Competition for capital and the drive to increase efficiency have defined the renewable sector over the past year.
Conflicting government policy has stalled investment just as governments are struggling to create jobs and deliver secure, low-cost energy without affecting the market. In addition, business failures and workforce redundancies are driving public opinion from the sector in some OECD countries.
On the debt side, Basel III and other programs designed to strengthen banks' balance sheets have seriously reduced lending, and the banks’ appetite to provide long dated capital. This, and the fact that the need to safeguard all important credit ratings in the power and utility sector has led to a tightening of balance sheets, has resulted in an urgent need for new capital.
In the US, expiry of the loan guarantee program and upcoming deadlines for treasury grants and tax credits are causing uncertainty. European countries are cutting incentives and policy supported mechanisms, and looking for competitive advantage amid the ups and downs of the capital markets. Mike Bernier, EY Senior Manager, Tax Credit and Incentive Advisory Services said, “Many are waiting to see who will be the next player to fall, which is impacting the ability to predict future financing.”
Project developers are wondering whether capital will be available to support growth, and, with few available exit strategies, how long it will take to capitalize on investment. Robert Seiter, EY Head of Cleantech in Europe, commented that, “If projects are too big, they become difficult to finance.” He added that many project finance sources have disappeared, forcing developers to look for co-investors, and resulting in increased lead-times.
Because of this, says Ben Warren, EY Energy and Environmental Infrastructure Leader, “Effective capital management has become a crucial part of an infrastructure developer’s business. There is a lot more stress in markets driven by capital scarcity. Innovative financing solutions offering financing certainty and a reliable source of low cost capital will become an increasing source of competitive advantage.”
Manufacturers are finding it difficult to respond to government policy and customer demand. The question for them is, given the competition, who will survive. Robert Seiter added, “It is becoming more difficult for supply chains to adapt to rapid changes in the market.”
“Those players in the renewables space who can raise capital cheaply will dominate – greater consolidation is coming,” said Mike Bernier.
Impact of gas prices on renewables and fossil fuels
Another challenge facing renewables in some countries (like the US) involves the reduction in price of natural gas, coupled with an imbalance of subsidies between clean energy and fossil fuels. The cost of gas has fallen considerably over the past few years as large quantities of shale gas have come onto the US market. Meanwhile gas prices have increased in European and Asian markets, where they are typically driven by the price of oil.
The decrease in US gas price is creating major M&A and investment issues.
Laurent Williot, EY Executive Director, Transaction Advisory Services, said, “Because the price of gas is now so low, the cost for electricity has also reduced – which is great for consumers but reduces the value of generators’ assets, ultimately determined by power price agreement rates.”
The use of hydraulic fracturing in shale gas extraction has come under fire as a risk to waterways and other natural resources, with opponents arguing that the “true cost” of fossil fuels must factor in environmental impacts.
Although WTI (Midcontinent US) oil price has not been directly affected by increased shale gas, it has been indirectly affected by the application of shale gas drilling technology to oil shales – leading to a regional oil supply excess, and lower prices compared with Brent crude – supported by tightness in global markets, like the loss of Libyan supplies and strong demand in Asia.
The increase in shale gas in the US has also affected the liquefied petroleum gas market, with little demand now for imported LPG. Low gas prices have also led to some utilities substituting coal for gas.
Another concern has been caused by an imbalance of government fossil fuel subsidies in relation to renewables, which is likely to have a negative impact on global efforts to combat climate change, and will no doubt be discussed at the COP17/CMP7 in South Africa.
Overcoming the challenges
According to Alexis Gazzo, EY Cleantech Leader for France, there have been a lot of large M&A deals recently.
Solar thermal has also caught the attention of some Middle East and North Africa region governments which are enacting robust clean energy policies in order to create jobs for the long term. Several large projects are in the pipeline, particularly in solar thermal and notably in Abu Dhabi, Algeria, Jordan and Morocco.
Alexis Gazzo predicted, “A lot of projects will begin over the next 12-18 months, which will change financier perspectives.” Ben Warren added, “Oil-rich nations also see solar as a means of protecting wealth by preserving reserves for export.”
He also said renewables are relatively low risk and tend to be good long-term investments for institutional investors, such as pension and life insurance funds. The challenge is that many don't have in-house credit assessment skills and therefore tend to invest via intermediary funds. On the debt side, we expect the market to look to structured finance which has much deeper pools of capital than project finance.
What does the future hold?
Multinational companies are being much more proactive around energy procurement and resource efficiency. At the same time, cash strapped governments are taking a much shorter-term view, focusing on clean energy’s immediate affordability.
Renewables provide a good opportunity for corporates to manage their exposure to volatile energy costs, and reduce their carbon footprint. Heather Sibley, EY Global Cleantech Assurance Leader said, “We are seeing corporations becoming a lot more focused on response to customer demand and concern for sustainability and greener products. Many of these changes also help them reduce operational costs and increase productivity.”
The future will also see growing support for renewables in emerging markets where countries with growing energy demands are leap-frogging fossil-fuel generation to secure a low carbon future in renewables. Fifteen emerging markets have been added to the CAI in the past two years, with Ukraine, Tunisia, Argentina, Hungary and Israel added this issue.
The question is whether renewables’ inherent capital challenges are a threat or an opportunity. Governments need to ensure a stable policy framework which can provide comfort for investors via guaranteed mechanisms that manage risk, allowing innovation and efficiencies to drive investment and growth. In the end, access to cheap financing will be one of the major challenges.