Euan McVicar, Energy & Infrastructure Practice, McGrigors LLP
November 10, 2011 | 0 Comments
Independent equity investment seems increasingly likely to play a prominent role in plugging a funding gap at the heart of Europe's renewable energy ambitions. What are the implications of this investment, both in pure private equity and in longer term pension and infrasctucture funds?
In the past few weeks figures have emerged from Prequin (the investment data firm) that proved something we have come to suspect over several months. Independent equity (including both pure private equity and longer term pension/infrastructure funds) investment seems increasingly likely to play a prominent role in plugging a funding gap at the heart of Europe's renewable energy ambitions.
People may think they have heard it all before, but the statistics are quite drastic. They show that, within the past 24 months, over €2 billion has been raised for investment in renewable energy projects in the U.K. and continental Europe.
In a further sign of increased appetite for investment in UK renewables specifically, the value of buyout deals – where investors have bought a majority stake in existing renewable projects — has rocketed in the first half of 2011. €670 million worth of deals closed so far this year, a figure which is nearly 10 times greater than in 2010.
The research will be a welcome boon for the renewable industry and policymakers. However, there will still be competition for funding with the best and well-structured projects attracting equity investment ahead of others. Quality is the watchword for investors entering this space, and is measured with reference not only to project characteristics (wind yield etc) but overall performance, innovation risk, exposure to regulatory change and, crucially, track record and the reputation of co-investors and project sponsors.
The figures clearly demonstrate that third party equity is well-placed to fill the project finance vacuum. There is no doubt this is good news – governments around Europe, but particularly in the UK, have pinned a lot on renewable energy both as a means to meet consumer demand for power and as a form of economic stimulus. This data shows us that private investors have bought into the vision, but the question now becomes one of where they think they can get the best return on their investment.
One particularly encouraging facet of the research is that the capital raised for investment in renewables during 2011 is approaching pre-recession levels. In 2007 almost €2.5 billion was raised for such projects, but that figure dropped to just €2 million in 2009.
However, 2010 saw a strong rebound in investor appetite. Significant capital was raised and, since then, we have seen a better deal flow in buyouts during 2010–11. Particularly this year, what stands out is the value of the deals. We've moved from a fairly modest average into mega-deal territory.
While it is unlikely that significantly more capital will be raised in 2011, there is still money in the pot from previous years and people will need to do something with it if they are going to be able to justify management fees to investors. However, those seeking investment cannot afford to think there is a pot of gold out there — they need to show that they can generate a decent return within 3–5 years, or equity investors will simply walk away.
Release of this data coincided with the Scottish Low Carbon Investment conference, held in Edinburgh in late September. For the second year running some of the biggest players in the global energy sector convened to discuss, among other things, how Scotland can meet ambitious targets for renewable generation.
The investment community has clearly taken a great deal of comfort from the clear agenda for growth in the low carbon economy and ambitious clean energy targets that the Scottish government has set. That said, it is also clear from the discussion that there is huge global competition for investment. A confluence of project pipeline, regulatory incentives, benign business environment and suitable infrastructure is required to attract the level of investment needed.
The Scottish government wants 80 percent of Scottish electricity consumption to come from renewables by 2020. One of the biggest question marks hanging over this objective is how it will be paid for, and this data — not to mention the mood at the Scottish Low Carbon Investment conference — gives a clear indication of where at least one answer lies.
A range of factors are combining to make the renewables sector attractive to private equity. Getting good returns for investors in the pervading economic environment has been difficult. PE houses, and other equity investors such as pension funds, have started looking at alternative assets, and renewables have emerged as one of the more attractive options. The technology is more proven, the infrastructure in many cases is up and running, and government commitment is clear and strong. The payment mechanism has been clarified and it is clear that the government views this as essential spend, which gives these investments something of a gilt-edged look. The returns are attractive and, for their part, equity investors have become more sophisticated in understanding the scale of the opportunity and evaluating the risks.
In this context, its worth looking at a recent deal: Marubeni Corp's investment in DONG's Gunfleet Sands offshore project. This investment marks Marubeni's first position in the U.K. wind sector. It is telling that it has seen potential in offshore wind — with scope for large replicable investments in the future — and has chosen a joint venture partner with an excellent pedigree in offshore wind development. DONG also has U.K. offshore wind joint ventures with Iberdrola's Scottish Power Renewables (West of Duddon Sands) and Scottish and Southern Energy (SSE plc) (Barrow).
This demonstrates that the U.K. is having some success, but there is still work to do. Earlier this year Blackstone made significant investments into assets in the German North Sea. This is a global game in which the UK and Scotland in particular are competing with the likes of Germany, Spain and Denmark. That's before we even consider the significant competition with South American markets (particularly Brazil) and China, which all offer scale of opportunity.
If the destination of the investment is a factor, so too is its origin. The vast majority of new equity investors in the sector regard themselves as global entities. However, there is recognition amongst many commentators that much of the future equity investment is expected to come from the Middle and Far East.
Investment priorities change depending on the provenance of the funds. Our office in Doha has reported, for example, that although a lot of people and institutions make eye-watering sums from hydrocarbons, they are also extremely sophisticated and careful about how they protect and grow that wealth. Renewable energy is on the agenda as an investment, but does not enjoy the same profile or emphasis as in the UK and Europe because there are not the same climate change targets or energy security concerns. The Qatar Investment Authority (QIA) set up a €286 million clean-tech fund with the UK Carbon Trust a few years ago, but since then there remains understandable caution in the market. You are probably just as likely to see investment in other assets, as the acquisition of a stake in French luxury handbag maker Le Tanneur recently highlighted. You really need to work hard to demonstrate what kind of return a low-carbon project can deliver, but not just in financial terms.
The statistics and trends provide evidence suggesting this is a market with scope for growth and significant equity investment.
Alternatives to Traditional Private Equity
Aside from private equity, it is worth considering what role major infrastructure funds are playing in funding renewable energy projects.
Some big deals involving the likes of Barclays Infrastructure Fund and others have taken place recently, but there are also many other unlisted funds out there doing business. In the first six months of 2011 they did as much business as in the whole of the preceding year, and it would be surprising if that wasn't topped in 2012.
Infrastructure funds, pension funds and classic private equity investors are all likely to have quite different investment strategies and aims. For example, pension funds are more likely to be interested in lower risk, lower return investments. A good example of assets likely to appeal to this class of investor would be a portfolio of operating onshore wind farm assets. This type of investment can have an important role in freeing up the balance sheet of developers to allow them to make investments in other low carbon technologies.
Also, there are larger privately owned institutional investors. They are looking at very long-term wealth creation over a number of generations, and a number of such entities are coming into the low carbon space. Energy is becoming increasingly important, and having some exposure to renewables is sensible in protecting investment in the long term. Low carbon is starting to look like a very sensible and significant element in a diversified long-term investment portfolio.
Those finance houses often look for similar investment criteria as another emerging class of investor in the low carbon space, the high net worth individual (HNI) or "family offices." HNIs and family offices investing the wealth of particular families are increasingly turning to this sector. And a number of wealthy individuals and families in 2011 who were first time investors in low carbon projects and have returned with an appetite for further projects. These investors are driven by attractive returns compared to other investments (particularly equities and gilts) in low-growth, low-interest rate environment. I would expect that trend to continue.
Euan McVicar is a partner in the energy and infrastructure practice at McGrigors.
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