Green energy feels the chill

There have not been many go-go industrial sectors since the financial crisis began but one of the few has been green energy. As if to underscore the point, last year’s investments in renewable electricity and fuel projects around the world broke all previous records. But they may also have marked a peak. The two big drivers of the green energy boom have been political will and state largesse, both of which are now – at least in the developed world – starting to wear a little thin.

Global investment in clean energy rose by 5% to a record $280bn in 2011, according to Bloomberg New Energy Finance (BNEF). Its definition excludes large hydro and – to the exasperation of the fission brigade – nuclear. As it points out, total ‘clean energy’ investment has grown nearly five times over since 2004, when BNEF first started keeping score and the sector attracted $54bn.

Unusually, in 2011 a lot more money – about half of the total – went into solar energy as opposed to wind. This was despite – or perhaps because of – the fact that prices of solar photovoltaic modules fell by nearly 50% during the course of the year. Wind, which is more used to topping the chart, accounted for one-quarter of the money spent. It, too, was affected by lower turbine prices, but also by a slowdown in China and a lack of regulatory clarity in parts of Europe.

Losing favour?

There was another surprise at the top of the country pecking order. US investment overtook that in China for the first time since 2008. Ironically, this was more of a last gasp than a trend, representing a stampede before the expiry of two important incentives – a US federal loan guarantee scheme, and a US Treasury grant programme. The clean energy business is still all about sweeteners, or the lack of them.

Energy has always been more susceptible to political interference than most other industries, but green energy takes political risk to a new level. The mantra that politicians chant to remind themselves of what a modern energy policy should achieve is ‘sustainability, security and affordability’. Though not necessarily in that order. Sustainability means progress towards carbon emission targets but it also means ‘subsidy’ and ‘higher bills’, without which green energy would founder. So green energy’s progress in any given jurisdiction depends on whether the government rates sustainability higher than affordability. Given the pressures of the financial crisis and the prospects of cheaper fossil fuels, sustainability is slipping down the list in the US and western Europe.

Consolidation phase

There are parts of the globe where renewables still cause excitement. One is Japan, which has turned its back on nuclear since the Fukushima disaster, and embraced renewable energy with the introduction of generous feed-in tariffs. Meanwhile, most of this year’s high-profile solar projects and programmes have been in the relatively virgin territories of South America, north Africa, the Middle East and South Africa.

But even China has now called an end to the 'blind expansion' of solar and wind, in favour of nuclear, hydro and shale gas alternatives. By the end of the third quarter of this year, it was apparent that 2012 would be unlikely to overtake 2011 in global investment terms, and it now looks like being the first year of contraction since data started being collected. In the West, certainly, the industry’s subsidy-fuelled infant growth spurt is over.

“We will probably see more transactions driven by consolidation in solar and wind,” says Ben Warren, environment finance partner at Ernst & Young. “Consolidation could be both vertical, as OEMs [original equipment manufacturers] invest in their supply chains, and horizontal – particularly involving Chinese outbound investment.”

Blowing hot and cold

Wind and solar continue to dominate green generation, consuming 75% of the funds going into the sector. Wave and tidal technologies are being deployed in small, usually standalone projects, but are very expensive and prone to failure in a hostile environment. As such, they are a long way from grid parity, the point at which they can compete, unsubsidised, with fossil fuels.

Geothermal projects enjoyed a phase of popularity in initial public offering (IPO) markets a couple of years ago, being touted, not unreasonably, as ‘green baseload’. On paper, geothermal is certainly cheap and clean, but the technology is still immature, with continuing risks of earthquakes and blowouts. The equity capital markets are no longer looking kindly on geothermal or, with the possible exception of new generation biofuels, on green energy in general. The WilderHill New Energy Global Innovation Index fell more than 40% between February and August and is still more than 20% down on the year to date.

That partly reflects how Western manufacturers have been battered by China’s rapid transformation into the world’s largest maker of solar panels and, more recently, wind turbines. As Chinese manufacturers have ramped up production and slashed prices, various Western manufacturers have fallen by the wayside, including US government-supported Solyndra and Abound Solar, as well as Germany’s Q-Cells and Solar Millennium. Chinese, South Korean and Indian firms have been acquiring solar casualties in Germany and the Netherlands. Boston-based GTM Research recently predicted that another 180 solar panel makers would go out of business or be bought by 2015 – and more than 50 of them will be Chinese.

Stormy weather

This activity has provoked trade skirmishes, if not full-blown war. The US has imposed tariffs on Chinese solar imports, citing grounds of illegal government subsidies and dumping prices. The EU has launched an investigation into alleged Chinese subsidies, while China responded with its own investigations into EU and US exports of polysilicon, the key ingredient of solar panels. Now the pain is spreading to the wind industry. The icon of the wind turbine business, Denmark’s Vestas, is in crisis, losing money, shedding jobs and now looking to sell up to 20% of the company. Its problem is a collapse in orders, partly due to Chinese competition and partly because activity has shifted from onshore wind to offshore, where Vestas has been less dominant.

Vestas has warned that the US wind turbine market will be all but wiped out if the last remaining federal support, a production tax credit for wind farms, is allowed to expire at the end of this year. It says that without it the market would decline by between 75% and 95%, since US wind has no chance of competing with the cheap shale gas now coming on stream. In the key UK market, changes and uncertainty in the subsidy regime have caused a freeze in offshore investment. The UK has more offshore wind capacity than the rest of the world combined, but the three main turbine suppliers have reportedly taken only one UK order between them this year.

