LONDON — Investment in renewable energy is changing, with those who were once the backbone of the market pulling out and new entrants increasingly taking up the slack.
Raising funds in the renewables sector is more challenging than elsewhere, claims Adam Workman of investment firm CT Investment Partners. He cites many important reasons for this: investors have traditionally shunned regulation-driven markets; the renewables sector is complex and contains a diverse range of technology challenges; renewable firms are capital-intensive businesses; competition is scattered across the globe; there are few experienced deal leaders but a range of follow-on investors; and financial returns to date have been mixed. In brief, investors want companies that can deliver sustained future growth.
However, according to Workman, a globally competitive technology, or an initial product that has been demonstrated with customer traction, will attract investment, even though it is likely to need several rounds of financing. Investors like the supply chain and energy efficiency services of renewables projects because they require less capital and are quicker to produce cash flow. Small-scale infrastructure projects are also popular because they meet equity funding requirements with secured revenue streams, he says.
India is the world’s fastest-growing renewable energy market. Until 2012 it had the best of both worlds, says Sanjay Chakrabarti, partner and cleantech sector leader at Ernst & Young, with independent power producers (IPPs) largely backed by big private equity firms and taxpayers making up a large market. But when the incentive for wind generation was removed in April 2012, the taxpayer market exited en masse. Since then, Chakrabarti says, the IPP market has grown but overall investment has dropped significantly. The wind generation incentive was restored in February.
Worldwide, pension funds and life funds are increasingly investing in renewables. These funds value stability over high returns, so few invest at early stages. Adrian Reed, head of energy, waste and renewables at international investment bank Altium, adds that pension funds want assets that become cash-flow yielding, with stable, predictable internal rates of return (IRR).
Reed says the main investors in large-scale European projects are major power utilities, IPPs who don’t have front-end distribution of retail power but play in the wholesale market – companies such as Vattenfall, Dong and Statkraft, all of whom are investing either off their balance sheets or alongside big infrastructure funds and debt finance.
In the offshore wind sector, Reed adds, IPPs make strategic decisions to supplement investments in coal, gas or nuclear. Although the offshore market is less mature than onshore, there is real volume and a diversity of investors. There’s new money coming into the industry, too, which Reed says should recapitalise developers and investors. “The more mature the assets are,” he adds, “the more they can move into traditional markets such as the bond market, or part of a portfolio – treasury bonds, wind farms, property.”
In the onshore wind market, Reed continues, as well as professional development teams within large utilities, there are many smaller investors who have backed one site and got lucky: “You have landowners, property developers, property consultants and estate agents moving to start to play in that market. Then you see private individuals, angel investors and community groups.”
Reed also describes a “virtuous circle” coming into play. As certain segments of the renewables market mature, as support mechanisms for assets improve and as understanding of asset value is refined, more non-specialist investors enter the sector. But, he cautions, different types of buyers value different types of criteria for different types of assets: “You have to match investor category with type of asset.” Smaller entrepreneurial investors are more able to make an assessment about what they buy, as opposed to life and pension funds, which are very structured and systematic in the types of assets they’re prepared to hold, he explains.
The larger the assets and the stronger their performance track record, the more likely they are to attract non-specialist investors – pension and life funds being the classic example. This is at end of the continuum that starts to recycle into the industry and free up more capital for more development, says Reed.
According to Ian Thomas of investment management firm Turquoise International, “For any particular deal or investment over the last three to four years, you have to look widely for investors because the policy backdrop isn’t helpful.” He finds investment increasingly coming from outside the traditional sources of specialist renewables or cleantech funds, and also sees a lot of interest in the sector from high net worth individuals and family offices: “We see investment from corporates and we see money from public sources, quite a varied range of different entities.” These include government-related funds such as sovereign wealth funds.
Thomas says investors in Asia, especially in China, are looking for specific things, for example technologies that can be deployed back in China. This learning or transfer exercise arises because they have opportunities in the home market but not the expertise to develop their own projects.
According to Thomas, some investors who have been in the renewables sector since the early or mid-2000s have failed to net the expected returns and have withdrawn. But, he says, new investors are still arriving, people who didn’t focus on the sector as early or decided to adopt a wait-and-see approach. It is a buyer’s market now, says Thomas, “so if you have the money to invest…”
Where Is the Money Going?
