The current interest in renewable energy has escalated greatly. Now, private equity firms are taking much interest in investing in only renewable energy projects. This is also under the backdrop of the need to acquire more energy resources by the various giants of the world. Still, the recent credit crunch and the financial crisis led the utility companies into cash-strapped positions. Therefore, their requirements for quick cash and other capital investment in newer renewable energy projects were met by the private equity investors investing in these companies and their projects. However, the greatest focus has remained on investing in more mature projects such as those related to wind and solar energy.
The UK-based private equity fund, Bridgepoint, recently invested nearly $850 million in wind energy projects in Spain. Likewise, other global private equity investment firms also drastically increased their activity to invest in nearly all the upcoming projects. The largest groups in the industry include KKR and Blackstone (Schäfer, 2011).
However, other firms are also engaged in funding these projects which have lesser downside risks and higher upside returns. The typical projects that are financed by these private equity firms include only those in the renewable energy sector moving away from the traditional fossil fuels. These projects include solar energy, wind, biomass, bio fuels, geothermal energy, and other projects related to energy storage and efficiency. Additionally, these investments are characterized by mostly very high growth, asset -based, capital-intensive investments (Hudson, 2012).
Private Equity Financing of Renewable Energy Projects
Like other private investors including the commercial banks, pension funds, and others, the private equity firms are also actively investing in renewable energy projects. These firms and groups specialise in the financing of renewable energy projects the world over. These firms usually have a pool of private equity fund that is generated through investments made by institutional investors and by other high net worth individuals. These funds are spread throughout the world and invest in mostly global renewable energy projects.
Currently, the method of their financing is such that they take the upside potential of these risks while avoiding the downside risks. This upside potential is only available in the most mature technology and the projects such as those of solar and wind energy. Then, these investors also have a quick exit strategy whereby these investors end their investments in about 3 to 5 years time. Their expected returns are calculated through the traditional project financing methods. They use the IRR (Internal Rate of Return) of the project to calculate their project return. The current hurdle rate of these private equity investors for these mature renewable energy projects ranges between 25% and 35%. However, it is said that these only represent the range of the hurdle rates while the actual returns realized by these pools of funds should be even considerably higher.
While these private equity investors look to their upside potential, they are also required to minimise their downside risks. These risks mostly relate to country and financial risks, regulatory and policy risks, project specific and technical risks, and market risks. The individual risks in the country and financial risks category include the economic risk, the security risk, the sovereign risk (which includes the country and political risks), and currency risks.
On the contrary, the policy and regulatory risks are very pertinent considering the drastic policy changes occurring in the renewable energy sector, especially in Europe. The regulatory risk relates to the laws and regulations related to the sector financing and those related to the operations of these projects.
The technical and project risks relate to the construction, environment, management, and technological risks. Lastly, the market risk relates to the off-take of the product or renewable energy service and other price risks, which relate to the prices of these products as well as those of their underlying derivatives that are traded on the various exchanges (Justice, 2009).
The private equity firms are increasingly specialising in financing the renewable energy projects coming up throughout the world. These projects mostly relate to the most mature energy projects such as those of wind and solar energy. These private investors fund only those projects that have very high upside potential and less downside risk potential. Consequently, they are able to realize their very high hurdle rates that range from 25% to 35% IRR. Furthermore, these global private equity investors and others also exit from the project in about 3 to 5 years thereby effectively maximising their returns.
The downside risks of these renewable energy projects are still there, albeit being lesser than those of early stage financing or that of the life-time financing of these projects. These risks relate to financial and country risks, regulatory and policy risks, project and technical risks, as well as the various market risks.
However, there are also other firms that invest in other renewable energy projects as well in addition to the most stable wind and solar energy projects. These include those renewable energy projects such as biomass, bio fuels, geothermal energy, and projects for storage and efficiency of renewable energy.