German battery investment dynamics ‘extremely good’

pv magazine: Pine Valley Capital structures finance and focuses on large-scale battery energy storage projects. What role does the company play?

Janis Schäfer: Yes, we structure finance and are financing advisors – some would also call it corporate finance or project finance advisory. We primarily support project developers and IPPs [independent power producers] in project financing and strategic corporate financing. We bring investors into the projects and help make them ready to finance. We place a particular focus on projects with a clear sustainability focus. Our goal is to actively shape the energy transition, which is why we specifically support companies and projects in the field of renewable energies.

Why are you interested in battery energy storage projects?

The expansion of renewable energies has recently been rapidly advancing, requiring the power grid to become significantly more flexible. Large-scale battery energy storage systems are a highly suitable means of achieving this. In addition, market dynamics are currently extremely strong. By comparison, traditional, ground-mounted photovoltaic systems are no longer quite as economically attractive. Many market participants currently see significantly higher short-term return potential in battery energy storage projects.

What are the challenges regarding bankability?

For example, we see many project developers from the photovoltaics sector now entering the battery energy storage market. However they often lack experience in how to make such a project bankable. One of the biggest challenges lies in the marketing strategy – that is, the question of how revenues are to be generated. There are very different approaches. For example, participation in the balancing energy market, peak shaving, arbitrage [charging at low electricity prices to discharge during peak demand periods] through electricity price differences, and so on. Each of these options has different risk and return profiles and this is precisely what ultimately needs to be presented credibly to financiers so that they can understand and price it. In addition, there are currently no established standard models or long-standing track records that banks can rely on. This makes structuring finance more complex because it requires more individual arguments and building trust – be it through existing market expertise, reliable and experienced partners, technical reports, or conservative assumptions.

Is it possible to obtain debt capital for a “merchant” project (where revenues are generated solely through trading on the energy market, without subsidies or fixed offtake agreements)?

Yes, in our view, the market is moving in this direction. While there are currently only a few investors willing to actually bear such fully merchant risk, interest is growing. Banks and other financiers are currently investing in expertise and internal structures to better evaluate and support such business models in the future. It’s clear that the financing landscape is changing but it still requires persuasion and trust to successfully structure merchant projects.

What knowhow do banks need to build up for this?

Above all, they need to develop a deeper understanding of the electricity market because, with a merchant model, the project is completely exposed to market mechanisms and price risks. At the same time, this model opens up the opportunity to participate in potentially higher returns, especially compared to traditionally-hedged structures. This makes it particularly attractive for developers and investors and requires banks to be able to thoroughly assess and evaluate these opportunities and risks.

Does that mean that banks need to get a feel for the risk? At the moment are they simply too afraid?

“Fear” is perhaps the wrong word – it’s ultimately a completely natural process. For a project whose revenues are secured, for example, through a tolling agreement [involving rental of a battery energy storage system for fixed fees], financing can be based on these stable cash flows. For a banking department that has previously primarily supported traditional renewable energy financing, it is significantly easier to engage with such structures. At the same time, however, as a project developer or operator, you are also depriving yourself of a certain upside – the opportunity to benefit from higher market prices. Another factor that plays a role is that some participants view the development of the electricity markets in the next two to four years with a certain degree of skepticism. There is concern that revenues could collapse significantly during this period – and it is precisely this risk that must be appropriately considered and hedged in the financing structure.

It is sometimes said that there is a discrepancy in Germany between the income available through tolling agreements and the expectations of investors.

I would agree. Fully merchant [operation] offers, at least currently, extreme upside. And given this perspective, I hardly know any project developers who are keen to hedge their investments. Developers are naturally willing to take certain risks – precisely because they expect higher returns from them. The reality is also that the cash flows from a tolling contract are often insufficient to generate an attractive return on equity for investors. This is precisely where the discrepancy arises – between what investors expect in terms of returns and what a hedged model can realistically deliver.

Presumably, the typical financing terms are shorter than for photovoltaic systems?

Yes, that’s right. For photovoltaic systems, the term is usually based on the EEG [Germany’s renewable energy act] [subsidy] funding period or, in the case of PPA [power purchase agreement-backed] projects, on the term of the respective power purchase agreement, possibly supplemented by market assumptions for the period thereafter. For battery [energy] storage systems, on the other hand, the typical financing periods are usually 10 to 12 years. However, especially for fully merchant projects, it can make sense to opt for a variable financing structure rather than a traditional linear repayment structure. Many projects currently generate very attractive returns – in some cases it is even possible to fully repay them within three to five years – provided the repayment structure is designed to be sufficiently flexible.

What are typical return expectations?
This depends heavily on the respective business model and [an investor’s] role in the project. For operators, the expected return depends largely on the model they choose. Those who are risk-averse and hedge through a tolling contract are more likely to expect an internal rate of return [on investment, annually] of 8% to 12%. Those willing to engage in trading – i.e., to bear merchant risk – can expect 15% to 20% or more, depending on market developments and optimization strategies. Project developers who sell their projects rather than operate them themselves are generally dependent on achieving a significantly higher return per project – if only to offset the development risks. Banks are less concerned with equity returns than with interest rates on the debt capital employed. These currently, usually, range between 4% and 7% – ​​depending on the project structure, risk profile, term, and available collateral.

From pv magazine Deutschland.