Green Investment Bank

Writtten evidence submitted by RenewableUK (GIB 28)

· The scale of the low-carbon investment challenge is large, with wind, wave and tidal stream alone looking for £85-90bn of capital in the next ten years.

· This scale and also the speed of mobilisation required point to the need for new catalysts for action, and a Green Investment Bank could therefore be a vital new institution.

· Any GIB must be the means of catalysing investment by others, and must not be in competition with existing finance and investment.

· The debate around the Bank is confused by the many different roles it could possibly take; it is difficult to be definite about how beneficial it could be without knowing more about Government thinking about its function.

· The extent to which the Bank is capitalised is key to how effective it can be, but all the routes by which capital could be channeled into the Bank appear problematic.

· No institution can compensate for bad policy; Government must ensure that investors see a stable policy landscape that they can navigate with confidence, which would result in a new Bank being able to be highly effective with relatively little resource.

Introduction

1. RenewableUK is the UK’s leading trade association in the field of renewable energy, representing over 650 companies in the wind, wave and tidal stream sectors. Together, these technologies will provide the bulk of the renewable electricity we will need to meet targets in 2020 and through to 2050, and should be the motors of new industrial growth, providing thousands of new jobs and significant export revenue. Ensuring that our members are able to secure sufficient finance will be key to delivering on this promise.

The scale of the renewable financing challenge

2. One of the key challenges in meeting targets for renewable energy and reduction of carbon emissions is mobilising the capital required to finance the build of many gigawatts (GW – 1GW = 1,000MW) of new generating capacity, alongside the need for funds to support the roll-out of efficiency measures and low-carbon heating and transport. There are a number of varying estimates of the total capital required, for instance a recent report by Ernst & Young [1] cites a figure of £170-180bn of investment by 2025 required in the power and gas industries, while a group of leading low-carbon investors led by Hg Capital and Hudson Clean Energy estimate £190bn by 2020, made up of £147bn for new generation capacity, £5bn for supply chain and £37bn for efficiency and smart grids/meters.

3. Whatever the overall figure for investment in the low-carbon transition, it is clear that renewables will be a significant slice of the pie. RenewableUK estimates that over the next ten years, approximately 1GW of onshore wind will be built each year. At a capital cost of £1.3m/MW, this implies a need for about £13bn of investment. Given the maturity of this technology and the experience already gained in its use in the UK, this should be easier to secure than for some other technologies, but it is no trivial task. It pales next to offshore wind, however.

4. The build-out of the Round Two projects identified in late 2003 should proceed up to 2015 at the rate of about 1GW per year. With capital costs running at about £3m/MW, this means that approximately £15bn of investment will be required over the next five years alone, though much of this has already been committed for projects being delivered in the next 2-3 years. In 2015-20, however, many of the 32GW of Round Three projects awarded in January this year will be coming out of the consenting process, alongside much of the Scottish Territorial Waters round from last year, giving an opportunity to ramp up delivery of offshore wind from about 1GW/year to as much as 4GW/year from 2017 onwards, at which rate £10-12bn per year of capital would be required. If 15GW of offshore wind capacity is installed in this period, a total of £40-45bn would be needed.

5. We believe that delivery of offshore wind at this scale is necessary to provide the ‘critical mass’ required to drive the creation of a manufacturing industry for this technology in the UK. If delivery were to continue at only 1GW per year to 2020, roughly the level in the UK’s National Renewable Energy Action Plan submitted to the European Commission at the end of June this year, then this would provide insufficient ‘pull’ to encourage manufacturers away from their existing supply chains in countries such as Denmark and Germany. If we are successful in doing so, however, then approximately £1.1bn of investment will be required in the UK in factories and other supply chain investments.

6. If the technologies of wave and tidal stream successfully emerge from the technology development phase and are rolled out at scale by 2020, a further £5bn might be required to develop projects, while further direct investment in the companies and technologies involved would increase the requirement further.

