Energy Financing Challenges - Coal, Gas and Renewables

NARRATOR Welcome to the DNV Talks Energy podcast series. Electrification, rise of renewables and new technologies supported by more data and IT systems are transforming the power system. Join us each week as we discuss these changes with guests from around the industry.

MATHIAS STECK Welcome to a new episode of DNV Talks Energy. My guest today, Tim Rockell, Director Global Energy Institute from KPMG as well as Sharad Somani, Partner Global Infrastructure Advisory, also from KPMG. Welcome, Tim; welcome, Sharad.

SHARAD SOMANI Thank you.

TIM ROCKELL Thank you very much.

MATHIAS STECK Tim, maybe we start with you. Both of you, I would like you to introduce yourself before we start and also explain a little bit what are you doing in KPMG.

SHARAD SOMANI Sure.

TIM ROCKELL Thank you very much. Yes, so my name's Tim and I'm the Director of the Global Energy Institute for KPMG, and my role is to make sure that we've got the Asia Pacific angle reflected in all the work that we do; from Houston to Europe, and that our clients understand what's going on in this region. So, it's a two-way street. I've been in Singapore for five years. Before that I was based in the Middle East and used to speak to Saudi Aramco quite a lot, based out of Bahrain and before that in London, but my career has primarily been in the energy sector. And since being in Singapore we've been heavily involved in the Singapore International Energy Week. We've now been involved in five SIEWs, and that's 50% of them, and we're very pleased with the way that the themes have developed and the conversations that are going on under this roof here in Singapore.

MATHIAS STECK Right, thank you. Thank you very much. Sharad, could you also tell us briefly about yourself?

SHARAD SOMANI Sure. I lead the Infrastructure & Project Finance Practice for KPMG. I'm primarily covering Southeast Asia as a market and a little bit in the Middle East as well. The primary focus that we have is in the area of power and utilities, covering traditional power, coal, gas and renewable energy; and we do also waste to energy, energy efficiency projects in the region. The kind of work that we do is work with the government and the private sector, helping them structure projects, get financing and essentially organize public/private partnerships.

MATHIAS STECK Right. So, having the benefit of having you both here in this episode, I would be keen that we cover maybe a little bit the importance of gas going forward in the energy mix, and also some related finance issues with regards to gas but maybe also with regards to renewables. But to get us started, Tim, you just came from a panel you moderated in the Singapore International Energy Week. So, it would be great if you could maybe share with us what were the main findings in that panel discussion around gas.

TIM ROCKELL Sure, yes, and Gas Asia kicked off today. So, today is Wednesday and during the earlier part of the week we heard a lot about renewables and big advocacy going on in renewables; people very positive and I think that the fossil fuels were slightly shut out. Yesterday we saw a few more statistics from the International Energy Agency, showing that coal and particularly gas is going to be an important part of the mix going forward - and if you look at countries like Thailand, here in Singapore, gas is a really important part of the mix. The panel that I was on today, Indonesia was there. And when you look at maps of Indonesia and the infrastructure that's required, there's a lot of head-scratching going on because the energy capacity build out is going from something like 166 million tons of oil equivalent today to over a thousand in 2050; and for just that they need all options.

So, they're going to need renewables, it's not going to get them all away. They're going to need gas but, of course, in this region you've got the decline of gas. So, very much today we were talking about the role of the buyer. And so you've got the American producers now offering fixed prices at $6. Originally it was $8, earlier in the year, but that number's now coming down to $6. And so people are looking at kind of, what are all the options, and I think we'll talk a bit later on as well around how does gas get into the mix, how does it sit alongside renewables; battery storage coming in as well. So, is it kind of gas, is it battery? But then still coal. You can still produce coal to international standards - and with the amount of coal in this part of the world, that's being discussed as well.

MATHIAS STECK Yes, thank you very much. So, you mentioned gas; resources are slightly going down in the region. We have at some parts in the region a lot of coal, but it's very difficult to finance any new coal projects. So, when I put that together, we have a lot of investments to come for gas for the different countries here. We will have to import, at least, in this part of the world, and on the other hand, we cannot do much with the coal going on because coal projects find it difficult to find finance. Maybe, Sharad, you could elaborate on this aspect a little bit.

