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United States

Creativity is the key in a hot money market

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Renewable energy in the US is seeing a surge in support from investors, but rising costs and the lack of long term purchase contracts and uniform standards means developers and financiers need to be resourceful when putting deals together

The wind turbine shortages that have hindered US wind development in 2005 could continue to affect the market for years to come. "Our belief is that if you are not a player on turbine orders now, you are not going to be much of player for the next couple of years," according to Michael Garland of Babcock and Brown, a London-based international investment and merchant bank specialising in renewables. He was one of a record 600 industry financing experts attending the Renewable Energy Finance Forum -- Wall Street 2005, held June 23-24 in New York.

While some industry observers believe a more stable policy environment, anchored by the country's newly minted energy policy that extends wind's $0.019/kWh production tax credit (PTC) through 2007 will help ease the situation, Garland is not convinced. "I go off and on about that, but my latest feeling is I don't think it will," he said, pointing out that many of the larger wind developers in the US are starting to place turbine orders to fill their needs out two or three years. "Now that the industry is starting to consolidate with pretty big players, they are taking pretty large positions and they are not talking stupid positions in most cases," he explained.

"You are going to find that, worldwide, 75% of the capacity for turbines is going to be tied up. It is not going to leave a lot of room compared to a few years ago. We used to use the rule of thumb that 80-90% of the projects in the country were developed by small developers, undercapitalised and without a tax base. That is all changing now."

Theo de Wolff was one of those small developers until last year, when he sold Atlantic Renewable Energy Corporation to PPM Energy, one of America's leading wind power companies with 574 MW of announced projects this year. "It is a tough challenge for small developers and it is getting even tougher," said De Wolff, now managing director of PPM Atlantic Renewable.

For bigger players

Although July's extension of the PTC gives the industry a two-and-a-half-year planning horizon, the boom-and-bust cycles that have characterized the US industry since the late 1990s has given companies that are able to move quickly and commit to turbine purchases an advantage. "A strong balance sheet is really a very strong asset in order to be successful," De Wolff told conference delegates.

Large companies like PPM, with more sophisticated power marketing capabilities, are also better equipped to deal with the challenges of selling a project, said De Wolff. Although utilities are increasingly seeing wind as a competitive alternative to gas and coal fired generation -- and the growing number of state renewable energy standards is creating a market for renewable energy credits (RECs) -- few buyers are prepared to offer long term power purchase agreements (PPAs) for wind power. "In order to make a project's economics feasible, you have to think outside the box, you have to go merchant, semi-merchant or use even more creative structures," said De Wolff, referring to the option of selling electricity at spot prices on the daily market instead of selling through a fixed-term power purchase contract.

Steep increases in equipment prices have been a feature of this year's turbine shortage, leaving some observers worrying about the impact on an industry where, in a stunning turnaround from two years ago when attracting new financial players was a key stumbling block, there is now, as one speaker put it, "just way too much money chasing just a few deals."

Potential investors, predicted Garland, are going to be disappointed. "This whole increase in the costs is going to push utilities into doing their own deals rather than PPAs. You are going to see very few deals and a lot of the investors who want to come into this industry are not going to get the volume."

Utilities may also start to see wind as a less attractive option, he warned. "I think you are going to find that this whole support for the wind industry has been in a large part because the PTC has subsidised the price of power, which meant it was a no-brainer to contract for wind. I think you'll see that changing over time now because it is being driven back up above conventional pricing for power and you'll see some push back."

Despite the relative scarcity of deals, there is opportunity for investors to come in at an earlier stage of the development process, said Keith Martin of the law firm Chadbourne and Parke LLP. "It is an interesting market because there is far too much equity that's willing to come in at the end of construction, but it is very difficult for small developers to raise development capital. So if you are an equity participant, you are interested in putting cash into deals and you are willing to take a little bit more risk, that is where the need is."

Experimental structures

Developers are also working to control the costs where they can by experimenting with new deal structures. Just hours before he was scheduled to speak at the conference, James Murphy, chief financial officer of Chicago-based Invenergy LLC, finalised a financing deal for a portfolio of three wind projects with a combined capacity of 260 MW. Located in central Montana, north-eastern Colorado and south-eastern Idaho, the projects have 20-year PPAs with three different buyers. The reduction in risk because of the diversification of wind regimes and offtake led to more favourable credit terms, said Murphy. Combining the projects also lowered the cost of putting the deal together. "Rather than doing three transactions we did one transaction, which meant very significant savings on the transaction cost side."

Shell WindEnergy also took a portfolio approach with Top Deer, a financing for two 80 MW projects in Iowa and Texas. The company sought bids from 18 lending institutions in October 2004 and within 44 days had closed the transaction with three banks for "the best pricing ever seen in US wind," said Shell's Sylvain Santamarta, who did not disclose the terms the company and its joint venture partner Entergy received.

"We brought this deal to the market with the objective of maintaining competitive pressure between lenders," he told delegates. "Top Deer in our view was a very good deal because the pricing was good, but also because the process was short and as a result we had low overall financing costs." The deal also gave Shell a chance to "get across the message" that it does not accept the premium borrowers pay in US wind deals, which are about 0.2-0.3% higher than in Europe. "For an institution like Shell, dealing mainly with European banks in the US, it is actually very difficult to understand the pricing differential," said Santamarta.

