An outlook for renewable energy and its industry

This article comes from law firm Reed Smith LLP and was written by Stefan Schmitz.

Author Stefan Schmitz

Not too long ago, investing in renewable energy projects was regarded a no-go for private equity as well as institutional investors: the returns were considered too low to be of interest, the sizes of the projects too small, and there were plenty of other competing opportunities in which to invest. This has been changed although not significantly over the last few years. While it is true many individual renewable-energy projects may not be of a size that a larger private-equity house would normally look at, the returns they offer, coupled with the lack of alternative investments, have lead to substantial amounts earmarked for renewable-energy investment via bespoke dedicated private-equity funds.

The interest is not surprising: these projects offer low-risk technology, mostly wind and solar, a stable and predictable cash-flow which comes from large and rated off-takers, such as big utilities, and predictable profits. Predictable because where traditional power projects need to buy feed-stock, such as oil, gas, or coal, the source for wind and solar projects will stay free and cannot go up. So while today it may be cheaper to generate a kWh in a coal or oil fired plant, it can be expected that these costs will increase, and increase significantly, while the costs for wind and solar will stay the same throughout the lifetime of the project—so that the profit margin of these projects can be increased as market prices for electricity go up.

The IRRs (Internal rate of return) that can be expected from renewable energy projects vary greatly and depend on a number of factors, especially the tariff or compensation system in a country as well as wind speeds and solar irradiance. Projects in Germany, one of the most attractive markets in terms of security, off take and legal regime, today offer low returns—often only around 5% (sometimes a lot less). Projects in the UK market should be in the low double digits, whereas new markets, such as South Africa and some Latin American countries, often offer more than 20% for wind and solar projects. The new markets might also be of increasing interest to investors because they allow for the construction of large projects: traditional European markets, countries with little space, tend to allow only smaller projects which are often of limited interest for PE or pension funds. Some of these traditional markets do, however, offer opportunities for large investments in offshore wind projects. Germany and the UK (and soon also France and some Scandinavian countries) have a long pipeline of large offshore wind projects which are looking for investments, and several require total investments of more than £1B ($1.49 billion). There are reportedly several pension funds looking at the UK and Germany for investment in offshore wind. The returns for these projects can be expected to be in the lower double digit region but provide stable and long-term income—in Germany a 20-year feed-in tariff is set by law.

In the current market, debt for renewable energy projects is probably more readily available than for other sectors. Even though many of the German landesbanks, who until the financial crisis, provided the bulk of debt for these projects worldwide have either departed or reduced their involvement, there are still quite a few looking to invest and new banks are trying to gain exposure to the market. Refinancing through Germany’s KfW bank, which provides very cheap loans, is also available to projects which have some kind of German nexus and similar opportunities exist with a number of export banks.

Reed Smith LLP
www.reedsmith.com