Piers Denne of Future Capital Partners says the renewable energy sector offers investors opportunities that do not carry the inherent risk of ‘new’ technology.
The debate over renewable energy has been running for some time now, and dependent on which interested party you listen to, you will receive a whole raft of different reasons for and against.
However, one thing is abundantly clear: through mandated legislation, renewable energy in one form or another is here to stay. Some facts would seem to be in order here. It is currently estimated that, in the EU, we blend 2.3 billion litres of renewable transport fuel (RTF) a year.
Through mandated legislation, this it expected to grow over the next 10 years to 23 billion litres, which is a tenfold increase. The EU Renewable Energy Directive (RED) has established a binding minimum target for renewable fuels to have a 10% energy share (13% by volume) of the transport fuels market by 2020. This directive is embodied in UK and other European states’ legislation and severe penalties will be applied to fuel retailers for failing to meet these blending benchmarks. Fuel suppliers currently have to blend 3.25% by volume, and this increases to 5% by 2013. So, as you can see, there is a market driven by legislation that needs to be supplied.
New technologies
One of the arts of introducing new technology is to do it in a way that means not finding a new market but rather supply or tap into an existing one that will use the product on a passive basis. (Dyson is a great example of this.) There is no need to change buyer behaviour because you are supplying something they already use, but hopefully in a better form. Some other facts will help with this: globally, transportation contributes one-quarter of all greenhouse gas emissions, with 80% coming from road transport and half from cars. Liquid Renewable Transport Fuels (RTFs) in the form of ethanol and biodiesel are the only current low-carbon alternatives to fossil fuels and the liquid fuel infrastructure already exists, meaning the transportation and distribution logistics are already in place.
Starting points
So when looking at trying to reduce greenhouse gas emissions, the obvious starting point has got to be with the biggest contributor. Some say we should ban cars, but the reality of this is, until we find a realistic alternative to the internal combustion engine, this is not going to happen. However, what people do not understand is the change is already happening. It is highly likely in the car you drive there will be some form of renewable energy mixed into your petrol. Linking this in with the first statistics, this market will be driven, not by consumers changing their behaviour, rather by governments ‘forcing’ change by legislative incentives and penalties on the suppliers to the market.
Gains potential
So what does this mean for the astute investor? Well, in its simplest terms there is the potential for significant gains to be made if the right investment opportunity is taken. How one finds that opportunity is the more difficult task. Investing in the next generation of renewable energy technology is exciting but will be a hit-and-miss business – with some amazing success stories but also much money disappearing into developing technology that simply never becomes commercially successful. Expert-led funds that diversify risk must be the way to access this type of investment, but diversification will also mean dilution of return expectation and the timescales for bringing genuinely new technology successfully to market could be very long.
We believe because of the projected shortfall in the supply of ethanol, investing in an opportunity that makes the most of the mandated legislation is using proven technology and already has the heads of agreement to sell the ethanol, high-protein animal feed and the liquefied CO2 is a fairly simple decision. The combined value of these agreements at current prices is estimated to be in the region of £1.5bn over the next 10 years.
The right way
But one has to look for the right way to access such a compelling opportunity because getting access to such investments is not easy. Most publicly quoted companies with RTFs in their portfolios have many other products and business interests that could act as a drag to performance. ‘Green’ funds may give exposure to RTFs, but once again diversification may mean successes from RTFs are dampened.
If one believes in the investment story, therefore, seeking out opportunities that isolate the production of RTFs is the way forward. This might be through companies that exclusively own and operate RTF facilities or through an investment directly in the building and commissioning of an RFT facility.
Triumvirate
Three other factors bring added interest to such an opportunity. Firstly, current market conditions mean the availability of project finance is limited and financing spreads are relatively high, especially during the construction phase. This means equity investors should benefit from windfall gains on refinancing post-construction or as and when liquidity returns to the financial markets.
Secondly, with oil majors having significantly under-invested in this technology over the past few years, vertical integration is likely in the future, with a trade sale offering a likely exit strategy at a healthy profit for prospective investors.
Finally, structured appropriately, this compelling investment proposition can also benefit from tax breaks associated with construction of major facilities, meaning the risk/reward balance of the investment is improved even further.
Advisers should be talking to their clients about ways of investing in the renewable energy sector. While this is a large and fragmented area, with the obvious pitfalls associated with a new and growing market, there are opportunities that do not carry the inherent risk of new technology. They also benefit from, as stated above, potential tax breaks that can underpin a client’s investment and the expected IRR’s are in the region of 30% over a five- to seven-year period.
Piers Denne is head of sales and marketing at Future Capital Partners
