Private equity firms have cultivated greater interest in renewable energy during the past few years and with many governments paying more attention to renewables, offering subsidies to encourage investment in the sector, it appears their timing could not have been better. But can the pace of growth be maintained?

Renewable energy is now big business. Over the past five years, more than $850bn has been invested in the sector by banks and investment institutions alone, according to data from Bloomberg New Energy Finance. Most of this money comes in the form of project finance. But, increasingly, the hardest-hitting element of the financial arena, private equity, has been playing a part in the industry.

Between 2006 and mid-2011, private equity and venture capital firms invested almost $50bn in renewable or clean energy. Although only a fraction of total spend in the sector, it is still a considerable sum and has held up remarkably well through the recent economic downturn. Last year alone, private equity and venture capital firms invested nearly $8bn in clean energy: in the first six months of this year, their investment came to almost $5bn.

Interest first became serious during 2006, when the bull market was at its height. Before that, most private equity firms seemed somewhat sceptical about the sector.

“Originally, there was little interest from private equity [firms]. They perceived renewable energy to be high risk and rather unattractive from an investment perspective. But over the past few years, attitudes have changed considerably,” says Daniel Guttman, a director at PricewaterhouseCoopers.

The climate change reality

The shift reflects a variety of different factors. Perhaps most importantly, there is a growing realisation that climate change is real and cannot be ignored. Whereas energy conservation was once thought to be faintly ridiculous, it is now accepted practice by all but the most die-hard sceptics. Reflecting this change in sentiment, governments around the world are increasing their commitment to clean energy – and backing up talk with action. In Europe, for example, politicians have pledged that 20% of energy will come from renewable sources by 2020. US president Barack Obama is also a keen supporter of seeking alternatives to traditional carbon fuels and emerging markets are fast tuning in to this mode of thought as well.

Political conversion to the benefits of renewable energy is not only driven by a desire to save the world: events over the past decade have also highlighted the importance of energy security. Problems in the Middle East and capricious decision-making in Russia have prompted governments to pursue policies that reduce their dependence on imported energy, and renewable energy ticks that box.

“There are some real, solid drivers for growth. It began with a fight against climate change but other factors play a part, too, such as security and independence of energy supply,” says Felipe Moreno, a director at private equity firm Bridgepoint. With this in mind, many governments – indeed most in the developed world – offer direct subsidies to encourage investment in renewable energy, effectively guaranteeing the cost at which renewable energy can be sold. For private equity, this has been an important factor.

“You are producing energy with a defined price so the key question is: how much will the energy cost to produce? And costs have been coming down materially in certain sectors,” says Bernard Fairman, chairman of alternative asset manager Foresight Group.

You are producing energy with a defined price so the key question is: how much will the energy cost to produce? And costs have been coming down materially in certain sectors

Bernard Fairman

Investor selectivity

But renewable energy covers a broad swathe of opportunities, ranging from mature, relatively predictable industries to early-stage, high-risk technologies. The sector is dynamic, and there is a recognised need for a move away from fossil fuels, with many bright minds devoting themselves to the alternative energy arena, pursuing hydrogen-powered cars, ultra-light ceramic batteries or smart electricity grids, for example.

Relatively unproven, these schemes are frequently too risky for private equity but they may be funded by venture capitalists, who focus on opportunities where the rewards may be phenomenal – if the technology succeeds – or non-existent in the event of failure. Funding for such advances has been sporadic. Before the financial crisis, billions of dollars were invested in companies keen to find the next ‘big thing’ in alternative energy. Now, venture capital funders are highly selective, their appetite for risk not helped by instances such as the bankruptcy of major solar group Solyndra in California this year.

Funded by a group of venture capital firms, Solyndra was at one time an alternative energy darling. It received a $535m loan guarantee from the US government and was touted as providing a template for all renewable energy firms, even considering floating on the stock market in 2010. The flotation was cancelled and on August 31 this year, Solyndra sought protection from creditors under Chapter 11 bankruptcy. Making matters worse, key figures at the company are now under investigation from the FBI.

Proven technology

The company blamed adverse market conditions for its bankruptcy. Observers suggest its cylindrical solar panels were losing out against the more popular flat panels. For private equity firms, Solyndra’s collapse highlights the importance of backing technologies that are proven and already commercially viable.

“Private equity is attracted to areas that have been up and running for a while and where the technology risk is no longer there,” says Michael Butler, chairman of investment banking firm Cascadia Capital, which specialises in technology and sustainable energy. In essence, this means private equity firms are primarily interested in three sectors within the renewable energy sphere – wind power, solar power from flat panels and biomass/waste (converting products ranging from wood chippings to plastics into energy).

“The most attractive type of investment is owning renewable energy projects, particularly capital-intensive ones, such as wind farms and solar plants,” says Tom Murley, head of renewable energy at private equity firm Hg Capital.

The most attractive type of investment is owning renewable energy projects, particularly capital-intensive ones, such as wind farms and solar plants

Tom Murley

Risk matches reward

Within this field, private equity can provide funding at various different stages. Firms can become involved at the very beginning of a project, seeking out planning permission, filing for technological permits and overcoming all the regulatory and legislative hurdles that accompany large-scale energy schemes. This is relatively complex but the rewards can be extremely generous. Alternatively, private equity firms can invest once a project is near completion or even up and running, where risks are lower but rewards are, too.

“In the renewable industry, private equity can take development risk, coming in early in the cycle, buying up land and developing projects from scratch. Or they can come in much later, where risks are lower but there are fewer opportunities to add value,” says Thierry Baudon, managing partner at private equity firm Mid Europa Partners.

