian cargoes.

It is unclear to what extent oil and gas producers will be interested in making new investments to increase production. The oil majors have started transitioning to renewable energy. Many lenders and equity investors are no longer willing to finance fossil fuel projects. US regulatory policies have made building new pipelines more difficult.

Any substantial increase in US exports of natural gas to Europe would have to be accompanied by increasing US production to mitigate the potential to increase the price of gas supplied to the domestic market.

Tax Equity

The potential for escalating political tensions with uncertain economic effects could lead to more price indexing in the tax equity market. Tax equity investors may be more likely to want to index the tax equity yield during the period between signing the letter of intent and document signing, one tax equity investor said.

More broadly, tax equity investors are worried that upward pressure on interest rates, raw materials and international shipping costs will increase project costs.

Costs have already been increasing due to tangled supply chains and general inflation. Russia accounted for 6% of the global aluminum supply and 5% of nickel in 2021. Aluminum prices are at an all-time high of $3,450 a ton after increasing 3% immediately after the invasion. Nickel is at a 10-year high of $25,000 a ton. Russia also accounts for more than 4% of the global copper supply.

Russia and Ukraine supply almost all of the neon that is used by lasers to etch features on computer chips.

"Increased fuel prices will drive up costs all along the supply chain and especially in the already-stressed logistics sector," Michael Alvarez, president of Longroad Energy, said. If defense procurement is ramped up in Europe and the US to supply or stockpile arms and equipment, more commodity demand could put further stress on the supply chain.

Escalating project costs have led to cancellation of as much as 30% of solar power purchase agreements for projects still under development as the projects are no longer able to supply electricity for the prices originally promised, according to some solar CEOs.

The higher costs are also leading to other challenges. Many developers of renewable energy projects stockpiled equipment in order to treat their projects as under construction before deadlines to qualify for federal tax credits. The stockpiled equipment had to amount to at least 5% of the total project cost. With escalating costs, the equipment is falling short.

Another consequence of escalating costs is appraisals for some projects are suggesting the projects are worth less at the end of construction than they cost to build. The construction costs have gone up, but the revenue expected under long-term power purchase agreements has not changed.

One tax equity investor said we may see "decreasing appetite for long-dated low-price PPAs on the part of sponsors not wanting to fix the revenue side when the price-indexed cost side remains unfixed." This could have a significant effect on how tax equity transactions are structured, he said, "such as more merchant risk, increased reserves, collateral requirements and more robust sponsor support." At the same time, it would eliminate electricity basis risk.

US Economy

The invasion increases the challenge facing the Federal Reserve as it increases interest rates and pares the $8.9 trillion in assets on its balance sheet in an effort to tame demand.

The Fed is expected to start increasing rates at its next meeting on March 15 to 16. Higher rates should lead eventually to higher rates in the project finance debt market. Tax equity yields are less directly correlated to interest rates.

The Russian supply shock will make it harder to bring the US economy in for a soft landing.

The US economy suffered both supply and demand shocks during COVID. Labor shortages and shipping difficulties were constraining supply at the same time that a $10.6 trillion global fiscal stimulus was adding to demand. However, some types of demand dropped precipitously, like for dining out and travel. The challenge for the Fed is how to tame demand just enough for it to match the constrained supply without stifling the post-COVID recovery. Some economists expect the invasion to lead to an increase in the US inflation rate to just below 9% rather than just shy of 8% as currently forecasted.

Many market participants worry about the effect the invasion could have on efforts to tame climate change.

A shift in focus to energy security is not as good for renewable energy development, one said.

Some worry that the invasion could sink whatever remnants remain of the "Build Back Better" bill as not only the invasion, but also the new Supreme Court nominee and the ongoing negotiations between Republicans and Democrats over funding for the federal government use up whatever available time there is on the Senate calendar this spring. The US government is still operating under budget priorities set during the Trump administration. It faces a March 11 funding deadline to fund federal agencies after having kicked the can down the road several times.


