Delivering the capital needed
Billions of dollars of capital is required to deliver the magnitude of renewable energy generation, storage and new transmission infrastructure required to meet Australia's energy transition targets.
Despite providing a number of helpful funding initiatives (including different types of concessional, loan and equity funding provided by the Clean Energy Finance Corporation (CEFC), the Australian Renewable Energy Agency (ARENA), the Northern Australia Infrastructure Facility (NAIF) and Export Finance Australia (EFA), among others, and revenue support regimes such as the Capacity Investment Scheme (CIS) and state equivalents), it is evident that the Government cannot finance Australia's energy transition single-handedly, nor can traditional equity alone solve the capital shortfall.
To enable the shift, there is a clear need to provide additional sources of capital across the whole continuum of the energy transition, from critical minerals through to generation and transmission. The full spectrum of debt and equity investors, including traditional banks, corporates and private capital funds (such as infrastructure funds (including the increasing number of funds established to focus solely on the energy transition), private equity, offshore pension funds, domestic superannuation funds and sovereign wealth funds) have a key role to play in bridging this gap.
What's the challenge?
Debt financiers and private capital operate in a truly global market, where Australia competes for its share of investment. While there is no shortage of capital available globally, Australia needs the right regulatory and policy settings to develop appropriately structured and investable projects. These projects must align with the requirements of capital providers to encourage investment where needed and ensure efficient capital supply meets demand.
The challenge lies in ensuring there are investment options that are attractive to different classes of debt financiers and equity investors by minimising risks and barriers to drive opportunities, and stabilising projected investment returns.
On the debt side, a gap currently exists between the project development pipeline and certain financier requirements and investor expectations, yet there is no one-size-fits all solution.
- When assessing whether a project meets their funding requirements, traditional debt financiers look for specific certainties. This includes a financing case supported by high levels of contracted revenues (demonstrating stable returns over their investment tenure) from creditworthy offtakers, mature and reliable technology underpinning the project, a fully contracted set of construction, operation and maintenance counterparties, and relevant connection and access rights.
- Such projects still exist, but the wave of consolidation and focus of traditional debt financiers on portfolio financings in recent years indicate greenfield projects increasingly struggle to meet these criteria. This is particularly due to permitting, connection, access and social licence hurdles. Greenfield projects have also faced challenges with volatile supply chain pricing and access in recent times.
- However, many transition projects sourcing capital lack a clean 'bankable' profile. They may involve new or emerging technologies, uncertain offtake profiles or lower-rated offtakers, thereby limiting traditional lender involvement. This gap opens opportunities for government funding and private debt capital.
- Private debt providers often offer flexibility in terms and structure to expedite transactions, contrasting with traditional debt providers. For projects relying on merchant revenues or using less proven technology, other private capital financiers play a crucial role given they are willing to engage higher up the risk-return curve, or may be supported by continued government lender involvement.
On the equity side, the key challenge facing the market at the moment is a supply and demand imbalance, as willing capital is faced with a limited number of investment opportunities. That imbalance is primarily driven by a development bottleneck, as considerable challenges face developers of renewable generation and storage projects, ranging from social licence concerns and supply chain disruptions, to skilled labour shortages and a protracted process for regulatory approvals. That imbalance is driving up the acquisition price of renewable projects, resulting in a downward squeeze on investment returns.
When combined with high interest rates and other macro-economic trends, this supply and demand imbalance has resulted in a challenging investment environment.
What's happening now?
Solutions require a combined effort from government, developers, investors and financiers to address the issues blocking funding where possible.
We are seeing governments at both state and federal levels striving to encourage investment in renewable energy projects by introducing initiatives intended to promote certainty and de-risk the investment profile. These initiatives include new offtake regimes such as the CIS and the NSW LTESA, which effectively underwrite projects against an agreed revenue floor; the development of renewable energy zones (REZs) aimed at addressing access and connection issues; and, more broadly, improving the efficiency of federal and state project approval processes.
Ultimately, the cost of financing projects will be a significant factor in the overall cost of financing the energy transition, impacting consumer power bills and making financing costs a key focus for the Government. To ensure the lowest possible pricing available, it is critical to structure projects in a bankable and investable way that reduces risk for lenders and capital providers.
For example, the Central West Orana REZ transmission infrastructure project in NSW, the first REZ transmission network in Australia, has adopted a novel structure that combines features of public-private partnerships (PPP) and regulated asset models. While PPP-style projects may not be appropriate in all circumstances, this sets a precedent for future transmission infrastructure to access private capital efficiently and fund significant capital cost.
There is an increasing diversity of equity investors participating in the energy transition, ranging from the traditional players such as domestic superannuation funds, offshore pension funds, sovereign wealth funds and private equity and infrastructure fund managers, to newer participants in the space, including funds focused solely on the energy transition and high net worth individuals. This provides a range of investment flexibility and drivers, allowing greater access to capital. The energy transition also provides an investment opportunity that aligns with mandates for ESG aligned investment—with appropriate diligence in light of the focus on greenwashing.
