Winning over the sceptics: The continued rise of private equity investment in clean energy

If 2005 was the year that venture capital and private equity investment in clean energy went mainstream, 2006 was the year it won over the remaining sceptics. New investment through venture capital and private equity totalled US$7.1 billion worldwide in 2006, an increase of 163% over 2005 levels. This boom is more than just a short-term trend, as a new report by New Energy Finance and the United Nations Environment Programme reveals. By Angus McCrone.

New Energy Finance (NEF) has conducted an extensive review of private equity (PE) and venture capital (VC) investments in the clean energy sector, derived from data going back to 2001, which covers 15,000 organizations (including start-ups, corporates, VC and PE providers, banks, and other investors), 5500 projects and 6000 transactions.

FIGURE 1. VC/PE investment by type, 2000-2006. Figures in brackets refer to disclosed deals/total deals. Grossed-up values based on disclosed deals. The figures represent total investment, so include PE buy-outs and investor exits made through OTC market offerings. OTC & PIPE deals are included. PE invested in projects is excluded. Source for all figures: New Energy Finance unless otherwise specified

Venture capital and private equity investment activity (total transactions) in sustainable energy totalled $8.6 billion in 2006, an increase of 69% over $5.1 billion in 2005 (Figure 1). The number of deals increased by just 12%, indicating a much higher average transaction value. Private equity dominated VC/PE investment, accounting for well over half of the investment. Of the PE expansion capital, $3.6 billion was invested in existing companies, with a further $1.4 billion changing hands through buy-outs and corporate spin-offs (Figure 2).

FIGURE 2. VC/PE investment by type, 2006. Grossed-up values based on disclosed deals

Although 2006 saw lower venture capital flows than private equity, especially at the early stages, VC funding nevertheless held its own in terms of number of deals – 148 deals were completed, compared with 74 in private equity. A relatively modest $42 million was invested in renewable energy companies in the form of seed capital or angel finance. The level of investment increased through further VC rounds, reflecting the growing number of technologies reaching commercialization.

Private equity investors are also using over-the-counter (OTC) markets and private investments in public equities (PIPEs) to increase their exposure to these sectors. A total of $1.8 billion was raised in 2006 through OTC and PIPE transactions – an increase of 200% over 2005.

FIGURE 3. VC/PE investment by Sector, 2000-2006. Grossed-up values based on disclosed deals. The figures include PE buy-outs but exclude OTC & PIPE deals. Source: SEFI, New Energy Finance

The three most active sectors for venture capital and private equity finance in 2006 were biofuels, solar and wind, accounting for $2.3 billion, $1.4 billion and $1.3 billion, respectively (Figures 3 and 4). Most of this money was used to increase manufacturing capacity, particularly in wind. However, in solar, a significant proportion of the capital invested – around 40% – went into developing new technologies. In biofuels, the proportion was about 20%, reflecting the surging first generation (corn-based) ethanol industry in the US, as well as research into second generation biofuels, including cellulosic ethanol.

There was also a healthy interest in newer technologies during the year with nearly $1 billion invested in energy efficiency (power architecture and energy-smart buildings), and a total of $371 million in the related sectors of fuel cells and hydrogen.

FIGURE 4. VC/PE investment by Sector, 2006. Grossed-up values based on disclosed deals. The figures include PE buy-outs but exclude OTC & PIPE deals

Marine technology, on the other hand, attracted relatively little VC/PE funding during 2006 – just $55 million – which reflects the ‘wait-and-see’ attitude that is dominating the sector. Several marine companies now have pilot projects being tested in the water and, while investors are clearly interested in the technologies, there seems to be a hiatus until the results are clear and winners start to emerge in this sector.

US dominates despite Kyoto omission

The US dominated VC/PE transactions in renewable energy in 2006, accounting for $3.8 billion (Figure 5). The total for the EU-27 countries was just $1.5 billion. The US has a long-established VC/PE investor base and a strong track record in developing new technology.

This will surprise some who have criticized the US government’s refusal to sign the Kyoto Protocol. However, the enabling environment for innovation in the US is very strong, with the VC industry now a significant source of capital formation in the clean energy sector. Some federal regulations are also helping, such as the production tax credit, and there is plenty of impetus below the federal level coming from state and local governments and from private sector investors and businesses.