Others see the reminder of European vulnerability to unstable fossil fuel supplies as a catalyst.

Andrew Waranch, CEO of Spearmint Energy and a former commodity fund manager and trader, predicted the "switch to alternative energy is emboldened to remove dependence on foreign energy." Jam Attari, former CEO of BayWa r.e. Solar said "uncertainty is a killer for long-term planning in any market," but "on balance, I think we come out ahead relative to other markets" because renewables remain a good bet for long-term growth.

Gabriel Alonso, CEO of 547 Energy and former CEO of the North American development arm of Energias de Portugal, said the invasion will force Europe to focus seriously on energy independence and a more stable energy partnership.

He thinks Europe will have to streamline its licensing approval process for use of both onshore and offshore resources before it can shift more quickly to renewable energy. It will also have to debate whether it wants to continue to rely on Russia for energy supplies to northern Europe and Algeria, Egypt and Libya for supplies to southern Europe, or shift possibly to the United States as supplier.

He does not foresee any major changes in financing for renewable energy projects in the near term. "If anything, the appetite to finance merchant projects or provide financing for longer merchant tails may increase if the supply of gas is viewed as more than an interim issue," he said.

Himanshu Saxena, CEO of Starwood Energy, said he sees a mixed bag. The invasion will "worsen inflation and supply-chain issues, thus keeping costs to build new projects high, but at the same time, it will keep commodity prices high, thus helping renewable projects get new PPAs."

The effect on US-China relations could prove very important. China is a major supplier of polysilicon, solar cells and modules, batteries and lithium. The US tried for weeks to get China to pressure Russia not to invade. China criticized the US in the immediate aftermath of the invasion, but then abstained from voting on a UN security council resolution condemning Russia and moved to a somewhat more neutral tone in its public comments.

Samir Verstyn, chief investment officer of Origis Energy, said, "China has appeared not to have actively sided with the West or Russia." Any shift in US-China relations could have "much larger global repercussions and implications for our business."

Verstyn said US power companies are having to increase cybersecurity materially, especially after Russia threatened retaliation if the US keeps supplying Ukraine with defensive weapons. Origis not only develops its own solar projects, but also operates large projects for other companies.

Emerging Markets

Political risk insurance will be harder to find for projects in former Warsaw Pact countries, affecting the ability to do projects in such countries.

The insurance markets do not cover war risks of the type that could lead to a loss in the current circumstances, one insurance underwriter said. Russia coverage has been difficult to find for the past several years because of sanctions, she said. Ukraine coverage had been virtually impossible without participation by multilateral lending or export credit agencies.

However, if there are non-war losses — for example, from political violence or forced abandonment, as happened after Russia annexed Crimea — this could affect premiums on future policies as underwriters look to recoup losses through higher prices.

John Schuster, former head of project finance at the US Export-Import Bank and currently president of JLS Capital Strategies, said he sees a negative effect on financing projects in emerging markets, "maybe even a very large negative effect." He said a large number of factors will outweigh the potentially positive effect of higher commodity prices that benefit many emerging market countries and the increased need and even urgency for renewable energy.

Those factors include the "generally higher risk profile of projects and the peril of doing business" in undemocratic countries, the threat of political violence and cyberattacks, and a "global slowdown in the economy and a tightening of financial markets that will follow a market correction," Schuster said.

Jeremy Hushon, a project finance partner who focuses on emerging markets with Norton Rose in Washington, said he expects the US government and European development finance institutions to shift emphasis to countries that represent the next line of defense — Poland, Romania, Hungary, Moldova and the Baltic countries. "Turkey will be particularly interesting to watch," he said. "Despite the recent history of tension with the West, I expect we may see a rapprochement and renewed investment in an attempt to keep the country away from Russian influence."

The issue for all of these countries will be whether private developers have any appetite for the risk.