SHARAD SOMANI Yes, I think it's an interesting dynamic. I mean, one statistic that came out from SIEW yesterday was, for the first time, globally, the total investments going to the power sector have surpassed the oil and gas sector. Which effectively means that people are investing more in traditional power and renewable energy, an aggregate in terms of total investments; which I think will only increase going forward, given the fact that there's a huge power requirement in this region specifically. I mean, if you look at the electrification rate in Myanmar, it's just about 25%. Indonesia wants 35 gigawatt over the next five years, so there is a huge, huge requirement. Now, I think what is happening in coal is getting a bit constrained, primarily because a lot of banks are shying away from coal projects. That is not to say that coal will not happen. Out of the 35 gigawatt that Indonesia is talking, at least 40% will still be coal; but they will do clean coal, which is super critical coal. It is also interesting to note that the Middle East has done coal as well as part of their fuel diversification strategy. So, we have got 2.4 gigawatt projects under development in Dubai as well.

When it comes to financing challenges, I think gas projects have a challenge, given the fact that the domestic gas is limited in this region. You have to necessarily have LNG import terminals developed to get the financing going; and if you look at the kind of LNG contracts which were signed to date, it's long-term commitments. It's not very many governments are becoming comfortable as yet. I mean, governments like Indonesia, Myanmar, Malaysia will take some time to get their head around long-term energy contracts, which is in a way also prompting on the supply side, on the LNG side, to look at shorter term contracts, which is happening and which is good news for the power sector in this region.

On the renewable side, I think I would say that when you look at the strategy of most of these countries, they have gas as a necessary component; and all these countries in the region are looking at 20% to 25% of their portfolio coming through renewable energy. Which is a great thing because, look at the renewable potential in the region. Solar, wind and geothermal - there's a fair bit of potential. Solar, of course, is leading the way. Mini hydro, we are getting a number of projects happening; run up the river type, which are environmentally quite friendly and, given these four sectors kind of contributing, we are seeing a number of good financings happening.

Now, the interesting thing about renewable is, unlike big gas-fired projects or LNG terminals, the renewable projects are typically smaller. We're looking at 30, 50, 100 megawatt kind of range, which is easy to finance. The challenge essentially in these countries is, of course, regulatory, environmental and land-related issues, which I must say are falling in place, but it's not happening at the pace that we would expect.

Countries like Indonesia have come out with very clear regulations around land acquisitions. There is a very clear mandate around regulated tariffs for renewables. So, I believe that once certain proof of concepts happen in each of the sectors in terms of projects, then financing will come in.

MATHIAS STECK Right. I would like to come back to the financing aspect a little bit later. DNV has just also launched the Energy Transition Outlook, and we see that gas is the single kind of largest source of energy also going ahead. But, as we also mentioned maybe in this discussion already, renewables are growing very strong and we expect that the electricity demand will grow by about 140% up to 2050 due to the electrification of different industries, like transport and heat, but that 72% of that electricity will be generated by renewables. So, we see there's certainly a competition between gas and renewables. We sometimes call it the frenemy, the friend and the enemy. So, I would like to elaborate maybe a little bit on how these two can fly together, the gas and the renewable, maybe if you'd like to share your views.

SHARAD SOMANI Sure. I think both have to co-exist. I mean, given the return nature of the renewable energy, you cannot take renewable energy beyond a certain level. I mean, typically, based on some of the technical studies we have looked at, not more than 25% of the grade can be sustained by renewable, unless you bring a massive amount of storage.

Now, as you see, the battery storage is still very, very expensive. Over the next five to ten years we expect the battery storage will become competitive but gas will have to continue to provide a peaking load as well as base load in some instances going forward. So, if you look at a typical mix, the countries we are trying to look at, if nuclear is an option they'll have nuclear as a baseload. Coal, if we have excess in some oil plants, they'll continue to operate coal as a baseload. Gas will be the peaking load and then renewable energy will be taking care of the difference.

One of the things that most countries have to do when they chart out their strategy on a portfolio of energy supply options, they have to essentially ensure that gas continues to be a critical component because it helps provide the necessary risk diversification; both domestic gas as well as international gas. So, Singapore is doing that. Singapore has got piped international gas coming from Malaysia and Indonesia but they have LNG terminals also developed.

The second thing is renewable energy in Singapore, in fact, we are talking of 1 gigawatt of renewable energy, so, that will be almost 10% of our total installed capacity. So, renewable in Singapore itself, given the size constraint is still a great achievement. But if you look at countries like Philippines where there is huge geothermal potential, Indonesia is more geothermal and solar and hydro, all three together, this will continue to coexist. So, it is not either or, it is probably gas and renewable which has to happen.