7. In total, therefore, the technologies that RenewableUK champions could need a total of £85-90bn of investment. The result of this investment would be approximately 15GW of onshore wind, over 20GW of offshore wind and 1-2GW of marine renewables, in total generating about 25% of this country’s power. We would also have world-leading industries in offshore wind and marine, which would be starting to earn significant export revenues from about 2020 onwards.

A Green Investment Bank

8. Given this need for capital in the coming decade, and the continuing fallout from the banking crisis of 2008, it is therefore welcome that the Coalition programme includes the establishment of a ‘green bank’. It is vital, however, not to lose sight of the fact that strong and stable policy is the most important factor in inducing banks and institutional investors to direct the required investment into low-carbon sectors. Without confidence that the policy underpinning investments is secure, private capital will be inhibited, and no public-backed bank will be able to make up the shortfall.

9. In our view, the key features that any institution in this area must have are:

• It must encourage and invest alongside private capital, and not be in place of or in competition with such capital;

• It should seek to correct market failures including those resulting from the credit crisis; and

• It should advise the Government on the financial impact of policy changes.

10. It is also important to note areas in which there exists a need for an investing institution and those areas where such a need does not exist. While we welcome the suggestion of bringing together the various forms of support for new technology development under a single roof, we do not see venture capital as being an issue for wind power. The deployment of wind on and offshore over the next decade will require in the order of £75bn of capital: this dwarfs into insignificance the amounts that will be needed to develop technologies and the companies that produce them. This is not to say that VC-type funding will not be helpful: firms in the marine renewable and small wind sectors may well benefit greatly. Innovation funds to bring forward cost-reducing techniques for offshore wind are also needed. But these other needs are orders of magnitude less than the requirement for mass deployment.

11. Ideally we would like to see the private sector bringing forward the capital needed for mass deployment of renewable generation capacity. With suitable financing structures, a situation is imaginable where banks could provide construction finance, exiting once projects are operating successfully through sales to institutional investors; the banks would be able to recycle limited capital after a 3-4 year commitment, while pension funds would have access to lower-risk, long-term investments that would fit their needs. It may take some time for such structures to develop, however, and there may well be a role for a ‘green bank’ to play in de-risking key parts of such a solution to speed its implementation.

12. When bringing forward a new institution in this area, we would emphasise strongly that public-backed funds alone will not be sufficient to ensure the investment required, and that care should therefore be taken to ensure that any ‘green bank’ does not compete directly against private banks. Given the better terms that an institution with the Government behind it would be able to offer, this would be unfair competition and result in a reduction of capital put into the market by the non-Government backed banks.

Possible roles for a Green Investment Bank

13. There are many different roles that a public or quasi-public financial institution could perform in the low-carbon investment area, and indeed that multitude of possible roles has led to much confusion as to the impact a GIB could have. We discuss some of these roles below.

14. At the start of the value chain, one suggestion for the Bank would be to consolidate and make more coherent the landscape of low-carbon innovation funding, making it easier to navigate and presumably making some efficiency savings in the process. RenewableUK has argued for some time that such rationalisation would be helpful, though it would not in itself make much more money available to the area, and additional funds are necessary if we are to have the technologies required. Investment in innovation will also be vital in attracting manufacturing industry. There is also a risk of hiatus in innovation investment as the different funding bodies such as the Energy Technologies Institute, the Carbon Trust and some of the work of the Technology Strategy Board, with their different staff and funding models, are brought together under one roof. We are also unsure whether a ‘Bank’ is necessarily the right type of institution to play this role, in that awarding grants for technology development is different from taking equity stakes or lending money – there may be a clash of culture if this role is combined with some of the others suggested.

15. The previous administration made a proposal for an institution capitalised with £2bn, which would take equity stakes in projects, with an initial focus on offshore wind. This could be a very useful function, ‘stretching’ the capital that offshore developers have available and leveraging in debt. If the GIB were to make such investments and then sell to other investors once the projects were operating, then its capital could be ‘recycled’ effectively, and relatively little money could have quite a large impact. There could also be a significant confidence boost through this model, as other investors could see that the Government had a direct stake in the success of projects part-owned by the Bank, and thus could be better relied upon to ensure the policy environment was stable.

