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Financing the UK’s energy transition
Read time : 5 mins Added: 02/03/2023
Britain’s future prosperity is closely linked to the success of the government’s plans for net zero. A focus on financing UK infrastructure is key if we’re to play our part in supporting the transition.
“The government has clearly articulated a vision. That vision translates into our strategy, and that strategy means we are working with developers and clients to deliver projects that will help us transition to net zero,” says James Taylor, Managing Director, Head of Infrastructure & Project Finance, Lloyds Bank. “We are effectively working with the government to make those projects deliverable.”
With a project finance franchise going back over 50 years, the team provide multi-product debt financing, and financial advisory and risk management solutions for assets across the infrastructure and energy space. Once closed, they then pass the projects over to 18 dedicated asset managers. Predominantly a UK bank, Lloyds Bank also has a North American project finance mandate.
“We're very much looking at what needs to be delivered in order to benefit the UK,” says Taylor. “Infrastructure is a societal enabler; it is integral to everything we do. Net zero is a continuation of that notion of enabling society.”
The cost of reaching net zero in the UK alone is extraordinary and could reach £60bn per year, or a total of £1.8trn by 2050. The figure for the US is even more extraordinary and closer to US$7.5trn per year or a total of $275.0trn by 2050. Mobilising that magnitude of transition finance cannot be accomplished by the private sector in isolation; it will need public investment, and bold and decisive government and regulatory support.
Financing the transition to net zero has its challenges
“The big challenge is bankability,” says Taylor. “A lot of transition financing is focused on creating bankable structures. Buying into new technology or a revenue stack, for example, requires banks to push themselves out of their comfort zone – whilst they may not initially exhibit all the traditional 'infrastructure' characteristics (high barriers to entry, certainty of cash flow, regulatory support), the end product clearly does.”
Government support is essential in justifying the level of upfront investment capital required to develop infrastructure projects. Contracts for Difference (CFD) have been successful in transforming offshore wind from a relatively niche market into “what has now become the most overbanked, most liquid project finance market within the UK and arguably the world,” he says. “That’s a measure of their success. That's what we want to see for other asset classes, such as hydrogen, and that’s how to unlock the liquidity needed for net zero.”
A reassessment of risk is also required within the banking community – particularly for new transition asset classes without the historical data that traditionally fuels rating models, or that come with exposure not usually accommodated in traditional project finance operations.
“Electric vehicle (EV) charging in the UK, for example, is not done on a concession basis, it's volume-based risk,” says Taylor. “Project finance banks don't normally get involved in volume risk, especially if it requires buying into a story without a proven empirical data set.”
However, EV technology is still relatively new from a project finance perspective.
“It will be seen as core infrastructure in 10 years, post-extensive roll out, but it’s nowhere near that right now.”
In June 2022, Instavolt raised £110m in senior debt financing from a group of banks including Lloyds Bank, to continue building a nationwide network of 10,000 rapid EV chargers by 2032.
“It requires a lot of people to get on board with the story, and we were able to do that with Instavolt, the first such deal in the UK in 2022,” says Taylor. “It’s a great example of where we were able to push boundaries.”
Lloyds Bank was also involved in financing another new transition asset class in 2022: interconnectors. It was part of the lending group in the €500m debt package put together in sterling and euros for the Ireland–Wales 500MW Greenlink interconnector project, and supported the UK borrower within the wider long-term debt package split into tranches of £1.4bn and €1.1bn for the NeuConnect 1.4GW UK–Germany undersea interconnector.
“We are the only UK bank involved in both of those deals,” says Taylor. “You've got relatively long dated construction risk, which requires people buying into the investment thesis. And that is where we're able to mobilise the bank's vision and passion.”
Whilst continuing to lend against the more established asset classes, such as offshore wind, there are significant opportunities in those that are still in their infancy, and promise the higher returns that come with ‘first mover advantage’.
As momentum behind the journey to net zero accelerates, the team will continue to focus its efforts on asset classes that contribute to the transition story.
“Nuclear has a clear role to play for the UK,” says Taylor. “In addition, there’s the application of tried and tested products to new areas, such as smart metering for water, and new technologies, such as hydrogen and tidal – there’s definitely a future for tidal in the energy mix – and we will see much more colocation of solar and wind with batteries. Fibre is also essential to the transition.”
Fibre is an example of where government commitment, in the form of participation from the UK Infrastructure Bank (UKIB), has resulted in deals getting across the line where once they may not have been successful. We’re working with UKIB to help the roll out of ultrafast broadband to UK homes.
“There's a liquidity shortage in the fibre market, but deals are still closing due to UKIB’s involvement,” says Taylor. “UKIB’s mandate is to ‘crowd in’ investments.”
In an effort to create a more sustainable future for the UK, our project finance team will continue to take a holistic view of infrastructure.
“It’s why we exist,” says Taylor. “We are enablers of society. Infrastructure allows the UK to function, develop and ultimately outperform.”
To find out more about our Infrastructure & Project Finance team, speak to us today - or get in touch with James Taylor on LinkedIn.