Reed believes that one of the challenges is that mid-level investment is missing from the global picture. There are very large transactions at utility scale, he says, in which people aim to invest in big fixed infrastructure, and then there are small applications, such as microgeneration, and very little in the middle.
The low end of the spectrum is a much less well understood market, says Reed. “How do you get small-scale biomass plants developed, or new technologies? In terms of returns versus risk, people are more wary if there’s less of something. 1.5 MW to 10 MW PV plants involve additional risk factors since there are fewer of them. They don’t catch the non-specialist mainstream asset acquirer’s interest.” He adds that he has seen biomass and waste-to-energy plants seeking pension and life funds.
Workman says the money is going to companies that already have investors and have made it to the point of trial or demonstration. It’s those companies that have capital, he says, while companies looking to raise money for the first time, or to scale up, are finding it harder: “The same pot of money is going to fewer companies, which tend to be more established, rather than the money being invested in one technology over another. If you look by quarter, one technology may do better, but that’s due to one to two very large deals. Over a two year period it’s difficult to see any big trends. The trends are more in terms of smaller renewable technologies: mini and micro-renewables and large-scale offshore,” he says.
Trends On the Ground
Trends on the ground depend strongly on which bit of the overall sector you look at, says Thomas. In Spain, for example, financial pressure on the government has lead to policy changes. Even German reductions in solar subsidies, although not of Spain’s magnitude, have had consequences for investors. In the UK, solar and biomass have had their ups and downs: “In biomass there will be policy clarity on one issue but then there are still two to three others to be clarified, so projects are on hold,” he says.
According to Thomas, there is less subsidy money around at the moment and people are less trusting that subsidies will continue, so in the long term he sees other commercial propositions, such as waste-to-energy and geothermal, as more interesting to investors. He also sees a huge interest in storage technologies.
No matter which part of it you focus on, says Thomas, clean energy is still a new sector with teething issues. Big investors need to see a new investment class mature over 5-10 years from when they first start to look at it to decide whether to invest.
When asked to identify the most interesting investment trend, Thomas points to an increased focus on propositions with purely commercial payback rather than those that depend on direct subsidies. “This is a continuing persistent trend,” he says, adding: “Now there are more commercial people who established a business track record in unrelated sectors and who see opportunity and can bring to investors their experience and business models that are robust, commercial and interesting.”
Chakrabarti also believes that a better quality of business is emerging. “The good news,” he says, “is that the IPPs are professional companies coming in with the objective of setting up quality assets, meaning the quality of industrial development will see a significant improvement.”
Thomas points out that for every country in which the policy environment is less favourable, another arises with an active programme. “In South Africa there is large-scale renewables development right now,” he says, “and China is clearly still adding huge amounts of wind capacity each year. The U.S. is still a market, although there’s still some political uncertainty now in the process of sorting itself out.”
What scares investors is regulatory risk and policy changes, says Workman. “Uncertainty is the thing they hate.” Even if rates change more than expected, he says, stability for 12-24 months as a minimum will see investors invest. Many projects have lead times of 36 months.
However, policy clarity is not necessarily a good thing, says Thomas: “When attractive tariffs were on offer, the cost side of the equation came down significantly. Valuations became stretched, and investors started to file in. [Policy] was all very clear, but when everyone was looking for solar investments other sectors were starved of funds.” But his firm is seeing this trend reversing somewhat as investors have looked for a better risk-return balance.
A Lost Generation?
According to Workman, between debt project finance and technology development – the two aspects banks focus on – the first is dominant today, and companies have set aside the second. “If the commercial market isn’t investing in that side and there isn’t significant government funding, what will happen to those businesses? Will there be a lost generation? It is happening now,” he warns. “With the current level of nervousness, we’re seeing growth more around energy efficiency than renewables, which leads to the question: are we missing a generation of renewable energy technology developers because of a lack of capital in the marketplace?”
Workman points to a trend that has established itself over the past two or three years: “Companies continue development but on very low levels of capital. The most obvious market in this regard is marine energy. A number of technologies have now gone beyond commercial trials and need to move into the first commercial farms, and as yet funding hasn’t materialised.”
Lead image courtesy Emerson Industrial Automation