FIGURE 5. VC/PE investment by country, 2006. Grossed-up values based on disclosed deals. The figures include PE buy-outs but exclude OTC & PIPE deals. EU-27 has been included, as have its constituents, but only for comparison purposes. Source: SEFI, New Energy Finance

Since 2000, US companies have attracted well over $6 billion in VC/PE funding, around nine times more than their nearest rivals in Australia, Spain and the UK, each of which has attracted around $850 million of VC/PE investment. In 2006, China followed the US in terms of value of VC/PE investment. It accounted for 74% of such investment in developing countries – a dramatic increase.

As China’s economic growth continues apace, an increasing number of investors are looking for opportunities, attracted by the heady combination of strong growth and the government’s commitment to clean energy. The spectacularly successful IPO of Chinese solar company Suntech at the end of 2005 sparked investor interest in finding the next success story out of China. Since then, a steady stream of solar initial public offerings (IPOs) has followed into early 2007, with many more in the pipeline.

The venture capital sector, in particular, is likely to benefit from the Chinese government’s desire to boost domestic technological innovation. The National Guideline on Medium- and Long-Term Programme for Science and Technology Development (2006-2020) aims to reduce the country’s reliance on foreign technologies from above 50% to 30% by 2020. The Chinese government hopes to cultivate home-grown, internationally competitive technologies by implementing preferential policies and channelling investment to promising companies.

European growth moves from private to public

By contrast, European companies lag behind in raising VC/PE funding. VC/PE investment in the EU-27 actually fell slightly between 2005 and 2006, despite the strong global rise. It is interesting that the UK, Germany and France, which are major European economies with important financial sectors, accounted for a very small share of VC/PE flows into sustainable energy.

This may be due to the deeper financial markets and an increasingly sophisticated investor base in Europe, which is broadening the range of options available to growing companies and enabling them to access the public markets sooner than in other countries. London Stock Exchange’s Alternative Investment Market (AIM), for example, has become a focal point for renewable energy companies seeking capital, particularly over the past couple of years. AIM is less regulated than many other markets designed for small to medium-sized companies, such as NASDAQ, and its accessibility – as well as its relatively low cost – have added to its attractiveness.

The fact that many European firms have already reached a more mature stage than their US equivalents, because Europe has been quicker off the mark in renewable energy, is a further reason for the lower levels of early-stage funding. Other factors include highly regulated labour markets in Europe, fewer experienced venture capitalists and fewer serial entrepreneurs.

Growth has continued into 2007. During the first quarter, $2.2 billion of venture capital and private equity flowed into the clean energy industry worldwide, an increase of 58% over the same quarter in 2006 and 60% over the fourth quarter of 2006. A few large deals dominated this investment activity, such as later-stage leveraged private equity investments.

While the US dominated in venture capital and private equity, the EU-27 attracted the most significant public market investment in 2006 – $5.7 billion compared with $3.5 billion in the US. This is partly because of the higher awareness of climate change and the role of renewable energy and energy efficiency in the EU, which, unlike the US and Australia, ratified the Kyoto Protocol. A number of EU countries offer generous incentives to promote renewable energy (such as the German feed-in tariff) and are starting to do so with efficiency. These factors help to explain why stock market investors in the EU have been particularly ready to pour money into renewable energy and why companies there have reached a relatively mature stage in their development.

Meanwhile, many US firms are still going through earlier stages in their development, a large number of them spurred on by the biofuels and solar boom. This activity has attracted heavy investment from venture capitalists and private equity funds. The European market’s relative maturity also explains why it dominated mergers and acquisitions (M&A) activity in 2006 with deals worth more than $20 billion. At $8.8 billion, M&A volumes in the US were relatively modest by comparison. It is important to note that M&A activity does not represent new investment into the sector but involves money changing hands between investors.

A number of drivers have contributed to the continuing renewable energy boom – with continuing concerns about climate change and energy security being the main ones. In addition, there is an underlying shift in investor sentiment towards renewable energy and energy efficiency that is enabling the overall sector to reach a critical mass, which itself fosters further growth.

Renewable energy was also pushed to the very top of the political agenda in 2006, helped by a number of events, notably the US mid-term elections in November, which confirmed clean energy as a mainstream issue, and the UK government’s Stern Review on the Economics of Climate Change, which made a strong economic case for investing in low-carbon technologies now while arguing that economic growth need not be incompatible with cutting energy consumption.