Subsidies generally have been coming down in Europe, forcing would-be project sponsors to re-do their sums. This is a logical response to falling equipment costs and rising technological efficiencies, which are helping some location-specific solar and wind plants move closer to grid parity. Spain spooked everyone when it cut solar subsidies two years ago. Realising it had encouraged too much solar development, too fast, at too high a cost, it made some of the cuts retrospective and has since halted renewables subsidies altogether. Germany and Italy, both very pro-renewables, have cut subsidies substantially, as has France (only to subsequently be challenged in the courts).

Investment partnerships

So the atmosphere is not as go-go as it once was, especially in Europe. And yet there is no shortage of projects, merely a shortage of finance, according to Romain Talagrand, BNP Paribas’ head of the power sector and project finance for Europe, the Middle East and Africa (EMEA).

“There is a huge backlog of projects needing finance,” says Mr Talagrand. “Changes in capital requirements have made project finance in the infrastructure sector more challenging for banks. So we will see a trend of disintermediation, as new sources of capital replace bank balance sheets.”

Utilities are shouldering much of the strain on their own balance sheets, notably with offshore wind developments. In years gone by, utilities tended not to develop their own onshore wind and solar projects – too small and fiddly for them – though they might acquire them once they were built. Offshore wind is altogether meatier, billion-dollar stuff.

“For utilities, there is now less focus on going out and buying wind farms,” says Christopher Thiele, Morgan Stanley’s head of EMEA utilities and power investment banking. “They can develop the projects themselves and extract more profit. But their balance sheets continue to be stretched, so most prefer to do offshore with partners, to diversify the risk and allow them to do more. They would rather own 50% of 10 projects than 100% of five.”

More utilities are now divesting or refinancing first phases of projects in order to free up capital, with prime interest coming once again from the East. Marubeni of Japan provided a foretaste last year when it paid £200m ($318m) for 49.9% of the Gunfleet Sands UK offshore wind park owned by Denmark’s Dong Energy.

Pension funds and insurance companies ought to be willing partners. Today, the average pension fund holds less than 1% of its total assets in infrastructure investments, and the merest fraction of 1% in renewables, according to the Organisation for Economic Co-operation and Development. But some are already alert to their attractions. PensionDanmark, one of the largest Danish funds, already has more than 6% of its assets in renewables and wants to raise that to 10% within a few years. Its holdings include a stake in Denmark’s huge Nysted offshore wind project, and it is a significant bondholder in Sweden’s Jadraas project, northern Europe’s largest onshore wind farm. Munich Re says it will invest €2.5bn in renewable energy assets by 2016, and Allianz has promised to add to the €1bn in renewable assets that it already owns.  

Elusive bond route

Finally, there is the promise of the bond market. There have been green energy bonds before now, but not many. The first rated and listed solar bond was issued at the end of 2010 by SunPower of the US to fund construction of a large solar park north of Rome. The 18-year bonds raised $195.2m. In August this year, Mexico’s Oaxaca, a wind farm company, raised $300m in two tranches of senior secured 19.5-year paper. The deal took nearly a month to pull off and the pricing had to be raised by 75 basis points (bps) to 7.25%. The wind farms had their own peculiarities but the main problem was the sub-benchmark size, which virtually guaranteed illiquidity.

In February, Mid-American Energy Holdings came to the debt capital markets looking for $700m over 27.5 years to finance its Topaz solar project in California. It went away with $850m priced at 380bps over treasuries. The size helped, but so too did the fact that the company is controlled by US multinational conglomerate Berkshire Hathaway. Mid-American says it may be back for more in 2013, but its success does not obscure the fact that the debt markets have not yet found a way to accommodate renewables in general. They are, however, looking for one.

“There will have to be more [bonds for renewables],” says Mr Talagrand. “In what form? That’s under development.” One possibility, he says, is via investment funds devoted to renewables debt in the same way as existing funds are devoted to equity.

When alternative energy technologies reach grid parity, that will change the game, according to Mr Talagrand. “It will make cost comparisons less exposed to regulatory and political risk, which will improve the profile of the projects,” he says.

Pricing risks

If grid prices stay where they are, or rise, some solar and onshore wind could hit parity in the next few years, though offshore costs remain stubbornly high. But what if they go down? Thanks to shale gas, US natural gas prices are at rock bottom – one-fifth of gas prices in Europe, and one-eighth of those in Asia. So US generators are replacing dirty coal, not with clean renewables, but with not-quite-so-dirty gas. The coal that they are no longer burning is being shipped to Europe, where it is displacing higher-priced gas. That is why, in spite of its refusal to sign up to international targets, US carbon emissions have been falling while in Europe, which has tried so much harder, they have been rising.

Gas is beginning to look more attractive than renewables to other cash-strapped governments. It is slowly dawning on them that wind and solar cannot completely replace coal-fired (and, in some countries, nuclear) generation. Intermittency means they produce electricity less than 30% of the time and, often enough, at the wrong time. As Germany’s grid is now discovering, a rising proportion of mandatory renewable supply brings imbalances and volatility that can create serious problems for industry. Space constraints limit the share of national energy needs they can satisfy and the more renewable capacity feeding the grid, the more fossil-fired back-up capacity is required.

If renewables could at least pay their own way, these negatives might have less bite. But if the shale gas revolution catches on, it will push grid parity further down the road and prolong the need for subsidy. How long will political patience last? One day, geothermal and marine technologies will provide reliable, affordable baseload generation. One day, the ability to store electricity on a large scale will solve most of wind and solar’s problems. Clean energy may have to wait until then before it really comes of age.