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Utilities Unbundled - Keeping the capital flowing for renewable energy - EY - Global

Utilities Unbundled    issue 12

Keeping the capital flowing for renewable energy

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Traditional sources of funding for renewable energy may be harder to come by in the wake of financial austerity, Basel III’s1 stricter capital requirements and cheap shale gas. How can the sector keep the capital flowing?

The renewables sector is currently being buffeted by some serious headwinds. Anemic economic growth has put downward pressure on power prices in many OECD nations, while austerity measures around Europe and the emergence of cheap shale gas in North America bring additional regional challenges.

With utilities’ capital expenditure budgets under pressure, concerns about value for money and affordability have influenced their ability to invest in renewables. Meanwhile, investment dollars are diverting to developing markets, which see clean energy as strategically important.

The current investment climate
The latest International Energy Agency (IEA) estimates suggest that the world needs some US$6t investment in renewable electricity capacity to 2035.

Global investment in clean energy reached a record level of US$260b in 2011.

European Union investment at a six year low
Investor confidence in renewables, a capital-intensive business with often lengthy timeframes for project delivery, relies heavily on perceptions of the stability of investment frameworks.

At a European Union (EU) level, commitment to emissions goals and renewables targets remains and the big European utilities are still planning to invest billions of dollars over the next five years. But at a time when capex programs should arguably be ramping up to meet EU policy goals, utilities have had to curtail their investment ambitions, under severe pressure to strengthen balance sheets and protect credit ratings, due in part to the Eurozone crisis.

Uncertainties in the US
Meanwhile, the closure of stimulus programs and the election cycle are causing uncertainty in the US. Last year, the country led the world in renewables investment.2 But ARRA stimulus money for wind projects expired at the end of 2011, and as things stand production tax credits are due to finish at the end of 2012.

Projects already in the pipeline will be completed, but we could then see a sharp drop in investment – potentially inflamed by a rush to get projects across the line before financial support measures end.

Sector still attractive in the long term
Despite these factors, long-term prospects still appear to be sound.

Reduction of carbon dioxide emissions is still considered a priority by global policymakers. Individual countries are still committing to renewables in their long-term energy policy.

However, there is widespread debate over the affordability of renewables in times of austerity. To continue to benefit from subsidy mechanisms the sector must deliver projects in as lean and cost-effective manner as possible, and communicate this effectively.

Energy deficit in emerging markets creates strong prospects
It’s clear that the underlying environment for investment in renewables is typically far more favorable in emerging markets.

This is underpinned by strong economic growth prospects, leading to growing demand for power. Underlying electricity demand is a key factor for investors evaluating the attractiveness of specific national markets.

Energy deficit makes the renewables sectors in emerging markets far less dependent on subsidy elements to make individual projects economic. Coupled with strong renewable resources, renewables look like a highly competitive option to satisfy demand for power. This is increasingly reflected in the local appetite to fund renewables projects.

Keeping capital flowing
Utilities and renewables developers are looking for new approaches to secure investment in renewables projects, including:

Looking to China and the Far East. China, Taiwan and Korea are all deploying renewables technology in domestic markets at a massive scale and targeting growth overseas. Last year, one in every two wind turbines deployed across the globe was installed in China.

Even if the Chinese economy is slowing down, it is not slowing as much as the rest of the world. Chinese utilities and banks backed by a significant amount of state capital have global ambitions and the cash to achieve them.

Accessing new sources of debt funding. Energy companies clearly need to tap deeper into sources of non-bank funding. Institutional investors are still committed to the sector. Pension and infrastructure funds want long term, predictable cash flows and they see renewables projects as fitting this criterion. It remains to be seen whether they could be persuaded to step in as a new source of debt funding, if European banks step back as a result of ongoing problems in the Eurozone and new tighter regulation on capital adequacy.

Financial engineering to attract pension fund investment. Efficient financing structures can have a major impact on the overall cost of renewables projects, because they are so capital intensive. For example a team at Edison Mission Energy recently developed a new way to attract pension fund money to a wind farm spinoff, using a highly innovative financing structure – see The Capistrano solution.

Changing ownership models. The renewables sector can draw on a history of recycling capital to ensure that assets end up in appropriate hands. The UK has seen utilities in equity partnership with long-term financial investors – for example, in the case of offshore wind farms now under development. This spreads risk, while allowing utilities’ balance sheets to stretch further.

Enhancing cost competitiveness to tilt the balance to investment. Ultimately, reaching grid parity will be what guarantees that renewables can attract funding. This could be closer than many people recognize, with onshore wind power in China and solar PV around Europe and in the US forecast by some commentators to become competitive with retail electricity prices within the next two years.

Conclusion: unlocking a renewable future
Strong projects, run by companies with a track record of success, will continue to attract funding. In other words, it’s a case of survival of the fittest.

The question is, can the sector achieve global targets for sustainable transition to a low carbon world just on the basis of the projects that survive - and if not, how will it attract money to do more?

Renewable energy has always been a hotbed of innovation. To continue growing in scale and fulfill its potential, the sector will need to draw on that heritage to unlock new means of accessing funding in future.

For more information, contact:

Americas Power & Utilities Leader
Global Power & Utilities Transaction Advisory Services Leader
New York, US
Direct tel: + 1 212 773 3382
Email Email

Power & Utilities Leader, Oceania
Brisbane, Australia
+ 61 7 3011 3239
Email Email

Environmental Finance, London
+ 44 20 7951 6024
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1 A global regulatory standard on bank capital adequacy, stress testing and market liquidity risk, with capital adequacy requirements due to be phased in from 2013 and liquidity requirements due to be introduced in 2015.

2 The US invested US$56b in 2011 according to Bloomberg New Energy Finance

 


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