Fighting the headwinds

Infrastructure investors eyeing US renewables may have to work a little harder to source attractive deals thanks to five trends rapidly reshaping the sector. Cezary Podkul explains.

At Infrastructure Investor’s Chicago forum last November, attendees gathered for the event’s energy panel witnessed some straight talk on investing in the US renewable energy sector. Robb Turner, co-founder of ArcLight Capital, the $6.8 billion energy fund manager, said his firm has had to pass on a number of renewable investment opportunities because the economics simply didn’t work.

The sentiment ricocheted across the audience – a who’s who of the biggest infrastructure investors in the sector – and soon, a broader debate was underway about the trends impacting returns in the sector. As managers across the room exchanged views, it became clear that attitudes toward wind farms, solar plants and other renewable energy investments ranged from absolute confidence to outright skepticism.

“My take away was that there was a significant difference of opinion as to whether the returns available for clean energy in the US marketplace were sufficient for the risk,” says Mark Weisdorf of JPMorgan Asset Management, who witnessed the debate.

Weisdorf’s personal view is that median returns for US renewable energy investments are lower today than they were two years ago. This may be one reason why Weisdorf’s infrastructure team has not invested in the sector since it closed a $700 million wind farm deal, Coastal Winds, in January 2009.

“Things are different now,” he says. “So the deals that you would negotiate are different.”

With that in mind, Infrastructure Investor reached out to utilities, lawyers, bankers and investors to find the top trends impacting returns in the renewable sector. Here’s what they had to say:

Natural gas pricing

Renewables don’t stand apart from the US energy market: they must compete with other forms of electric energy generation. And one of these – natural gas-fired generation – has become a strong source of competition to renewable.

Thanks to technological advances, energy suppliers are able to extract more gas out of the ground in the US than ever before. As a result, the price of natural gas used for electric generation in 2009 and 2010 has been hovering in the $4 to $5 range per 1,000 cubic feet, versus $6 to $11 in 2007 and 2008, according to the Energy Information Administration (EIA).

The EIA does not break down electricity price by source, but its latest estimate of electric generation costs puts natural gas at the bottom, with all other sources benchmarked above it. That means renewable sources like wind, solar and geothermal are currently less competitive vis-à-vis natural gas.

“If natural gas prices are at $4 or less, that will shape the price of everything else,” says Tim Vincent, a partner at boutique investment bank Greentech Capital Advisors.

Vincent still believes there are jurisdictions where “renewables will make sense” for utilities, such as California. But as long as natural gas prices stay low, utilities are unlikely to want to pay more for renewable sources, especially since natural gas can often help them meet their carbon reduction targets at a lesser cost.

“Energy is a commodity at the end of the day,” Vincent adds.


The marketplace for renewable energy is also becoming more competitive, as many utilities can attest. More competition means big buyers of renewable electricity can find better bargains when they solicit bids for long-term power purchase agreements (PPAs) with wind, solar and other developers.

“Every year that we do a competitive solicitation, the number of offers, or projects that we get essentially doubles,” says Marc Ulrich, vice president of renewable and alternative power at Southern California Edison, a large California utility that has more than 17 percent renewable energy in its power mix.

Ulrich thinks much of the competition is driven by technological advances that are making solar photovoltaic (PV) generation more economic. “Between August 2009 and now I’ve signed over 60 contracts for renewables and 50-plus have been solar,” he says. “And why is that? Because solar PV costs are falling pretty dramatically.”

The result of this is lower pricing for renewable PPAs. And where developers can’t match lower pricing with lower input costs, their margins may suffer.

“This is all basic economics. There were a few suppliers in the beginning. They got to enjoy decent prices on their behalf. Now the market is much more competitive,” Ulrich says.


Luckily, the US government has given renewable energy developers more options than ever before to make the numbers work. One of the measures introduced in the $787 billion stimulus bill President Obama signed into law in 2009 was a cash grant programme for the US’ two tax credit-based renewables incentives, the production tax credit and the investment tax credit.

The programme allows investors to trade in those tax credits for cash. For example, assuming it meets all the requirements, a $100 million project might qualify for a $30 million cash grant reflecting the 30 percent tax credit, effectively lowering its construction cost to $70 million.

“The cash grant programme was like an IV drip for the industry during the early days of the Great Recession through the present,” says Sarah Fitts, co-chair of the energy and natural resources group at law firm Debevoise & Plimpton.

Equally importantly, the cash grant programme reduces the need to transfer ownership of the tax credits to someone else. Because newly built renewable power plants are often not profitable enough to take advantage of the tax offsets provided by their tax credits, historically developers needed to transfer their ownership to a so-called “tax equity” investor with enough taxable income to fully utilise them.

Transferring the ownership is possible but it usually comes at the expense of non-tax equity investors who often don’t share in the economic benefits of the project while the tax credits run their course. A lease agreement with the non-tax equity investor can help preserve some yield, but it takes some creative structuring to make it work.

“It is comparatively simple to apply for a cash grant and does not have some of the long delays or complications of other programmes,” Fitts says.

The return of ‘tax equity’

Still, thanks to the improving economy, when the cash grant does expire, there may be more tax equity players around to invest in the sector. Traditionally, this has been the foray of big banks such as Citi, Bank of America and Morgan Stanley.

“They’re the guys interested in these deals because they have large tax obligations at the federal level each year,” says John Harper, a partner at Global Energy Investors, a Massachusetts-based renewable power generation investor.

During the financial crisis, there was very little – if any – earnings to shield so their need for tax equity investments lessened. But now that the economy is recovering and their earnings have stabilised, “most of these players have returned and the appetite is increasing” for tax equity, observes Harper. So investors will have plenty of partners to whom to transfer their investment and production tax credits.

Signs of stability

An important caveat to the above discussions of cash grants and tax credits is that they’re temporary in nature. Congress extended the cash grant past its original expiration of 31 December 2010, but only for another year. And qualification for the tax credits the grant is based on, the production tax credit and the investment tax credit, sunsets between 2012 and 2016, depending on the type of renewable electricity generation.

The tax credits have in the past become “political footballs” when Congress allowed them to expire, says Bill Green, senior managing director of Macquarie Group. “But they’ve always come back,” he adds.

Green believes “what's important is to depoliticise this conversation and move this country into a dialogue about long-term options”. And that’s precisely what seems possible in Washington DC at this moment.

In his annual State of the Union address, President Obama urged Congress to support a “clean energy” standard: a broader yardstick for measuring America’s move away from fossil fuels by promoting clean coal, nuclear and other non-renewable options.

“The clean energy standard says ‘instead of just wind, solar, biofuels, geothermal’ we’ll include coal and nuclear. So now we have legislators from coal states saying ‘we’ll get behind this’” says Green. He believes this support could translate to a long-term energy policy in the US that could finally give renewable investors the regulatory certainty they so crave.

“I think we’re moving into an interesting period legislatively and we will begin to see some answers,” Green adds.