MATHIAS STECK Yes, and this was not exactly what I wanted to talk about at the beginning but since you just mentioned that, you also had nuclear in there and I think we had a very ambitious colleague here, also on SIEW, who was trying to push that industry forward and admitted that he had a problem maybe to make the right advertisement because there is a perception issue about nuclear. So, maybe, Tim, what would be your view on this? I mean, even the Japanese colleagues tell us they have trouble with promoting nuclear in Japan. What will happen to that industry?

TIM ROCKELL Yes, I mean, that came up on the panel as well today and, of course, the kind of nuclear switch-on in Japan post-Fukushima is still an issue. So, there are a number of plants now which are ready to come on, more that are being readied for approval. And some of the stats that we saw today were showing that, no, Japanese imports of gas have probably peaked because of the renewables coming back on board. So, that then changes the whole dynamics as well. So, you've got the gas buyers in Japan looking to place that gas somewhere else because they're over-contracted. So, what they're looking to do now is to remove destination clauses from contracts, go towards a shorter contract that Sharad has mentioned, but also look for destinations for that gas in Southeast Asia.

So, we're seeing a number of the Japanese players now looking to place that by investing in power and other assets in the region, which I think is going to be really useful. And I think you've summed it up quite nicely, Sharad. When I think of gas, I always put the word ‘and’, so, after the ‘and’. So, ‘gas and renewables,’ ‘gas and transport’. And the good thing is that here in Singapore you've kind of got gas and talent. So, you've got a number of big gas players based here but there's going to have to be a shift in the skills of that talent as well. So, if you look at the traditional companies, the larger companies, very good at building the mega projects, very good at dealing with national governments, very good at securing rights.

If we're looking at the gas and renewables angle, very different skills. You're dealing with smaller regional governments, you're looking at securing land access rights, you're looking at building small pipelines and not all these projects are bankable. So, you've got the talent, the negotiation side, you've got then the bankability of these projects. We know that there's money out there, but the projects aren't always bankable, so different funders are looking for different things from these projects and that's something we've been working on with pension funds to private equity on.

MATHIAS STECK Right. That actually leads me nicely into my finance questions again, what you just said at the end. So, one thing we pick up is that banks, insurers and reinsurers are approaching us having trouble to assess risk of some of the projects coming up here in the region. and so in the case of DNV, it's especially offshore wind; where they have trouble because the assessment or maybe project certification regime is very different from the markets they're used to working in, like, for example, Europe. So, maybe that's a question for you, Sharad. How do you see that? What can we do to make banks/insurers/reinsurers more comfortable to invest?

SHARAD SOMANI Yes, I think a fair bit needs to be done because increasingly the region is quite reliant on ECA financing. Not very many commercial banks are coming and funding projects. It's not only with renewables, but also traditional projects are quite dependent on Exim banks coming in and giving guarantees to make projects happen. There are a few challenges and I think there's an institutional framework being put together, the challenges being most of the projects don't have a very well-defined path to development. With very, very sophisticated projects like Central Java IPP in Indonesia, it took around five years from conceptualization to financial close. And this is something which very few investors have an appetite to wait for.

If you look at what's happening in other smaller projects, increasingly they are depending on either Exim guarantees or some kind of corporate support, meaning that the sponsor is providing support. Now, this, of course, cannot continue for bigger projects because there is only so much corporate support that can be offered. Indonesia has specifically come up with what they call as the Indonesian Infrastructure Guarantee Fund, which effectively guarantees some of the sovereign obligations on the projects, which is making some institutional investors comfortable. I don't think that's a complete solution, but it's a good start.

Then there is a newer entity which has been set up. It's a created guarantee and investment facility which has been set up in the Philippines through ASEAN, plus three governments. And the idea is to guarantee issuance of local currency bonds for projects. Now, that's one market that has been totally untapped in the region, where there is no capital market support for infrastructure. There are no institutional investors who are supporting infrastructure financing. So, the pool of financing available for infrastructure projects is only for commercial banks and ECAs, Exim banks. Once you open the tap from insurance companies, institutional investors, private equity houses, infrastructure funds and capital markets, I think that will be a huge boost to the infrastructure financing.

The real challenge for that is how do you get credible projects. Now, credible projects can be split in two parts. One is a good development phase and second is good operation. I think development risk to my mind in the foreseeable future will still have to rely on ECAs and commercial banks. On the operating side, I think capital markets are becoming comfortable. The business trust model started in Singapore has been reasonably successful. A lot of infrastructure projects in operation phase have been put as a dividend yield play on the business trust. So, that's a good solution for operating phase projects.