Growing consumer awareness of sustainable energy – and the longer-term potential for cheaper, not just greener, energy – has become another fundamental driver of the sector’s growth. The increase in growth has also been driven by persistently high oil prices, which averaged more than $60 per barrel over the 12 months of 2006.

Overall investment in sustainable energy worldwide increased 43% to $70.9 billion in 2006 and is expected to reach $85 billion in 2007. While venture capital and private equity experienced the strongest growth, investment via public markets increased by almost as much – up 140% to $10.3 billion, with the flow of IPOs of clean energy companies particularly strong in the second and final quarters of 2006.

Is the sustainable energy boom itself sustainable?

While the growth surge in the clean energy sector is undeniable, there are those who are comparing it with the technology boom of the late 1990s and early 2000s. However, not only does the volume of investment flowing into clean energy dwarf the dotcom boom, but clean energy sector growth has continued for longer than the dotcom boom lasted and is showing no sign of abating. Furthermore, unlike the dotcom bubble, renewable energy and energy efficiency are underpinned by real demand and growing regulatory support, as well as considerable tangible asset backing by manufacturers and project developers.

This, then, is not some niche sector promoted only by governments and environmentalists. But with new renewables (not including hydro) today accounting for only 0.5% and 2% of the global energy and electric power sectors, respectively (according to the International Energy Agency’s World Energy Outlook 2006), should these developments be taken as indicators of true disruptive change to the energy sector?

The fact that clean energy still makes up a minor section of global energy is a little misleading. Since the capital stock turnover is very slow (most generating facilities have operating lives of 40 years to 60 years), such figures say little about today’s technology choices and even less about the future energy mix. Mostly, they give a picture of the technology options that were available in the 1950s through to the 1970s, when most of today’s plants were built.

The marine technology sector is dominated by a ‘wait-and-see’ attitude OPT

To get a more complete perspective on the current and future role of sustainable energy technologies in the energy mix, it is more useful to look at today’s investment trends. In 2006, between $110 billion and $125 billion was invested in around 120 GW of new power generation globally. Of this investment, $30.8 billion was in new renewables, which included $21.5 billion of asset finance in new generating plants, and the remainder in small-scale systems, such as rooftop solar. The $21.5 billion in renewables plant financing represents about 18% of total power sector investment. At first glance, these figures imply that renewables are more expensive than conventional options, costing on average 28% more per installed GW. Indeed, renewables are currently more expensive than conventional options, and the variable nature of wind and solar means that their capacities are not directly comparable in terms of electricity produced. However, this premium is mitigated by the ability of producers to generate carbon credits and government obligations to purchase renewable energy. Clean energy also does not have anywhere near the operating expenses of conventional types, specifically fuel costs. In developing countries, fuel costs alone are equivalent, on an annual basis, to investments in generating capacity.

Another financing trend to consider is the level of investment in new technology and manufacturing capacity. In 2006, on top of the $21.5 billion invested in new generating capacity, the renewable energy sector received $25.2 billion in new technology and manufacturing capacity investment. This is in stark contrast to the rest of the energy industry, which, on the whole, has seen R&D spending from public and private sources stagnating or declining. The renewable energy sector’s very high level of investment in technology and manufacturing capacity indicates that investors are expecting strong growth for the sector. When the $21.5 billion in asset finance, the $9.3 billion in small-scale systems and the $25.2 billion in new technology and manufacturing capacity are added up, total 2006 investment in the renewable energy power sector comes to $59 billion, a significant figure no matter how it is compared with global power sector investment.

Attracting all types of finance

2006 saw a continuing positive shift in the attitude of financiers to risk associated with renewable energy, which in turn is broadening the range of financial instruments available to renewable energy investors. The most established technologies, such as wind, are benefiting from lengthening maturities and lower borrowing costs, while equity finance, from venture capital through to public markets, continues to be widely available for all renewable technologies.

Four years ago, banks were only interested in mainstream financing for renewable energy, such as the wind sector in Germany. Now, they are being swept along by a surge in interest in renewable energy and energy efficiency and are responding by developing innovative financing and by broadening their exposure beyond mature technologies in stable markets.

These trends are being driven by a range of factors, including concerns about energy security and climate change and by governments putting renewable energy near (if not at) the top of the political agenda. The US, for example, dramatically changed its attitude to biofuels at a federal level during 2006, which has resulted in a biofuels boom.

