Warranting closer attention

Ever larger wind farms, and longer-term turbine warranties, are putting increasing pressure on manufacturers’ balance sheets – and making it harder for developers to raise money. Mark Nicholls reports

Earlier this year, GE Energy unveiled its latest weapon in the battle to dominate the wind turbine business. It announced the launch of 12-year ‘contractual service agreements’ (CSAs), offering buyers of some of its turbines – initially only 1.5MW machines installed in Europe – guaranteed repairs, maintenance and upgrades over the duration of the contract.

“This is the default business model in other power generation operations – wind is no different,” says Steve Zwolinski, the Amsterdam-based president of GE Energy’s wind operations.

Bigger turbines, in riskier locations, raise the ante on manufacturers’ financial strength

Such agreements offer customers greater predictability of cash flows, and reduce the investor’s exposure to equipment performance and reliability,” GE says. Zwolinski adds that the company plans to introduce similarly long-term CSAs for its full range of turbines, across the rest of the world, within the next year as the necessary actuarial data on turbine performance becomes available.

GE is not the first to offer a long-term service agreement. In Germany – one of the oldest markets for wind turbines – manufacturer Enercon began offering the five- or 10-year Enercon Partnership Plan” in 1994. However, despite its leading position in the German market – it claimed a 34% market share in 2003 – its emphasis on the smaller end of the market means that such warranties don’t pose an intolerable burden on the company.

But the wind energy market is evolving, with manufacturers offering increasingly large turbines, and developers and utilities constructing ever larger wind farms. Providing warranties on such large developments, some financiers and investors fear, could begin to put unbearable strain on the balance sheets of all but the largest manufacturers. And any questioning of the viability of the warranties that manufacturers offer will, in turn, heighten the risk profile of new wind farms, making it more expensive for developers to raise financing.

This is particularly true for planned offshore windfarms, warns Michaela Pulkert, head of renewables at Germany’s HypoVereinsbank. “No-one has substantial experience so far in offshore technologies – the reliability of the warranties will have an even higher value in our due diligence and risk assessment for offshore financing.”

“There’s no doubt about it – the way the industry is going will mean that the smaller players will not be able to keep up,” says Bruce Jenkyn-Jones, a London-based fund manager with Impax Capital, a boutique environmental investment bank. “They’ll become niche players, or have to team up with companies with stronger balance sheets.”

Indeed, such a process has already begun. “We have to concentrate on smaller customers,” says Ralf Peters, head of corporate communications at German manufacturer Nordex. “We can’t compete with GE on big projects.”

The company is in the process of a financial restructuring, to help it respond to the changing market. Until this is complete – due by the end of the year – Peters says Nordex is focusing on wind farms in the 30–50MW spectrum – way below the 200MW-plus farms under development in the US and, increasingly, in Europe. For these projects, it is now offering nine-year service agreements, with the potential to add an additional three years.

And late last year, Vestas, the largest European turbine company, merged with fellow Danish manufacturer NEG Micon, a move interpreted by analysts as a takeover of the latter. In May and June of this year, Vestas tapped existing shareholders for more cash via a DKr 2 billion ($325 million) rights issue to strengthen its balance sheet.

“We know there have been doubts about our financial strength,” says Morten Keller, head of investor relations at Vestas. “This is exactly why we entered into the transaction with NEG Micon, and carried out the rights issue.”

“We are confident that we have the necessary size and that, as the market grows, we can increase credit lines as is necessary,” he adds. The company offers “normal warranties” of between two and five years, and Keller says these can be extended in some markets. Any extensions are backed by insurance contracts, but he declines to elaborate.

But while limited insurance cover is available, some specialists doubt whether there is much that insurance companies can do to help smaller manufacturers. The problem, explains Nigel Baker, of Swiss Re in Zurich, is that the real risk is with “serial losses”, that would typically be caused by the failure of components made by a third party. The problem for the manufacturers is that, while they would be able to recover costs from the component makers’ insurers, they would be liable for repairs immediately.

“Everything would go through the manufacturer’s balance sheet,” says Baker. Unfortunately, the weaker the balance sheet – and the greater the need for insurance cover – the more expensive the cover would be, he adds.

However, there are alternatives, Pulkert says. For developers, lower levels of gearing – using less debt, and putting up more equity – will help them tap financing. And for offshore sites, developers are likely to receive a more favourable hearing from their bankers if they choose turbines with as long a track record as possible, she says.

Turbine manufacturers should also ensure that their balance sheets are transparent, she adds, allowing investors to accurately assess their financial strength. But ultimately, for many companies, some strengthening of balance sheets – whether through consolidation, or capital raising – will be necessary.

However, Jonathan Johns, a partner at professional services firm Ernst & Young in the UK, doubts whether the market will evolve to a point where financial clout is the only thing that matters. “Balance sheet strength is clearly an issue, but it’s more to do with the reliability of turbines – good manufacturers shouldn’t have problems.”

“I don’t believe there will only be room for manufacturers with huge balance sheets,” he continues. “A super group is likely to emerge, but there is also room for a good second tier.” EF