The Government continues to contribute capital towards the energy transition through leading roles played by CEFC, ARENA, NAIF and EFA. They accelerate investment through traditional project financing, debt market solutions like green bonds and direct equity investments. The Government's National Reconstruction Fund also supports with $1 billion earmarked for 'value-add in resources' and $3 billion for 'renewables and low emission technologies'.
Portfolio refinancings are used as a tool to pool greenfield risk with operating projects, driving investment across numerous clean energy projects that need to reach the market and commence development. Debt financiers also show a willingness to support new co-located storage projects on site with existing generation projects, or to finance new greenfield generation projects with storage solutions.
Traditional equity investors are comfortable with risk and variability of return, seeking to capitalise on the upside. Private debt, however, will increasingly play a role for private capital investors looking to deploy capital differently.
An investment strategy blending equity and debt allows investors to support the energy transition with a more balanced risk-return profile that better aligns with investor and member requirements. Private debt is increasingly seen as a well-positioned asset class for investors and an attractive capital source for borrowers.
As base rates increase, making the 'all-in' cost of bank debt more expensive, private debt, traditionally more costly for borrowers due to return hurdles, will compete more closely on price with debt from traditional bank lenders. The flexibility of non-bank lenders allows for bespoke solutions and structures—crucial when raising capital for new technologies or in high-risk profiles that do not fit traditional debt frameworks.
Blending of terms is a defining feature of this market, alongside the continued use of international products. There is also a broader perspective on market segments, such as traditional venture capital-style concepts emerging to support activity in the energy transition.
Private debt offers founders a way to access capital needed for growth and developing new technologies and businesses without diluting ownership. Described as 'intelligent money', borrowers can leverage the experience, expertise and resources of lenders incentivised to promote growth.
It is not necessarily an 'either/or' situation—private debt can complement traditional debt financiers and government funding initiatives in the capital stack. This helps de-risk traditional debt while ensuring developers and sponsors have the capital to deliver projects.
Critical minerals project proponents are also finding alternative ways (beyond equity capital raising and traditional debt) to raise funds in advance of production.
Mechanisms, which are increasing features of projects in this regard, include farm-ins where an investor funds costs to earn an interest in the project, pre-paid offtake agreements and granting of private royalty rights in respect of future production from the project.
We are also seeing a focus on offtake security as an increasing feature in the 'net zero' or green technology space—in this case the 'offtake' of new products manufactured by early stage companies to be used in the energy transition supply chain. Investors (often investing out of energy transition funds that apply an infrastructure-like lens to risk and return) are increasingly looking for offtake certainty, both as a means of underwriting operating expenses for the company and to demonstrate early market appetite for the product.
What's next?
- Given the continued need for offtake arrangements to support traditional debt financiers and to give comfort to equity investors, large electricity buyers should consider the continued opportunities to achieve favourable terms when partnering with renewable generation projects.
- Investors should continue to explore opportunities that align with their capital investment drivers, risk profile and return requirements, across a range of investment opportunities. For those investors seeking to invest in renewable generation and storage projects, but frustrated by the current supply and demand imbalance with regards to utility scale projects, that should include the consideration of alternative investment opportunities such as distributed renewable energy platforms. Investment opportunities in the broader energy transition include investment in the infrastructure that is required to support the transition (eg contestable transmission assets) and 'net zero technology' such as smart energy technology and alternative battery solutions.
- Investors should also assess financing options from the various available debt providers, with private debt potentially able to provide novel solutions, particularly for new technologies or businesses not supported by traditional financiers.
- Over the past two years, higher overall rates of return on senior debt have made debt investments more appealing to private capital investors. As a result, we anticipate private debt will continue to grow as an investment option for private capital, offering diverse ways to generate returns for investors and members.
- The traditional means of generating capital through the sale of later-stage development or 'ready to build' projects remains a viable means of funding for developers. However, to accelerate growth, many developers are looking to the private capital markets: seeking investment from private capital investors to help fund pipeline projects (increasingly through the creation of new platforms).
- Given traditional debt financiers' commitment to ESG targets and green investment mandates, developers should consider the best ways to structure projects to tap into the available capital pool, including through co-located or hybrid renewable energy projects that combine generation and storage.
- Developers should also stay informed about the potential unlocking of viable projects for investment and traditional debt funding through the expansion of the REZ regimes and access to further offtake support, such as the CIS regime.
- As Australia's offshore wind industry develops, developers should focus on having a clear financing strategy to ensure these large-scale, high-cost projects are as investable as possible during their early feasibility and procurement stages. Developers should also consider how best to leverage export credit agencies (ECAs) to bring further debt investment to these projects, consistent with overseas experience.