Never better

While wind power is clearly the leading renewable energy resource in the US, REFF -- Wall Street 2005 made it clear that financiers and investors are setting their sites on the entire spectrum of clean power technologies. "Renewable energy is very hot right now," said conference co-chair Dan Reicher, a former assistant secretary for energy efficiency and renewable energy during the Clinton administration and president of New Energy Capital. "The drivers for renewable energy -- soaring oil prices, climate change, improving technology -- are making this a very attractive field."

John Anderson of the John Hancock Life Insurance Company, which along with its Canadian parent has $1.2 billion invested in renewable energy, agreed. "Prospects have never been better for renewable energy, driven by four big factors. One, we've got more demand for the product. Number two, the evolution of technology has made the cost and the economics of the product more attractive. Number three, surging coal, oil and gas prices have made the relative value of the product more attractive. And four, we've seen a strong surge in support from investors."

One area where that support is most obvious is among venture capitalists, who invested $540 million in the clean energy sector last year, up from less than $10 million just eight years ago. "This is very much an emergent sector in venture capital," said Nancy Floyd, managing director of Nth Power LLC, a company that is one of the leaders in the field. For a relatively mature technology like wind, however, the level of venture capital investment pales in comparison to the money going into fuel cells and solar.

"As early-stage venture capital we look for capital efficient business models. We try to figure out how we can deploy small amounts of capital for large ownership stakes that over time don't get diluted because of the capital requirements. Traditionally, sectors like wind require so much capital they have not been areas where VCs have played," explained Ira Ehrenpreis of Technology Partners. "With wind we see opportunity in things like software inputs, which is a great way to play in the industry."

On the equity side, investors are not only looking to put their money into wind power, but also into less mature resources like geothermal and biomass, a situation that "is going to lead to consolidation in this business across different technologies," predicted Ed Feo of the law firm Milbank, Tweed, Haldey and McCloy LLP,

Pension fund equity

One emerging source of money for the renewables sector, conference delegates heard, is public pension funds. California Controller Steven Westly, a candidate to be the state's next governor, used the event to announce a $30 million joint investment by the California State Teachers Retirements System and VantagePoint Venture in Reicher's company. Winston Hickox, portfolio manager for the California Public Employees Retirement System, told delegates that environmental issues are an important element of the fund's investment equation.

"Climate risk creates opportunities," he said. "Climate change will make winners and losers of countries as well as companies. So it is incredibly important for institutional investors to take this into account."

Although the Bush administration is not a signatory to the Kyoto Protocol, several US states are taking matters into their own hands. New York has committed to regional greenhouse gas emissions targets as well as a renewables target of 25% by 2013. The state, which spends $45 billion annually on energy, is 85% dependent on foreign sources of petroleum products. "Those are dollars that leave New York's economy," said Peter Smith, president of the New York State Energy Research and Development Authority (NYSERDA). "We should be doing this because what we will get with greenhouse gas emissions reduction is economic opportunity."

In fact, delegates heard, the states are also leading renewable policy development in the US. Right now, 28 states and the District of Columbia have some form of clean energy support, ranging from renewables targets to carbon trading mechanisms. "This is where the action is," said Lewis Milford of the Clean Energy Group, a non-profit advocacy organisation. "The bottom line is when you add this up -- a billion here, a billion there -- you have what starts to look like a market."

At the same time, the risks are significant. Much of the policy is under development, and attention to implementation details is essential to ensure they work as intended. The durability of public support is unknown and the lack of uniformity from state to state makes for a difficult market. The differences in how RECs are created and defined in different jurisdictions, for example, is "one of the most intractable problems in our industry," said Michael Eckhart, president of the American Council on Renewable Energy (ACRE), which organised the conference with Euromoney Energy Events.

National REC trade

ACORE is working with the American Bar Association to try and create a national trading system for RECs and make it easier for developers to factor that revenue stream into the financing equation. Whether it can be done without accompanying national legislation setting a minimum standard for renewables in power portfolios facilitated by RECS trade, remains to be seen. A federal renewables portfolio standard was rejected by Congress during its final energy bill negotiations in late July.

"We are trying to facilitate RECs transactions, we are trying to reduced the time, cost and risk of those transactions by at least having a standardised contract," said Roger Feldman of the law firm Bingham McCutchen LLP, who is leading the effort. "The question remains, can the different policies that lie behind the different approaches be squared in a way so that we can have one market?"

Another barrier, particularly for wind, that needs a national solution is transmission, said Eckhart. "The development of that transmission system, however, is not likely to be done for wind power. It is going to be done for national security reasons. Wind power is going to piggy back on that and will benefit from it."

The US needs to approach transmission, now organised in a patchwork of utility service areas, in much the same way it did transportation when it created the Interstate highway system in the 1950s, said Eckhart. "This is a whole higher level of thinking that needs to be addressed and there are people around who are beginning to address it," he explained. "What is stopping it is the political power of a few utility companies who do not want a national grid because it reduces their control and their profit making on their own company owned transmission systems."

Despite the challenges, the line-up of speakers and delegates participating was a clear indication that renewable energy financing in the US is entering the mainstream. "This conference demonstrates that we've arrived," said Gerard Strahan of Euromoney Energy Events, the conference's co-chair. "The growing involvement and interest from the financial community for the renewable energy sector is proof of the true emergence of the renewable, clean, and cost-effective kilowatt hour."

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