There is also a concept which has been introduced in Singapore recently, is the fact that you can do take-out financing, meaning that once the construction is completed and the project is commissioned, the take-out institution will come and buy out the banks which have funded the development. So, effectively that frees up the bank funding for commercial investing in new projects.

The other interesting thing which we should look out for is privatization of assets. I think a lot of governments in the region, particularly Indonesia, has recognized that greenfield projects take a long time, and it's a dampener on the spirit of investment by the private sector. What they are proposing is they are offering a few projects from PLN or the road sector, all the sectors, effectively privatizing existing assets which are easy to fund because you know the operational track record is immediately generating funds. And that to my mind will be a great opportunity for all investors and lenders in the next three to five years.

MATHIAS STECK Okay. There is a second aspect which I would like to show some light on and I am afraid we are slowly also coming to the end of this episode; but we are hearing about the importance of renewables going forward, we are hearing about them becoming cheaper and cheaper. Especially now also in the auction system, but I am also talking to equity investors, for example, who are a little bit concerned about the yield rates they can get out of these projects because, obviously, finance has to become cheap as well. So, there are some ideas, I think, maybe discussed before we started recording about hybrid projects, renewables and gas maybe together, so to bundle things to make them bigger, the projects more attractive. So where is it going, are we going into a deadlock in renewables financing because the yield rates are not attractive?

SHARAD SOMANI That's a very good point and I think we require some recalibration of expectations on all sides. I think the governments are thinking that prices have to keep going on and the interest rate has to be very, very attractive. I think if you see the last six, seven years, we have been in a low interest rate environment for a long time but expectations of the equity investors have not been recalibrated. We have worked on a few projects and we closed three projects in the Middle East recently and most of these projects closed a single digit return for equity investors, which effectively means that if the project is reasonably certain, the technology is reasonably established and risks are contained, you can't expect super normal returns in those projects.

When Thailand implemented solar projects five years back, they had some very good returns. But if you look at the most recent auction that happened in Malaysia on solar, 30 to 50 megawatt, mostly were single digit or low double digit kind of returns. So, effectively, when we talk to private equity houses and infrastructure funds, we are actually suggesting to them that if the project is certain and risks are contained, we may have to recalibrate our equity return expectations, and that's the only way you can get into projects.

MATHIAS STECK Okay, thank you very much for that outlook. I have one last question for both of you before we close, and that would be, what is your main take away from the Singapore International Energy Week 2017? Tim.?

TIM ROCKELL Yes, well, I think once again the organizers have really hit the nail on the head, but what really struck me was the conversations around energy access that seems to be a part of a lot of the sessions now. This part of the region we know the potential. Still 100 million people can't switch on a lightbulb but people are talking about that, then measuring it and they're now predicting that we will get to 100% access in the next couple of decades and that for me is going to have enormous impacts on GDP. It doesn't just increase the GDP because you bring more people into the economy, but also for the people that currently have, there's a lot more marketplace for them. So, I see energy as an enabler of GDP as well.

And the other thing that's being talked about and is now being measured for the first time by International Energy Agency is digitalization. So, there is a whole leapfrogging of technology. We've seen it in telecoms, I think we'll see it in electricity and power as well. So, a lot of the people who haven't currently got electricity probably will never see an electricity bill. They might not even have a bank account at a physical bank but they're going to pay for their bill. It'll all be done on mobile. So, I think this digitalization is very exciting for the region. I think we're going to see innovation created here, but the big thing for me is this energy access and the transparency that is now talked about as a part of the main theme of the conference.

MATHIAS STECK Right, great, yes, exciting times ahead, definitely, yes. Sharad, what is your view?

SHARAD SOMANI Well, three big takeaways for me. I think one is renewable energy will continue to play a very, very important role, and there is a lot of bullishness amongst all the players, utilities, developers, bankers about it. Second is I think micro grids will play a very, very important role going forward and, to Tim's point about access, micro grids will increasingly play an important role together with renewables to taking electricity to remote parts of the region. And Cambodia was a great example where the minister was talking about renewable energy giving access to electricity. And third is of course innovation and digitalization is going to help leapfrog the sector and we do expect a fair bit of potentially disruption happening where nuclears will come and make electricity available to the masses.

MATHIAS STECK Very good. So, Tim, Sharad, thank you very much for your very valuable insights and for your time, and to the listeners out there, thank you very much for listening in. That were Tim Rockell, Director Global Energy Institute as well as Sharad Somani, Partner Global Infrastructure Advisory from KPMG.

NARRATOR Thank you for listening to this DNV Talks Energy podcast. To hear more podcasts in the series, please visit dnv.com/talksenergy.