Driven by investor confidence and greater competition for deals, a wider range of financing options has become available to borrowers. The bond market is open to onshore wind projects (though new issuance remains very limited) and rating agencies are comfortable evaluating their risks. Onshore wind has been a particular beneficiary of the trend towards mainstream financing, with a 331 MW wind farm portfolio of assets in Germany and France being financed in the debt capital markets in the groundbreaking Breeze 2 deal in May 2006. To date, there have been very few bond issues or securitizations in the renewable energy sector, with Breeze 2 (and its precursor Breeze 1) the only bond issues offering investors exposure to the wind sector.

Private debt investors now offer developers greater flexibility, providing not just pure project finance but also portfolio and turbine finance for wind, with some lending to the solar and biofuels sectors as well. Debt investors are also increasingly willing to assume off-take risk, which gives them an edge in the increasingly competitive financing market.

Onshore wind has been a particular beneficiary of the trend towards mainstream financing THEOLIA

But it is not only project developers who have benefited from a positive shift in investor perception and surge of money into the sector. Listed renewable energy companies have seen their shares soar over the course of 2006, and most IPOs in the sector have been enthusiastically received and comfortably oversubscribed. The EU-27, in particular, have seen a surge in public market activity, and the strong deal pipeline suggests this is set to continue.

The year 2006 also saw a growing number of cross-border deals, which reflects the situation of too much money chasing too few deals, driving asset prices higher. Companies in developing countries have become more aggressive, notably Indian wind turbine manufacturer Suzlon, which has made a number of overseas acquisitions over the past year.

Nevertheless, there is still some way to go. Investor enthusiasm for renewable energy is far from evenly distributed across technologies, types of projects and different regions. Offshore wind projects continue to be approached with caution, with projects running into difficulties with planning and sourcing turbines, while in other emerging sectors of the market, major non- or limited-recourse financing is sporadic.

FIGURE 6. VC/PE investment by region, 2000 – 2006. Grossed-up values based on disclosed deals. The figures include PE buy-outs, but exclude OTC & PIPE deals. Source: SEFI, New Energy Finance

Geographically, too, investment is concentrated in areas where resources, technologies, policies and financial markets are relatively mature (Figure 6). Investors are still sticking to the markets they are familiar with and understand – predominantly the EU-27 and the US – even though they openly acknowledge that emerging economies such as India, China and Brazil will become the most important renewable energy markets in the medium term, with massive financing needs. In conclusion, sustainable energy markets are becoming more liquid and more global.

Here to stay

The various forms of capital now being deployed across the value chain signal the sector’s shift into the mainstream. Given the maturing sector fundamentals, the recent capital build-up does not appear to be a sign of short-term volatility but part of a longer-term trend. With individual sectors there is considerable volatility. However, risk and uncertainty can be diversified across technologies and geographies. These trends have continued through the first half of 2007, with new investment globally in sustainable energy expected to total $85 billion for the year.

What these figures represent is not so much a fine-tuning of the current global energy system but rather full-scale economic development. Despite considerable discussion about the low-carbon energy technologies of tomorrow, the investment community already believes that the technologies available today are capable of decarbonizing the energy mix.

The sustainable energy sectors – combining renewable energy generation and transport fuels with improved supply and demand-side efficiency – together have the potential to change the structure of today’s energy sector, using current technology and building on a widening array of enabling policy frameworks. Those in the finance community have seen this potential and have been investing at a level that implies their belief that disruptive change is now possible and, indeed, inevitable in the sector.

This feature is based on Global Trends in Sustainable Energy Investment 2007, a report produced by the United Nations Environment Programme in co-operation with New Energy Finance. New Energy Finance is the world’s leading provider of financial information, research and services to investors in renewable energy and low carbon technologies. Through New Carbon Finance, it also provides forecasts and deep analysis of the drivers of prices on the European carbon market.

Angus McCrone is from New Energy Finance, based in London, UK.

This feature is based on Global Trends in Sustainable Energy Investment 2007, a report produced by the United Nations Environment Programme in cooperation with New Energy Finance. New Energy Finance is the world’s leading provider of financial information, research and services to investors in renewable energy and low carbon technologies. Through New Carbon Finance, it also provides forecasts and deep analysis of the drivers of prices on the European carbon market.

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