To some people, renewable energy conjures images of ugly wind turbines and huge solar panels. But to a growing number of bankers and investment institutions, renewable energy is an increasingly attractive business. Once considered the preserve of vegans and sandal-wearers, alternative energy is moving towards the mainstream.
The shift has been rapid and pronounced, fuelled by a variety of factors. First, there is a growing acceptance that climate change is real and has come about, at least in part, as a direct result of the world’s use and abuse of fossil fuels. The EU has made a commitment to derive 20% of its energy from renewable sources by 2020.
Although some countries, such as Germany and Spain, have made good progress on this front, most of Europe is lamentably behind schedule and is trying hard to catch up.
Lloyds TSB estimates that meeting the EU’s renewable promises should create capital costs of up to €95bn by 2010 and substantially more between 2010 and 2020.
“Europe may well spend less than is necessary to meet its commitments during the next few years but there is no doubt that tens of billions of euros will be allocated to this industry in the short and medium term. The opportunities are significant,” says Richard Simon-Lewis, head of energy and utilities for Lloyds TSB’s project finance division.
There is also a growing fear about energy security. Most countries in the EU are heavily dependent on imported oil and gas, with many exports coming from Russia and the Middle East.
Russian monopoly Gazprom is the biggest supplier of natural gas to Europe, meeting about 40% of demand. Disputes between the Russian giant and Commonwealth of Independent States nations such as Ukraine and Belarus resulted in power cuts when supplies were briefly cut off. Although the situation did not last long, it made Europe acutely aware of its vulnerability.
Oil vulnerability
The sentiment is given extra impetus by the ongoing fear of terrorist activity and concerns about the way in which terrorism could affect the supply of oil to the West.
Politicians are keen, therefore, to find stable sources of home-grown energy. Their enthusiasm has intensified as oil and gas have become increasingly expensive, putting pressure on consumers and industry alike.
Rising oil and gas prices have come at an interesting time for the renewable energy sector. The technology behind wind farms, for instance, is relatively mature and costs are coming down. Equally, some technologies, which were considered just too expensive to contemplate a few years ago, make more economic sense with crude at $100-plus a barrel.
“The industry is growing fast. In Europe, it is growing at about 16% a year, in North America by about 30% and in Asia at more than 30%,” says Torsten Hinsche, head of renewable energy at Commerzbank.
Commerzbank has one of the largest renewable energy loan portfolios in Europe. The bank lent more than €1bn last year in this area and total loans amount to approximately €3.5bn. The bank has even created a renewable energies centre of competence, dedicated to sourcing and financing opportunities in the alternative energy space.
It is not alone. Banks, infrastructure funds and private equity firms are devoting time, effort, manpower and money to this industry.
Mark Kerr, a director at listed private equity group 3i, says: “On the banking front, German, Spanish, Belgian and Dutch banks are all heavily involved, as are UK lenders, such as Royal Bank of Scotland. US investment banks have come into the industry too and hedge funds are becoming involved as well.”
Money first, environment second
This interest has not been sparked solely out of a desire to save the planet. The key fact is that politicians across the world have created incentives to encourage the creation of renewable energy capacity. Incentives vary from country to country but, broadly speaking, they make renewable projects financially more viable.
In the UK, for example, the government devised a scheme whereby utility companies are required to source a certain amount of their energy from renewable sources. Renewable obligation certificates (ROCs) are used as proof that the companies have fulfilled their obligations in this area and utilities can buy these certificates from alternative energy businesses.
“Businesses that qualify for ROC status are particularly attractive,” says Mr Simon-Lewis.
Many banks, for example, are intrigued by the so-called waste-to-energy sector, in which the gas produced by waste is converted to energy.
“Local authorities are being driven towards developing waste schemes and they are ROC qualifying, which makes it very attractive for banks to get involved,” says Mr Simon-Lewis.
Strong wind
The dominant alternative energy is, however, wind. In 2007, more than €2.5bn was spent on this sector in Europe alone and the industry delivered compound annual growth of 29% between 1994 and the end of 2007. Banks are involved both as project finance lenders and, increasingly, as equity providers.
“We see more and more banks taking equity shares in projects. At Société Générale, we have set up a dedicated team looking at infrastructure and energy opportunities around the world. The bank’s own money is being invested in some of these projects,” says Emmanuel Fages, carbon and coal analyst at SG Corporate & Investment Banking.
From a lending or equity perspective, market dynamics are extremely positive. Due to government subsidies, tariffs and obligations, this energy source provides a relatively predictable, long-term revenue stream.
| “The market is supported by favourable legislation and the knowledge that renewable energy is a long-term growth story,” says Bruce Huber, head of clean tech investment banking at US mid-market specialist Jefferies International. |
Wind offers opportunities up and down the supply chain. Although banks may be involved in lending to wind farms themselves, the companies that supply component parts for wind turbines are also seen as good investments. “We look at renewable energy businesses but we are also interested in the services side and the supply chain,” says Mr Kerr.
In recent years, solar energy has also demonstrated strong growth. Since 2004, the industry has expanded by about 30% annually but it still accounts for less than 1% of electricity generated worldwide. Nonetheless, banks and other investors are backing this sector and certain countries, such as Spain and Germany, are particularly focused on developing this energy source.
Risky business
Biofuels have also attracted attention during the past couple of years, although they have not been without controversy. In fact, the sector highlights some of the risks inherent in the wider alternative energy sphere.
Mr Kerr says: “Investment in this industry clearly has some risks. There is development risk – will companies receive planning permission and can they access the transmission grid? There is technological risk – will the kit work? There is operational risk – will there be sufficient wind, sun, etc, to create the necessary amount of energy? And there is financial risk – does the cost of creating the energy make it viable and will the authorities continue to provide the requisite support?”
This is a crucial point. In the biofuel sector, for instance, opinions have changed amid growing concern about the use of staple crops for energy and once-attractive investment opportunities have turned sour.
“The bloom has come off the rose a little in the biofuel market,” says Tom Sikorski, managing director at private equity firm, First Reserve Corporation.
Overall, however, banks and private equity firms are enthused and excited by the renewable energy sector. Banks want to see if businesses have a reasonable track record and they are also keener to lend to low-risk technologies, such as wind, but debt finance is still available for good projects.
“After the credit crunch and associated market slumps, this is one of the few areas of sustained interest,” says Mr Fages.
Selective thinking
The sector has not been completely unaffected by the market environment, however. Last summer, there was huge liquidity in the market, and although the interest is still there, people have become more selective. Banks are more keen on tried-and-tested technologies than on unproven technology.
Lending methods have also changed, says Mr Simon-Lewis. “For larger schemes, such as waste or wind, banks are clubbing together. There is a definite preference for club deals as opposed to syndicated loans and the days of one bank doing the whole deal are not really there.”
Learning lessons
If lessons have been drawn from the subprime crisis, Commerzbank’s Mr Hinsche is keen to point out that that this industry performs well. “Banks are cautious and will not lend on foolish terms [but] default rates are actually very low compared to other industries.”
The appetite for debt is also strong. Many alternative energy businesses have accessed the equity markets for funds during recent years but in the past few months the initial public offering (IPO) market has virtually dried up.
“Asset prices were inflated last year but, now that the IPO route is virtually closed, companies are looking to the bank market and prices have become more realistic,” says Mr Kerr.
Pricing may ebb and flow and some sectors may move in and out of fashion. However, there is a fundamental requirement to increase the amount of alternative energy in terms of supply and use. The challenge is lending to the right businesses, with the right technology, in countries where the regulatory regime is supportive. The opportunities are undoubtedly there. It is simply a question of spotting the best ones.
