Banker: Transmission assets are ‘goldmines’ when built, but development risk makes capital pricey

The funding needed to build transmission projects is readily available through today’s financial markets at competitive interest rates, but funds for the development of those same projects are harder to come by and are considerably more expensive, according to an investment banker speaking at TransmissionHub’s TransForum West.

“It really is a tale of two tapes,” Ray Wood, head of U.S. power and renewables at Bank of America Merrill Lynch, told the forum in San Diego July 17. “You have the development business, which is incredibly time-intensive. It doesn’t take a lot of capital but it is very expensive capital because [development] is quite risky.”

Once the uncertainty is removed from a transmission project, however, the cost of capital drops, and is as low as any other asset class in the energy business, he said. When transmission projects reach the “notice to proceed” phase, the liquid capital markets become “white-hot to embrace the asset, to fund it and own it for a 40- or 50-year life.”

Part of the reason for the high level of interest among investors is the stability of a completed transmission project as an investment.

“Transmission assets, when they’re already built, are goldmines,” he said. “They’ve got a long life, they’re stable, and generally not as subject to tariff reductions as other asset classes because the percentage of the bill that ultimately goes to the end user that revolves around transmission is relatively light.”

The perception among investors is that transmission is a great asset class, Wood said, adding that the perception has resulted in a much broader interest across the investment community.

“It used to be just big strategic [companies] coming in; now, there are all those big strategics but there are just countless financial institutions that have billions of dollars … of long-term pension and insurance money that are buying into this at very competitive cost of capital,” he said. “The public has an appetite for stability combined with growth, and transmission will fit that to a ‘T’.”

That is good news for transmission developers, many of whom have faced regulatory and other delays, as according to Wood’s assessment, those same developers should have little difficulty getting the attention of the financial markets.

“We don’t think availability of financing is going to be the bottleneck for transmission,” he said. “The challenge for transmission will continue to be the regulatory overhang, the siting, and the fact that regulators are trying to respond to market changes that are happening evermore quickly. There is still a fair amount of pent-up demand for [transmission] and capital watching it.”

Virtually any transmission developer who continues to own a portion of the product they have developed will be able to highlight that in a public market or with insurance companies or infrastructure funds at a very attractive cost of capital, Wood said.

“We also think that there are financial structures in place to even more efficiently finance transmission,” he said.

Those investment vehicles include real estate investment trusts or a strategic mergers and acquisition process.

Among the types of transmission projects that have captured the attention of the capital markets are projects designed to transport renewable energy from distant locations to the load centers. While much of the demand for such projects was driven by state renewable portfolio standards (RPS) in the early years, changing market conditions are making renewable energy more fiscally attractive.

“We’ve seen incredible price reductions on solar, and we’ve seen the power purchase agreements that utilities have signed go from $130 [per] MWh … to $70 or $80 per MWh,” he said, a factor which makes purchasing solar power more appealing, even apart from a mandate.

In addition, capacity factors are increasing for wind-generated energy, adding value to transmission projects designed to move wind. 

“We’re seeing capacity factors, or wind capture, exceed 50% in some areas, so the amount of technology brought to wind to compete with [current] low natural gas prices has been incredible,” he said. “We think there’s going to be evermore demand as we continue to put resources in isolated, non-urban areas and try to get that power to the load centers.”

At the same time, he said, more distributed generation is being installed at load centers, offsetting some of the need. However, that opens up other opportunities for astute transmission owners and investors.

“There’s an incredible arbitrage to do it, whether it’s curtailments [or] whether it’s [arbitraging] time or distance,” Wood said, noting that merchant transmission developers could obtain a hedge from another transmission provider, or they could sell the asset with an arbitrage commodity element to it.

All those options will attract capital, but at different prices, he said.

Wood said: “2013 was supposed to be ‘the year of transmission.’ It hasn’t quite worked out that way, but there is still an enormous wave of capital that’s going to come into transmission because of all the need.”