Private Equity Financing of Renewable Energy Projects
Introduction
The current interest in renewable energy has increased considerably. Now, private equity firms are becoming very interested in investing only in renewable energy projects. This is also in the context of the need to acquire more energy resources by the various giants of the world. Still, the recent credit crunch and financial crisis pushed utility companies into cash-strapped situations. Therefore, private equity investors who invested in these companies and their projects met their requirements for quick cash and other equity investments in newer renewable energy projects. However, the greatest focus has remained 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 power projects in Spain. In addition, other global private equity investment firms have also dramatically increased their activity 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 that have less downside risk and higher upside returns. Typical projects that these private equity firms finance include only those in the renewable energy sector that move away from traditional fossil fuels. These projects include solar, wind, biomass, biofuels, geothermal, and other projects related to energy storage and efficiency. Furthermore, these investments are mostly characterized by very high-growth, asset-based, and capital-intensive investments (Hudson, 2012).
Private Equity Financing of Renewable Energy Projects
Like other private investors, including commercial banks, pension funds, and others, private equity firms are also actively investing in renewable energy projects. These firms and groups are specialized in financing renewable energy projects around the world. These companies typically have a private equity pool that is generated through investments made by institutional investors and other high net worth individuals. These funds are spread around the world and invest primarily in global renewable energy projects.
Currently, the funding method is such that they take advantage of the upside potential of these risks and avoid downside risks. This growth potential is only available in the most mature technology and in projects such as solar and wind energy. Then these investors also have a quick exit strategy whereby these investors finish their investments in about 3-5 years. Your expected returns are calculated through traditional project finance methods. They use the project’s IRR (Internal Rate of Return) to calculate the return on your project. The current critical rate for these private equity investors for these mature renewable energy projects ranges from 25% to 35%. However, these are said to only represent the range of floor rates, while the actual returns realized by these groups of funds should be even considerably higher.
While these private equity investors look for their upside potential, they must also minimize their downside risks. These risks are mainly related to financial and country risks, regulatory and policy risks, technical and project-specific risks, and market risks. Individual risks in the country risk and financial risk category include economic risk, security risk, sovereign risk (which includes country and political risk), and currency risk.
On the contrary, regulatory and regulatory risks are highly relevant considering the drastic changes in policies that are taking place in the renewable energy sector, especially in Europe. Regulatory risk is related to the laws and regulations related to the financing of the sector and those related to the operations of these projects.
Technical and project risks relate to construction, environmental, management and technological risks. Finally, the market risk is related to the off-take of the renewable energy product or service and other price risks, which is related to the prices of these products, as well as their underlying derivatives that are traded on the different stock exchanges. (Justice, 2009).
Conclusion
Private equity firms are increasingly specializing in financing renewable energy projects springing up around the world. These projects are mostly related to more mature energy projects, such as wind and solar power. These private investors finance only those projects that have very high upside potential and low downside risk potential. Consequently, they are able to realize their very high minimum rates of return ranging from 25% to 35% IRR. Furthermore, these global private equity investors and others also exit the project in around 3-5 years, thus effectively maximizing their returns.
The downside risks of these renewable energy projects are still there, although they are less than those of the initial financing or lifetime financing of these projects. These risks relate to financial and country risks, regulatory and policy risks, technical and project risks, as well as various market risks.
However, there are also other companies that invest in other renewable energy projects besides the more stable wind and solar power projects. These include those renewable energy projects such as biomass, biofuels, geothermal energy, and renewable energy storage and efficiency projects.