The current interest in renewable energies has increased significantly. Private equity firms are now very interested in investing only in renewable energy projects. This is also happening against the background of the need to acquire more energy resources through the various giants of the world. Nonetheless, the recent credit crunch and financial crisis have left utility companies tight on their budgets. Therefore, their need for quick cash and other capital investments in newer renewable energy projects has been met by the private equity investors investing in these companies and their projects. However, the main focus remains on investing in more mature projects, such as those related to wind and solar energy.
UK-based private equity fund Bridgepoint recently invested nearly $850 million in wind energy projects in Spain. Likewise, other global private equity investment firms have also drastically increased their activities to invest in almost all upcoming projects. The largest groups in the industry include KKR and Blackstone (Schäfer, 2011).
However, other companies are also involved in financing these projects, which have lower downside risks and higher upside returns. Typical projects funded by these private equity firms include only those in the renewable energy space that are moving away from traditional fossil fuels. These projects include solar, wind, biomass, biofuels, geothermal and other projects related to energy storage and efficiency. In addition, these investments are characterized by mostly very fast-growing, asset-based, capital-intensive investments (Hudson, 2012).
Private equity financing of renewable energy projects
Like other private investors, including commercial banks, pension funds and others, the private equity firms are actively investing in renewable energy projects. These companies and groups specialize in financing renewable energy projects around the world. These companies typically have a pool of private equity funds generated through investments from institutional investors and other high net worth individuals. These funds are spread all over the world and invest in mostly global renewable energy projects.
Currently, their method of funding is such that they bear the upside potential of these risks while avoiding the downside risks. This upside potential is only present in the most mature technology and projects such as solar and wind energy. Then these investors also have a quick exit strategy, which makes these investors end their investments in about 3 to 5 years. Your expected returns are calculated using traditional project finance methods. They use the project’s IRR (internal rate of return) to calculate their project return on investment. These private equity investors’ current hurdle rate for these mature renewable energy projects is between 25% and 35%. However, these should only represent the range of the hurd rates, while the actual returns of these funds are likely to be significantly higher.
While these private equity investors are alert to their upside potential, they also need to minimize their downside risks. These risks mainly relate to country and financial risks, regulatory and political risks, project-specific and technical risks and market risks. The individual risks in the country and financial risk category include economic risk, security risk, country risk (which includes country and political risk) and currency risk.
On the contrary, the political and regulatory risks are very relevant given the drastic political changes in the renewable energy sector, especially in Europe. Regulatory risk relates to the laws and regulations related to sector funding and those related to the operation of these projects.
Engineering and project risks relate to construction, environmental, management and technology risks. Finally, market risk relates to the downtake of the product or renewable energy service and other price risks related to the prices of these products as well as the prices of their underlying derivatives traded on the various exchanges (Justice, 2009).
Private equity houses are increasingly specializing in financing upcoming renewable energy projects around the world. These projects mainly relate to the most mature energy projects such as wind and solar energy. These private investors only finance projects that have a very high upside potential and a lower downside risk potential. Consequently, they are able to realize their very high hurdle rates ranging from 25% to 35% IRR. Additionally, these global private equity investors and others will also exit the project in about 3 to 5 years, effectively maximizing their returns.
The downside risks of these renewable energy projects are still there, albeit less than those of early stage or lifetime financing of these projects. These risks relate to financial and country risks, regulatory and political risks, project and technical risks and the various market risks.
However, there are other companies investing in other renewable energy projects besides the most stable wind and solar energy projects. These include renewable energy projects such as biomass, biofuels, geothermal, and renewable energy storage and efficiency projects.