Navigant Research Blog

Yieldcos for Renewable Energy: “Now Is the Time”

— March 8, 2015

Enel Green Power is forming a yieldco with its renewable assets in the United States, joining a trend that started about 2 years ago and accelerated in 2014.

The idea behind yieldcos is not new. It involves the creation of a company to buy and retain operational infrastructure projects and pass the majority of cash flows from those assets to investors in the form of dividends. Structurally, yieldcos are very similar to real estate investment trusts (REITs). They are also almost ideal for renewable energy projects such as wind farms.

A crucial aspect of yieldcos is that they are not exposed to development or construction risk—this is borne by either the parent company or a third-party developer. Yieldcos simply acquire infrastructure projects that are or have recently become operational. They fund the acquisitions by issuing shares (normally debt is only used at the project level), which they can do at a lower cost of capital (the return on the investment that shareholders want to invest in the company) than their parent companies or developers because they’re shielded from development and construction risks.

Squeezing Out Risk

Another key aspect of yieldcos is that their assets produce fairly predictable cash flows that can be paid to shareholders as dividends. That’s why renewable energy projects such as wind farms are perfectly suited for them. Wind farms and solar power projects are not significantly exposed to changes in the market. On the upstream side, they depend on free resources—wind and light—while on the downstream, they are protected by regulations (feed-in tariffs, long-term power purchase agreements, Renewable Portfolio Standards, and so on).

For developers, yieldcos offer a quick way to sell maturing assets and redeploy capital into early-stage developments that offer higher returns. From an investor point of view, yieldcos offer an investment option with very little risk—which is a testament to how far the investment community’s understanding of wind and solar technologies has come.

New Era or Fad?

The emergence of yieldcos has been driven by a strong initial public offering (IPO) market in the United States and Europe over the last few years, as well as the impact of quantitative easing (QE) policies around the world that resulted in lower interest rates and returns from conventional financial products (i.e., bonds and equities). As a result, the 6%–7% dividend yield of listed green infrastructure funds looks attractive to investors, compared to 4% interest rates on 10-year corporate bonds and even less for government paper.

Still, yieldcos might turn out to be a short-lived fad. As the economic recovery accelerates, and talk of interest rate hikes in the United States fills the financial media, investment vehicles like yieldcos could lose some of their appeal. So if you have solar or wind assets lying around, you may want to take some fashion advice from Enel’s CEO Francesco Starace (an Italian, after all): “Now is the time to do this.”

 

Energy Efficiency: Overcoming Financing Hurdles

— March 4, 2015

With little hope for meaningful near-term legislative action to drive national shifts in energy and resource consumption to tackle climate change, energy efficiency offers an impactful avenue for climate mitigation. But the enabling technologies often require capital investment that are hard to justify in constrained corporate budgets. As a result, a growing number of major banking institutions are making new commitments to financing projects with direct climate impacts, including those that deliver results via energy efficiency.

A recent GreenBiz article highlighted Citi’s updated climate and sustainability commitment of $100 billion to “lending, investing and facilitating” conservation and efficiency projects. Expanding on its 2007 $50 billion commitment focused on alternative and clean energy technologies, Citi has recognized the need for transparency and guidelines alongside the funding to ensure that the investments result in the kind of sustainable and climate change benefits intended. Citi, Bank of America Merrill Lynch, Crédit Agricole Corporate and Investment Banking, and JPMorgan Chase made up the drafting committee for the Green Bond Principals, which were released in January 2013.

Quality Control

Anne Paugam, CEO of the French Development Agency (AFD) recently published an article discussing the importance of transparency and accountability in Green Bond issuance as a model for success. “These instruments have all the characteristics of conventional bonds, but they are backed by investments that contribute to sustainable development or the fight against climate change … In September, the AFD issued €1 billion ($1.2 billion) in climate bonds, with one goal being to contribute to the development of concrete quality standards.”

The World Bank is also on board, and looking to shape investments that fuel sustainability, tackle climate change, and generate strong financial returns. According to a recent article in Barrons, the World Bank has sold more than $7 billion green bonds since 2008, and now officials hope to create a market for green growth bonds, starting with clients in Hong Kong and Singapore.  The World Bank says it is aiming for $225 million in bond sales in the next 6 months.

Green bonds, if offered with transparency and accountability, represent an important source of financing to expand energy efficiency investments and generate large-scale improvements that will have direct and quantifiable climate change and sustainability impacts.

 

Vestas, Mitsubishi Settle on Offshore Turbine Design

— February 24, 2015

In 2014, Mitsubishi Heavy Industries (MHI) formed a joint venture with Vestas called MHI Vestas Offshore Wind. The strategy behind that joint venture is now substantially clearer. MHI’s decision to stop the commercialization of its 7 MW SeaAngel offshore wind turbine, to focus instead on the Vestas V164-8.0 MW turbine under MHI Vestas Offshore Wind, makes sense given Vestas’ expertise in the offshore market and the need to move forward without confusion or conflict between the two turbine platforms.

Technology-wise, the SeaAngel’s novel Digital Displacement Transmission Technology (DDT) looked like the more advanced drivetrain system. It employs a sophisticated series of hydraulic pumps, values, and motors to transfer the energy from the constantly varying rotor speed to a fixed speed generator, without the use of a gearbox. No other wind turbine employs a hydraulic drivetrain like this.

