Clever capital: survival of the fittest in energy's new world order
Mike O'Neill, CEO of Element Power, explains how investors are managing the transition away from subsidies - and why this has proved problematic for some. Mike was a guest speaker at our Financing Wind Europe 2018 conference. To find out more about Financing Wind 2019, visit our conference site.
The renewables market is changing
A tremendous amount of capital has come into the renewable energy sector in recent years, on a promise of long-term contracted revenue streams. Low risks have meant lower yields on investment, but still higher than fixed-income alternatives. This capital has been channeled into dedicated funds, listed vehicles and other structures for an appropriate ‘handling fee’. Banks have almost reverted to their pre-crisis behaviour.
There has been a clamour for the last of the projects able to ride the final waves of feed-in tariffs, and a highly competitive secondary market, with analysts once again trying to squeeze out the last drops of juice from their exhausted models to make their capital the most competitive.
So as the comfort blanket of feed-in tariffs is taken away, those in charge of deploying capital in the sector have to respond to ever-decreasing circles of available shovel-ready projects and equity returns. People who have been used to avoiding risks are now having to re-think their approach in two principal areas: project development and routes-to-market.
Success requires a new approach
Securing a dedicated pipeline of future investment opportunities seems like an obvious panacea to thirsty investors experiencing the project drought. However, stepping into development is not as straightforward as it might seem for those unused to getting their hands dirty. Investors more familiar with making decisions based on ‘red-flag’ due diligence reports with only the odd fleck of crimson, will be faced with something that looks like a Tarantino movie script. It will require a different mind-set to adapt and evolve and thereby control their own destiny.
However, they need to proceed with caution. ‘Development’ does not mean ‘just a bit of finishing off to do’. Securing a long-term, sustainable flow of investment means having a portfolio of projects at all stages of maturity. In this world, the skill set required for success is less about raising capital and more about understanding and managing development risk - how to assess opportunities, oversee projects through the various stages, and make decisions on deploying capital before everything – or anything - is locked down.
Having €2 billion at your disposal does not guarantee success; deploying this to build out projects is the easy part! The real challenge is spending €20m-€30m a year to successfully develop the pipeline to build.
The other piece of the jigsaw is the revenue stream. As if having to move over to the ‘dark-side’ of pre-financial close development isn’t bad enough, investment managers now have to understand how energy markets work.
Renewable energy, now able to compete in those markets, has come of age.
Everything up to now has been setting the foundations on which we will truly start to build. This is the most exciting time that we have seen, and the opportunities are huge. But with the subsidy stabilisers taken off the bike, some will wobble and fall over, whilst others will start going up through the gears.
Again, it is not about the volume of capital but the ability for it to be deployed into building projects that have less certain cash flows. This will require in-house knowledge of how to secure routes to market, stack different revenues and operate assets.
And it is not just about getting a better understanding of the revenue streams; only the most competitive projects will succeed, and therefore the approach to costs will need to change. For example, the gold-plated 15-year operational arrangements that have been driven by the project finance market and proved lucrative for the OEMs will need to be re-thought, and project design and operating strategies become more bespoke.
Re-emergence of utilities
All this points to a fresh opportunity. Those most naturally able to respond to the new renewables age are those who already possess the required DNA to develop energy projects, manage grid, understand the energy markets and operate plant efficiently - the utility companies themselves.
And some of the more forward-looking will become an increasingly dominant force. Statkraft was best placed to acquire Element Power’s Irish and UK platforms in a deal we completed at the start of October. In doing so they have now taken a leading position in these markets, following an offtake structure for a project in Ireland secured a few weeks earlier. Others will follow as the inevitable market consolidation continues, and we see evolution take over with the survival of the fittest.
The ‘smart’ capital has already seen this coming, and is ahead of the curve. They will succeed in taking a share of the market alongside the utilities, and also work with them to provide liquidity. Those stuck with an investor base and model that fits the old world may find themselves facing extinction.
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