Sustainable energy projects are growing by leaps and bounds for several reasons. First, a number of countries and states have set strict goals for the future share of energy from renewable sources, typically around 20% in many US states, and up to a goal of 100% renewable energy in countries like Denmark. The question that arises is how do you finance these projects, especially when in some parts of the world fossil fuels are still very price effective due to direct and indirect government subsidies and credits, and when the financial markets still perceive these projects as ”risky” investments. Therefore, most of these projects have been financed by private equity funds looking for high returns from high-risk projects, and corporations (including utilities) looking to take advantage of tax credits and subsidies.
In addition, there are major regional and global changes occurring in the traditional energy sectors, with a glut of “clean” (relative to coal) cheap natural gas becoming available in the US from enhanced production techniques leading to old coal-fired plants being closed, and the market collapsing for new coal-fired plants due to increased environmental regulatory costs. Overseas, countries like China are looking to exploit both renewable energy and locally available fossil resources, thus creating large markets for production and installation of utility-scale wind and solar energy farms.
One of the ways the financial world is looking to finance sustainable energy is through moving from an equity-based investment model to a “green bonds” debt model. Why is this happening? Sustainable energy projects tend to be capital intensive, but with low operating costs and zero fuel cost risks. However, once the projects are up and running, the permitting and development risks end and these new projects start producing long-term consistent positive cash flows. The private equity owners are then looking to re-finance the operating wind and solar energy farms by selling “green” bonds with fixed returns to replace their equity capital, and then reinvesting that equity capital in more new wind and solar energy project development efforts.
How big is this switch? Well, last fall, at the UNEP-Financial Initiative Sustainable Finance Roundtable held in Washington DC, Rick Lacaille, State Street Global Advisors’ Global Chief Investment Officer, predicted about $1.4 trillion in “green” bonds will be sold by 2020 in Europe alone to refinance wind and solar energy farms. These bonds would have a market-competitive return, low risk due to the elimination of fuel cost volatility (certainly lower volatility and risk than Greek or Spanish government bonds!), and would appeal to both retail and institutional investors interested in sustainable and responsible investing without having to give up financial return.
Of course, the most efficient form of renewable energy is energy efficiency, and innovative ways of financing this form of sustainable energy are also emerging. One of the difficulties of funding energy efficiency in schools, hospitals and municipalities is that federal and state tax credits are of no use to those tax-exempt entities, and they are often short on available capital. So a number of investment groups are looking to set up private equity funds that would buy a hospital or college power plant and make it more efficient (and/or install renewable energy wind or solar projects), and then “sell” for a fixed price the energy savings (or electricity) generated to the not-for-profit institution for a set period of time. The fund could take advantage of the tax credits by passing them through to their limited partners in the private equity fund, thus reducing the capital costs of the sustainable energy improvements, and also benefit from accelerated depreciation. At the end of the contract, the fund could sell the improvements to a third party (or the institution) for a residual value. Everyone wins, as the institution has a lower fixed price for part of their energy costs, with no price volatility risk for a period of time without investing scarce capital, and the fund investors receive tax credits, a stream of income, and a residual payment at the end of the contract. Everyone wins by reducing risk while increasing income and reducing energy costs.
These are just a few of the innovative approaches that the financial world is looking at to profitably, and at lower risk, accelerate the rapid implementation of renewable and sustainable energy, now and in the future.
John L. Cusack is Head of Financial Services Risk Management, Maplecroft Limited, and was former startup CEO and Co-founder of Innovest Strategic Value Advisors, Senior Vice President for the Environmental Risk Consulting Practice of Marsh, and a senior executive running subsidiaries of Asea Brown Boveri in Europe and North America. He teaches an online “Finance & Sustainability” course for Marylhurst University’s MBA in Sustainable Business.