Now is the time to seize on the momentum of renewable energy

Current trends, financing considerations and government plans indicate that renewable energy investments look favorable.

Renewables market trends

Understandably, some P&U companies may question whether the COVID-19 pandemic has delayed or derailed the clean energy transition; but underlying trends show that, if anything, it is accelerating. We focus on what we call the three Ds:

• Decarbonization. At least 13 of the 30 largest US publicly traded electric and gas utilities have set goals to achieve zero or net-zero greenhouse gas emissions by 2050 or a 100% clean electricity goal by 2040. This trend is also reflected at the state and local levels of governments, which are making pledges of their own. Now, the federal government is headed in a new direction as well: rejoining the Paris Agreement on climate change and driving the relevant policy changes. And environmental, social and corporate governance (ESG) concerns are becoming more prominent with corporate investors and in board-level conversations.

• Decentralization. Distributed solar generation may have slowed a bit in 2020 due to global supply chain bottlenecks on solar photovoltaic (PV) and batteries, as well as local limitations on rooftop installations amid the pandemic. However, we anticipate a rebound this year with safe harboring of projects eligible for government subsidies. One utility has announced a more than $600 million portfolio of distribution-level projects with accelerated construction dates before 2025. Among participants in a recent EY webcast , 44% said that distributed solar PV plus storage would contribute the most to the clean energy transition.

• Digitization. The pandemic spotlighted and accelerated new, innovative ways of working, better allowing utilities to deliver contactless service and be guided by data-driven insights. Utilities have expanded their use of automation software, which in turn has enabled remote operations, with employees using secure laptops and other mobile devices. Mobile and virtual solutions have emerged as essential pathways to sustainable operations and business continuity.
  

Collectively, the three Ds point to an environment with greater opportunity. But the shift to utility-scale wind and solar alone will not be enough to achieve zero-carbon goals by 2050. To accelerate the transition, a combination of mature and emerging technologies will be needed, including offshore wind, decentralized generation, grid-edge technologies and green hydrogen.

EVs should also be a large part of that mix. While 2020 EV sales in the US dipped amid the pandemic, 2021 is poised to be a record, approaching 2.5% of all passenger vehicle sales, and consumers can now choose from more varieties. Battery costs are approaching the $100-per-kilowatt-hour milestone, the point at which many analysts feel that EVs will achieve price parity with gasoline engine vehicles — which we estimate will arrive in 2024. “Even with the Biden infrastructure plan, upward of $100 billion of electric sector involvement can support this transition,” said Brad Hartnett, Power & Utilities Domain Analyst at Ernst & Young LLP. “Utilities are in a place to drive this transition and lead in that shift.”

Availability of capital for renewable energy

Aside from a blip in 2020, total investment in renewables has been rising in the US year over year, thanks to lower costs via technological improvements, more favorable tax and regulatory policies, and increased demand from consumers and investors. “At the most basic level, investment capital is going to chase economic returns,” said Michael Marino, US Investment Banking Senior Vice President at Ernst & Young Capital Advisors, LLC. “Where returns are improving is where capital will flow. This is no different for renewables.”

In 2020, global renewable energy dollar volume in the equity capital markets reached a four-year high of $14.8 billion, while the sector’s activity hit a record 74 transactions, according to Dealogic. Dollar volume in the Americas was up 64%, while declining 24% in Asia-Pacific. EMEA led in deal count with 42 of the 74 transactions globally.

In the public market, ESG investing is affecting capital. The largest fund managers have dedicated ESG funds and analysts, and they are making allocation decisions based on ESG scores and the principles of public companies. Now, the amount of ESG assets under management in the US has climbed 42%.

Asset allocation in the debt and equity markets has climbed, and investment-grade companies are doing most of the green issues. By the midpoint of 2020, capital flows had accelerated, along with valuations, amid a very active M&A market. This surge began before the broader market started pricing in the change of administrations at the federal level, and then it became supercharged. Right now, valuation premiums are highest in the EV segment.

In this environment, tax equity has become an important way to bring in capital to construct a project from an entity that wants to put its tax capacity to efficient use — an arrangement that has existed for decades in real estate but has since evolved into the renewables space. In other words, the companies that have the skill set to build and operate such a project, such as a solar developer, can’t necessarily use the tax benefits to the same extent as, say, a bank or larger corporation with a tax liability. Tax equity involves structuring partnerships and leases to effectively transfer partial ownership that’s generating favorable tax attributes to another entity that can use them, for a raise that might be 40% of the typical project cost in a solar deal, for example. The typical structure is one that persists as long as the tax attributes do — maybe six or seven years for a solar project, driven by the five-year investment tax credit recapture period. In wind, with a 10-year window, such deals are perhaps 11 to 12 years. Note that, as refundable tax credits potentially change, the tax equity market should evolve as well.

Players should take a thoughtful approach, particularly if they are newer entrants and don’t fully understand the risk profile. “A leading practice is to take a step back and ask: Which part of the market should I play in? Do I need a partner? Do I need tax equity?” said Stephanie Chesnick, Strategy and Transactions Principal with Ernst & Young LLP. “Take the time to model out the economics. When you’re investing capital in an area where you haven’t in the past, modeling it out can be more challenging. Do this before you have an investment opportunity in front of you — you need to be ready to move.”