16. In theory the Bank could provide debt finance to the low-carbon sector, but it appears unlikely that it could provide enough debt to make a difference. If it were lending, it would also inevitably end up competing to a greater or lesser extent with existing lenders. Were this to result in a withdrawal of lending by the private sector, then the whole initiative would have backfired spectacularly. We do not think this is a risk that should be taken.

17. While providing sufficient returns on investment is of course key, also vital is ensuring those returns are commensurate with the risks. One way of bringing new capital into the renewables market is to improve the risk/reward balance by reducing risks. The GIB could do this by providing targeted risk reduction products, such as insurance against weather risk in constructing offshore wind farms. We believe this would be a very beneficial role for the Bank to play, providing a significant impact for relatively low outlay of capital.

18. A further beneficial role for the Bank would be to provide a conduit for particularly institutional investors to channel funds to the renewable sector with the right level of risk and reward. This could be through Green Bonds or otherwise structuring portfolios of projects so that they can attain investment grade. While these kinds of structures might emerge organically, as noted above this may take too long for the needs of renewable developers, and the Bank could provide the impetus to make it happen sooner.

19. It is important that Government has good advice about how its policy measures will impact on the finance and investment communities, and this is a role that the GIB could very usefully play. We fear that the Government is currently making policy in the electricity sector partly on the basis of perceived needs of the investment community that we are not convinced reflect the reality. While a new institution will not be in place quickly enough to affect the current policy process, it could make a big difference in the future by dispassionately reflecting the position of the finance sector in its totality.

Capitalising the Bank

20. If a new institution is to make a significant difference, then it will have to have sufficient capital to work with. The previous administration’s proposal for £2bn, made up of £1bn of public money contingent on certain asset sales plus £1bn of private co-investment, would have been useful but to a certain extent just scratching at the surface. The Ernst & Young report referred to above gives a figure of £4-6bn in the period to 2015, and this would of course be better, but also much more challenging in these stringent times. All the possible routes to provide funding look problematic.

21. Treasury officials appear to have ruled out using the proceeds of asset sales to fund the Bank, given the need to reduce the deficit, and as the previous administration showed, these sales would have only provided limited capital in any case.

22. The sale of Green Bonds, or Green ISAs to the general public, is another key option. But if there is any explicit or implicit Government guarantee then at least some of the value will reside on Government’s balance sheet – again, something the Treasury will be keen to avoid. Without such guarantees, then what would make such a Bank different from any other? There is also an issue in that, as it stands, low-carbon is a higher-risk, lower-return kind of investment: will institutional or retail investors buy bonds or ISAs in such technologies?

23. It is possible that the GIB could borrow wholesale, using its credit rating to get lower interest rates, and then lend it on to its low-carbon customers. The European Investment Bank uses such a model. However, there would be no question of using such borrowing for anything less than fully commercial business, and thus the GIB would be restricted in its activities. How the GIB would achieve such a high credit rating without a Government guarantee is also not clear.

24. There will have to be a certain amount of direct Government subvention if the Bank is to perform an innovation funding role. It is possible that this could come from EU Emission Trading System auction receipts, or simply from general Government funds. This line of capital would be relatively limited given the severe limits on Government spending, and would be limited to grant-type funding.

Conclusion

25. There is a strong prima facie case for a Green Investment Bank, given the scale and speed of the transformation in our energy economy that we require. A ‘paradigm shift’ is required, and other countries already have such institutions, which are increasingly taking on the roles being talked about for a UK GIB. The scope and function of such a Bank must be carefully defined, however, if it is to catalyse investment and not compete with the private sector, which must provide the large majority of the investment. How the Bank is capitalised, and to what extent, will clearly be key to its effectiveness, but however much money it is given, it must be regarded as secondary to the job of ensuring that the policy that underpins low-carbon investment is right. If the mechanisms in place are effective, then even a Bank with limited funds can have a significant impact; if the policy is wrong, no amount of capital can compensate.

18 October 2010


[1] Capitalising the Green Investment Bank: Key issues and next steps , Ernst & Young, October 2010.