Market Outlook: Renewables Make Good Financial Sense

Renewables are of particular importance in Iceland. The country has no fossil fuel resources and today 72% of its primary energy consumption comes from renewable sources, as compared to the global average of 13%. The National Bank of Iceland, Landsbanki, has helped foster this industry by providing specialized financial support for renewable energy.

In February 2008, Landsbanki and Mergermarket, an independent mergers and acquisitions (M&A) intelligence service, jointly undertook a survey of 100 renewable energy industry-focused professionals. Those canvassed included corporate executives, investment bankers, and legal and private equity executives from around the world. Respondents were asked for their views on a wide variety of relevant topics, such as oil price trends, drivers of recent inbound US M&A activity and the effect of the UN Climate Change Conference on deal flow, as well as M&A expectations among renewable energy companies in the next 12 months.

In the space of this brief article, only a few points can be highlighted. When asked about the impact of the credit crisis on the renewables sector, respondents were surprisingly upbeat: 76% believe renewables M&A activity will at least increase over the next year. Only 3% of respondents believe that activity would decrease.

Both company managers in the renewables sector and financial experts predict continued expansion and consolidation among renewables producers. Growth in the renewables market is measured in double-digit figures and companies in the field enjoy a high level of goodwill and investor confidence. A large percentage of those respondents with a positive outlook for M&A activity in the sector described how this currently fragmented sector cannot help but undergo consolidation, with larger players buying out smaller development players.

A number of important factors appear to be holding back growth in the industry, ranging from difficulties in obtaining planning permissions to develop sites to a shortage of key materials, such as silicon for solar panels, or wind turbines or specialized vessels to develop offshore wind farms. Until some of these bottlenecks loosen up, the rush to meet renewable energy targets may continue to boost valuations of existing undertakings.

In the opinion of some respondents M&A is the only way to gain a major market presence, given the lengthy lag in developing new sites, despite the fact that greenfield development can bring greater rewards.

How To Back the Right Horse

As with any new technology, some of the early frontrunners in new energy development may fall by the wayside and investors need to consider how mature a company’s technology is and how close it is to commercialization. And companies need to have reached a certain level of development before the market is ripe for consolidation.

Survey respondents believe M&A prospects are strongest in the wind and solar sub-sectors over the next 12 months. In contrast, only 16% of respondents believe that the geothermal industry will witness high levels of activity.

This may be a question of economic feasibility: wind especially, and solar and biofuels to a lesser degree, are becoming more financially viable and have pricing structures designed to support them as the technology improves. Although hydro has long been profitable, it has little growth potential. Marine power and tidal technology are still a long way from large-scale commercial viability, with many different technologies competing for investment.

Where Will Funding Come From?

Despite the credit crunch, respondents are relatively optimistic about future levels of private equity activity in the renewable energy sector. 80% expect that it will at least increase in the next 12 months and only 4% of respondents believe private equity’s participation in M&A will decrease.

Renewable energy IPOs are expected to soar in the next 12 months according to 66% of respondents. Only 11% of respondents believe that renewable energy IPOs will fall in the coming year. One Spain-based legal respondent ascribed an expected rise to the fact that “IPO sponsors and investors will be drawn to renewable energy firms who offer stable internal rates of return, while at the same time renewables need the money that IPOs can generate.”

Another said that the long-term shift from fossil to renewable sources of fuel positively impacts the number of IPOs taking place. “Everyone knows that fossil-fuel usage is coming to an end,” said one U.S. CEO. Yet another U.S. corporate CEO respondent simply said that sectoral IPO activity will increase due to “the lemming effect.”

A few disagreed with these sentiments. An Australia-based lawyer claimed that “equity markets are too volatile at the moment for the absorption of early-stage renewables.” However, a Denmark-based corporate executive believes that “lots of renewable energy companies and businesses don’t need the financial markets.”

Environmental Concerns and Politics A Key Factor

62% of respondents believe that the recent UN climate change agreement will increase M&A deal flow. Wide acceptance of climate change risks has prompted national authorities and international institutions to adopt stricter environmental legislation. EU legislation is also a significant driver for the industry.

Political issues are expected to be a leading driver of renewable energy M&A in years ahead. 60% of respondents believe that political issues will be at least a very important driver of renewable energy deal flow. Economic issues will also be significant, high energy prices have increased awareness of the feasibility of developing new environmentally benign energy sources. 56% prioritized economic aspects as very important, ahead of social issues (47%).

As one European corporate respondent explained: “Political issues are very important because the renewable energy sector is highly dependent on subsidies — it couldn’t develop without government intervention.”

Another U.S. corporate respondent noted that “the availability of turbines, viable sites and experienced staff will drive acquisitions.” One European energy consultant believed that “government incentives, such as favorable price regimes and green credits, will drive private equity activity.”

Another U.S. private equity respondent noted that “changes to U.S. capital tax regulations” will be an important driver of private equity deal flow in the sector.

Yet some of those surveyed are less sure. A Spanish banker said that “unless the debt markets recover, private equity firms will not be able to gear their operations to buy renewable energy targets.”

The survey indicated that 45% of respondents believe that favorable U.S. legislation is driving the foreign acquisition of U.S. renewable energy firms. But 37% of respondents believe that overseas interest in the U.S. wind has been driven by the market being relatively unsaturated. Other reasons cited by respondents include: the number of experienced companies that reside in the U.S.; the relative saturation of the European market compared to the “virgin U.S. market”; the existence of tax credits and incentives in the U.S. and its reliable legal framework.

What About the Price of Oil?

In addition, high oil prices that are unlikely to drop significantly in coming years and concern about energy security are encouraging national governments to require more renewables in their energy portfolios.

Even in what respondents deem is the unlikely event of a falling oil price, the majority dismissed any correlation between falling oil prices and dropping interest in renewable energies, with 67% stating that there is no minimal oil price below which the significance of renewable energy fades. Many respondents felt similarly to one German lawyer who stated the correlation did not exist because “alternative energy supply is of vital importance in the medium to long term. It is also one of the few ways to avoid energy dependency on OPEC countries or Russia.”

Other respondents highlighted the fact that in most territories government incentives exist to encourage and stimulate the development of alternative energies therefore insulating the industry from the price of oil. In addition, in the words of UK private equity executive: “Public awareness and increasing support from the investment community will generate sufficient momentum in the renewables markets regardless of oil prices.”

These are only a few of the issues addressed by the survey. In his foreword to the survey report, Landsbanki’s Director of Corporate Finance Bjarni Þ. Bjarnason pointed out that “most companies in this still relatively emergent sector are classified as either small- or mid-cap. We expect these young and vital companies to grow rapidly over the next years, both organically and through acquisitions.” Clearly, respondents expect a major share of the financing for rapid growth will come through market listings.

Born in Iceland, Margrét Ormslev Ásgeirsdóttir studied industrial engineering and economics. Prior to joining Landsbanki’s Research department in 2007, Margrét worked at the geothermal division of VGK consulting engineers. She is currently employed in Landsbanki’s Corporate finance division focusing on renewable energy projects.

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