Like other project finance shops, GE Energy Financial Services is looking for opportunities in a changing industry landscape amid coal-retirements, the growth of wind in Texas, and the build-out of gas-fired facilities in areas with capacity markets such as PJM Interconnection.
Unlike other investors, GE EFS is also experiencing a period of transformation at its parent GE Capital, which is downsizing as it attempts to shed its too-big-to-fail designation. But this is not expected to have an impact on the firm’s project finance and asset M&A activity, which is strategically aligned with the turbine manufacturing business of its ultimate parent, GE.
As equity sponsor, alongside Competitive Power Ventures, GE EFS recently closed debt financing for the 785 MW Towantic Energy Center in Connecticut (PFR, 3/11). The project will be fitted with two of GE’s 7HA heavy-duty gas turbines.
In the first part of this exclusive interview, Don Kyle, senior managing director at GE Capital Markets, and Tim Howell, m.d., power and development, at GE EFS, discussed the firm’s investment targets and strategy for conventional generation in a shifting U.S. power market with PFR reporter Fotios Tsarouhis.
PFR: You’ve recently arranged debt financing for multiple projects on the east coast, in markets like PJM Interconnection, New York State, and New England. Where are you seeing the most demand and opportunity for financing?
Tim Howell: The megatrends in the U.S. really are low gas [prices] and environmental policy.
Low gas is driving coal-gas switching, it’s driving coal retirements, it’s driving nuclear retirements. Environmental policy is driving the renewable build, it’s driving coal retirements, it’s driving older generation capacity retirements. And so, from a technology standpoint, the growth is from gas-fired generation and renewables, and the biggest renewable gains have been by wind and solar. So that’s what’s driving the changes and those are the technologies. We are investing primarily in gas, wind and solar in the U.S.
In terms of markets, the CPV Towantic deal was in New England-ISO. There has also been a lot of activity in PJM, driven by coal retirements and replacement primarily with gas, driven by low gas prices.
In Texas, there’s been a very large wind build, with limited new gas generation, not from a limited gas availability standpoint, but it is difficult to support new gas generation in the ERCOT energy-only market at current prices.
In California, they’re looking to add flexible gas-fired generation and storage technologies to support the large renewable build, and in particular the solar build.
The Southeast has been a little bit slower, but there’s a lot of coal in the Southeast. Much of the new build in the Southeast has been on the utilities side as opposed to the [independent power producer] side, but there are pockets of opportunity.
On the equity and debt side, our recent successes have been in markets like PJM and New England.
Don Kyle: New build thermal construction continues to be an area of opportunity for the debt markets. If you think back to 2013 when the first “quasi-merchant” projects were financed — prior to ’13, most of the power projects you were seeing had power purchase agreements. They had some sort of long-term contracts in place — after the recession, a lot of the financing opportunities that our clients were bringing to us were opportunities to sell our newest technology to projects without contracts and that were essentially merchant. So back in ’13, the model that developed — that we helped to develop — was what emerged as the quasi-merchant structure.
What was or is really different from the last time merchant projects got financed is that a lot of the overbuild that occurred back in the early 2000s is not really occurring today, because you have a lot of retirements and plants being taken offline.
The other factor that has given the banks more comfort is the fact that most of these projects have 50% to 60% debt to equity, so a significant amount of equity from generally strong sponsors. The projects also have five plus years of hedging in place, thus providing cash flow certainty and allowing projects to deliver to 50% or less of comparable enterprise values. Finally, these projects are utilizing the most efficient turbine technology in the market which should result in high dispatch.
The debt markets got comfortable with the structure, so fast-forward to 2016, and we probably have about 15 of these projects financed in the markets, with traditional project finance banks, many of them in PJM.
We have a number of projects in our pipeline with good clients, so that’s still an area of focus and opportunity for us on the debt side.
There’s been a lot done in the market, and I think the area of concern is going to be whether banks start bumping up on how much they have in PJM where a lot this has been done. Some likely refinancings should help to recycle some of that capital.
We expect PJM, New England, New York state, certain select other opportunities, to continue over the next 18 to 24 months.
PFR: What kind of activity are you seeing in the M&A sphere?
Don Kyle: On the M&A side, it’s been fairly quiet. The fact that the B loan market has been closed for a while — and we think it’s going to continue to be selective for at least the near-term — is putting constraint on M&A activity, but no doubt there’s so much money chasing investment in the power space, it’s going to pick up.
Tim Howell: We’re seeing a few assets starting to come to market, some that are large, in the 5,000 MW to 6,000 MW range, but mostly single projects that are being sold for a variety of reasons.
Some had contracts that are approaching their end, and there are more natural owners for merchant generation versus the owners who owned during the contracted period. There are others that are changing hands because the markets that they are in have changed, so they’re transitioning to more natural owners. Some are changing hands because they’re within private equity funds that have targets for when they want to monetize their assets. I haven’t seen a mass-migration out of one asset class into another class.
The only big new class of investor recently has been the yieldcos. We haven’t been involved in a yieldco as an investor. We have sold assets to yieldcos, and supported on the financing side. Some yieldcos are having some challenges right now that are pretty public.
PFR: You mentioned the southeastern U.S., which includes a lot of coal country. Do you think conversion to gas is a viable strategy in the short-term for a lot of these to-be-retired facilities?
Tim Howell: There’s a lot of coal-to-gas switching, but that’s mostly been gas-fired generation running at a higher capacity factor and coal-fired generation running at a lower capacity factor, as opposed to actual coal plants being converted to run on natural gas. Many of them can’t, because it’s not easy to run a coal-fired boiler on natural gas. From a repowering standpoint, it’s a different type of steam turbine, different steam conditions, and it is usually an older coal plant that you would think about repowering. When you do that, you need to consider the age and remaining useful life of your bottoming cycle — your steam turbine, your condenser, your water systems — do you want that to be 40 or 50 years old combined with a new gas turbine and heat recovery steam generator?
A lot of companies have looked at repowering, but it usually ends up being more efficient to build a new greenfield combined-cycle, or build an adjacent combined-cycle that takes advantage of the electrical interconnects, but not necessarily much of the coal-fired power plant infrastructure.
PFR: What factors have influenced GE Capital’s and EFS’s investment strategy in the past 12 to 18 months?
Tim Howell: As mentioned before, low gas prices and environmental policy, coupled with improving gas-fired and renewable generation technology, are the main drivers behind the gas-fired and renewable generation additions to replace retiring coal and nuclear. Some of the older capacity that is retiring is nearing the end of its economic useful life, so replacing with gas and/or renewables is a natural evolution given the alternatives in today’s market.
There were also very high reserve margins coming out of the financial crisis. As the economy has recovered, there has been corresponding demand growth, and when coupled with retirements, some regions have returned to the point where they need to add capacity to maintain reserve margins. Demand-side management and energy efficiency have slowed the need for new capacity, but not eliminated it.
PFR: What sort of deal volume being expected over next year to eighteen months?
Don Kyle: On the debt side, 2015 was a good year relative to 2014. Our expectation is somewhere in the $700 million to $1 billion area in investments on the debt side. GE is looking for EFS to grow.
Check back next week for part II of this interview, in which Kevin Walsh, m.d., renewables, at GE EFS discusses the renewables market with PFR.