“At the early stages, returns can be really interesting but it involves greenfield risk, project finance risk and such. This is very different from a typical LBO [leveraged buy-out] and only a few firms have the expertise to handle this type of risk,” he adds.

Betting the wind farm

US private equity giant Blackstone is an example of a firm which can tackle greenfield projects. It recently announced a €1.2bn investment in the construction of Germany’s largest ever offshore wind farm, Meerwind, an 80-turbine project, set for completion in 2013 and intended to supply enough energy for 400,000 households. Blackstone’s involvement follows an express commitment to wind from the German government, particularly after its decision to scale back on nuclear energy after the Japanese crisis at Fukushima earlier this year.

Many firms, however, prefer to invest in extant projects, where income is guaranteed and returns can be made by consolidation or increased efficiency. Bridgepoint, for example, paid €597m for 11 Spanish wind farms in Castilla Leon earlier this year, hoping to generate value by improving efficiency and acquiring other wind farms on a selective basis. 

“Private equity has been investing in wind energy for quite a while. You start with an installed base, keep developing new capacity and eventually build an asset that is attractive to a traditional utility group. They are looking to shift their energy base away from fossil fuels and we can create a business that helps them do that. For us, it is a safe play therefore – a cash-generating asset that will become a strategic asset over time,” says Bridgepoint's Mr Moreno.

Wind has other attractions as well. “It is subsidised but it is the cheapest form of alternative energy and its costs are almost commensurate with conventional energy. Over time, therefore, government subsidies are coming down as the cost of production comes down,” explains Mr Moreno.

Spain's solar price reduction

Such considerations are particularly important to private equity investors now, when governments in the West are strapped for cash and looking for ways to trim budgets. The Spanish government, for example, raised concerns this year when it reduced the price it was prepared to pay for solar energy by 30% and made the decision retroactive, affecting prices from 2010 to 2013. To mitigate the impact, politicians also extended the period during which solar plans will receive incentives: even so, the move provoked outrage among some investors, who are seeking legal redress.

In the renewable industry, private equity can take development risk, coming in early in the cycle, buying up land and developing projects from scratch. Or they can come in much later, where risks are lower but there are fewer opportunities to add value

Thierry Baudon

To some, Spain’s decision highlights the risks associated with renewable energy. “We took the view that governments in Europe would live up to their commitments.  Along with almost everyone in the private equity space, we were caught off guard. It has shaken confidence dramatically,” says Mr Baudon.

Others are more sanguine, however, suggesting that the cost of solar production has come down substantially in recent years so the Spanish move, while clumsily executed, was right in principle. “Solar has evolved dramatically and costs have come down significantly. The Spanish move reflects that reality,” says Ben Warren, head of environmental finance at Ernst & Young.

“The Spanish move did affect confidence to a certain extent but several deals have been done since and most people believe the solar decision was a one-off. Spain won’t do it again,” adds Mr Murley at Hg Capital. 

Nonetheless, seasoned private equity players and their advisors believe investing in renewable energy is most appealing in situations where government subsidies are not a prerequisite for success, at least in the long term.

“If you can see that the industry in which you are investing will reduce its dependence on subsidies so the long-term business model does not depend on continued support, the investment proposition becomes much more attractive,” says Mr Butler at Cascadia Capital.

Foresight Group goes further. “As the cost of producing renewable energy comes down, there will be an exponential increase in private equity investment,” predicts its chairman, Mr Fairman.

Supply chain attraction

Private equity’s interest in renewable energy is not restricted to projects such as wind and solar, however. Indeed, many in the industry are equally or even more attracted by opportunities in the supply chain. “Private equity can facilitate the growth of companies in the technology supply chain, particularly support services such as the service and maintenance of wind turbines. This is an area that private equity [firms] understand really well. They like the cash flow and the proven business fundamentals,” says Mr Warren.

“In many instances, these support services companies can develop a global footprint, so private equity firms can help to finance that development and provide operational expertise,” he adds.

Interest in this part of the renewable energy field is relatively recent but it is increasing rapidly. “Over the past two to three years, private equity firms have begun to invest all along the supply chain, in companies that make the blades or brakes for wind turbines, for example, or the foundation structures for offshore turbines,” says PwC’s Mr Guttman.

Energy diversity

In many instances, these companies do not simply service or manufacture goods for the renewable energy sector. Instead, they use their expertise in traditional energy and extend it to renewable energy – making structures for oil rigs and bridges, for example, as well as offshore wind farms.

According to consultancy Cleantech Group, nearly 30% of private equity investment so far this year has been in energy-efficiency firms, recycling and water conservation

Such diversity can make it hard to quantify private equity’s involvement in sustainable energy. And analysis becomes even more difficult if energy conservation is added to the equation. Looking more broadly at sustainability, private equity is invested in recycling companies, environmental consultancies, even businesses making office blinds that reduce the need for air conditioning. Taking all of these factors into consideration, private equity’s financial contribution to the clean energy space becomes even greater.

According to consultancy Cleantech Group, nearly 30% of private equity investment so far this year has been in energy-efficiency firms, recycling and water conservation. Including all these areas, the firm estimates that $8bn has been poured into the clean energy space so far this year and chief executive Sheeraz Haji believes interest will continue to grow over the coming decade. “I expect interest to grow significantly over the next 10 years but I believe it will be 'lumpy'. Firms will take their time studying the space and then we will see some big deals,” he says.

Mr Murley echoes this conviction. “Private equity has a small share of the total market but it is growing. The interest is real and will increase,” he says.

Ultimately, though, private equity’s involvement in clean energy, as in anything else, is dictated by success. “I think the biggest factor will be the performance of the companies. If a number of large, growing and profitable companies emerge in each of these clean-tech sub-sectors, private equity will continue to invest. It’s as simple as that,” says Mr Haji.


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