That novel technology, however, adds uncertainty to the construction and operation of offshore wind farms.

Risk Avoidance

The increased construction and turbine servicing costs and associated risks for offshore wind increase the rate of return that investors expect to up to 12% compared to an onshore wind farm’s 7% to 9% in developed markets. Once you add the risk of employing a completely new transmission technology system, you likely outweigh the benefits offered by the new drivetrain design. The joint venture with Vestas provides access to a similarly sized turbine based on a proven and more conventional, medium speed geared technology, eliminating the added risk.

Although Vestas’ turbine is also new in the market, the company’s offshore turbine reliability has dramatically improved since 2004, when it had to replace the transformers and generators in all 81 of its then new V80 machines at Horns Rev offshore wind farm. Much refinement and advancement specific to offshore has been achieved by Vestas and its peers.

No Confusion

It’s also important to send a clear signal to the market that the Vestas V164-8.0 turbine is the primary turbine offering of the joint venture, without a separate Mitsubishi-branded product offered outside or within the joint venture. Although the SeaAngel turbine will disappear as a stand-alone brand, testing of the hydraulic technology will continue.

Onshore testing of the full-size 7 MW turbine officially began on February at a test center in the United Kingdom for validation of the drivetrain design. A similar hydraulic-powered turbine may be installed later in 2015 in Japan on a floating platform,  depending on the results from the U.K. tests.

Ultimately, the aim of the effort is to focus on refinement and validation of the hydraulic drivetrain for possible future use under the MHI Vestas joint venture. The floating platform may, in coming years, become part of the joint venture’s offerings as well. For now, though, the V164-8.0 turbine using proven Vestas technology is marching out to sea, having recently landed its first order of 32 units for the 258 MW Burbo Bank Extension project on the west coast of the United Kingdom in the Irish Sea. Hiring has just begun to build the 80 meter turbine blades.

Roberto Labastida contributed to this post.

 

Oil-Gas Price Swings Slow New Energy Investment

— February 18, 2015

As I wrote in this blog in 2012 and in 2013, rising volatility in the oil-to-gas ratio points to a substantial shift in market dynamics for clean energy. Even if short-lived, this shift will have substantial implications for investment in new energy technologies.

In recent years, as the price of oil climbed to over $100 a barrel, the oil-to-gas ratio—which compares the price of a barrel of crude oil to that of a million Btu (mmBtu) of natural gas—spiked to as high as 52:1 in a single month from a relative constant of around 10:1. While this apparent equilibrium had held steady since the mid-1980s, the widening gap between the price of oil and that of gas seemed to represent a new reality, with natural gas prices holding below $3 per mmBtu (Henry Hub).

In the last several months, as oil prices have slid to less than $50 per barrel, that ratio has come crashing back down to Earth. At a current 13:1, the oil-to-gas ratio is once again nearing historic levels—and again reshuffling the deck for a cleantech industry yearning for macroeconomic certainty.

Ratio of Crude Oil to Natural Gas: 1990-2015

Oil-Gas

(Source: Navigant Research)

While the boom in shale oil and gas recovery (among other factors) has ushered in an apparent return to historical equilibrium, experts are divided on what the future holds. Some argue that the recent spike in the oil-to-gas ratio was a short-term anomaly and that forces will continue to act to bring prices back into their long run equilibrium. Others question whether a stable long-term relationship between crude oil prices and natural gas prices even existed in the first place.

While the jury is still out on the putative correlation between oil and gas prices, we can expect continued volatility in the oil-to-gas ratio. This creates a challenging environment for new energy technologies going head-to-head with existing infrastructure.

The Incumbent Edge

Volatility dampens growth in new energy technologies in several ways. First, it cools investors’ appetite for clean energy ventures, due to the potential risk that seemingly profitable investments one day may turn out to be unprofitable due to changing fuel costs. Building natural gas infrastructure may look attractive in 2012 if you’re in the United States, for example, but not so wise when the price of a barrel of crude oil drops by more than 50% in 2014. This is an issue of asset stranding.

Second, it lowers customers’ tolerance for risk. As noted in our recently published report, Combined Heat and Power for Commercial Buildings, the impact of price swings are most acutely felt by consumers looking to hedge with one fuel against the other. When oil prices accelerated past $100, consumers of heating oil and gasoline, for example, began looking to natural gas alternatives. These decisions can be straightforward when price signals are stable, but actual (or even perceived) volatility favors a wait-and-see approach.

The Underminer

Third, it undermines the role of incentives and other mechanisms for stimulating the deployment of new energy technologies. Still more expensive than incumbent technology in most cases, clean energy has enjoyed incentives that put emerging energy technologies on an even playing field with fossil fuels. Fuel price volatility can make it especially challenging to establish reasonable incentive levels for the long term.

While Navigant Research’s forecasts for distributed generation technologies like solar PV (see our Global Distributed Generation Deployment Forecast report) and energy storage (see our Community, Residential, and Commercial Energy Storage report) in the United States remain strong despite lower energy prices, volatility is likely to mostly benefit the status quo.

 

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