The article below is from our BRIEFINGS newsletter of 12 August 2019
Eight years after the Fukushima nuclear disaster, Japan has diversified its energy supply through its investment in renewables. We sat down with Toru Inoue in Goldman Sachs’ Investment Banking Division to discuss the implications for investors and the energy landscape.
Tell us a little about the renewables space in Japan.
Toru Inoue: Japan’s clean-energy capacity has grown exponentially in the wake of the 2011 earthquake and tsunami, which triggered a nuclear accident in Fukushima prefecture. The accident highlighted the need for an alternative to nuclear energy and jump-started renewables in a way that was previously unimaginable. As nuclear power plants nationwide were taken offline, the country set out to aggressively increase the proportion of renewables in its energy mix by introducing generous feed-in tariffs – or long-term contracts with renewable energy producers that are designed to accelerate investment. Startup ventures and developers globally piled in alongside major Japanese corporations to help the country build capacity quickly. Solar sector growth has been particularly strong, with a nearly 70-fold increase in installed capacity, from 550 megawatts in 2011 – the year before the new incentives went into effect – to almost 38 gigawatts at the end of 2017, according to data compiled by Bloomberg NEF.
How has this growth in renewables been financed?
Toru Inoue: Since banks have traditionally dominated the corporate-finance sector in Japan, a company’s ability to access credit often depended on having friendly relationships with local lenders. This has been true even in the infrastructure sector, despite the fact that infrastructure projects often require financing over a term longer than most banks are prepared to lend. As a result, these projects require frequent refinancing, creating additional costs and complexity since interest rates reset with each refinancing.
The renewables boom, however, has been a catalyst for change. Overseas developers struggled to secure financing without local connections or corporate guarantees since Japanese banks weren’t sure how to price loans for these products. “Non-recourse” debt – which is secured only with collateral – and green project bonds in particular emerged as potential solutions. A common means of financing infrastructure in North America and Europe, this debt is repaid purely from the cash flows generated by a given project. In this way, renewables have unlocked a long-awaited opportunity to connect infrastructure investment with capital market investors in Japan.
Who is investing in this non-recourse debt?
Toru Inoue: Japanese life insurers were the first to favor this new asset class as the long-term nature of infrastructure financing dovetails with these investors’ need to fund large portfolios of long-term liabilities comprised of their customers’ life insurance policies. Interestingly, Japanese regional banks have also become purchasers, which reflects their appetite for stable, yen-denominated yields amid Japan’s zero-interest rate environment and sluggish loan demand. As renewable-energy plants tend to be located outside of the big cities, being able to support a local enterprise is another draw for these regional lenders.
More recently, pension funds have also started to show interest. They initially took a wait-and-see attitude because they needed a certain level of liquidity. Now, given that five years have passed since Japan Renewable Energy – one of Japan’s largest renewable energy companies – issued Japan’s first green-project bond, the market is sufficiently liquid and deep enough for these influential investors to consider making an entry.
How do you see renewables and their financing developing in Japan going forward?
Toru Inoue: From a demand perspective, Japan’s clean-energy needs look set to increase on the back of a national goal to raise the share of renewables in the fiscal year 2030 power-supply mix to 22% to 24%, compared with 16% as of 2017. In addition to solar, offshore wind power development looks set to accelerate on the back of new legislation. However, cost reduction is a priority as feed-in tariffs have been slashed to less than half their initial levels, and look likely to be withdrawn completely in the near future. New risks have also emerged: Issues with congestion in the electricity grid, for example, have given rise to “curtailment risk” – the possibility that grid operators force renewable electricity producers to curtail their output in order to balance supply and demand, which hurts operator cash flows.
This is a natural development as the sector is simply becoming more sophisticated at all levels. The lower feed-in tariffs have accelerated professionalization among operators; new projects are still feasible and financing is available but only the most astute and experienced developers can survive under the new regime. There is also demand for financial products that address the emergent risks, and for solutions for developers looking to exit their existing investments.
One thing that is clear is the enduring demand among Japanese institutional investors for this renewable infrastructure-related debt. The experience of the past five years has helped them get comfortable with the asset class. For example, despite the difficulty of quantifying curtailment risk, JA Solar Japan had no problem selling a new type of project bond that addressed this issue through stress testing and a staggered set of early repayment triggers. Going forward, we expect developers will enjoy an increasingly conducive funding environment, as the growing, global trend towards Environment, Social, and Governance investment adds to the appeal of renewable-energy debt products.