Catching a tailwind

Just a few miles south of Tehachapi, California, a popular hang-gliding destination on the edge of the Mojave Desert, renewable energy developer Terra-Gen Power is getting ready to construct 320 brand new wind turbines. The goal: to create a giant wind farm capable of producing up to 800 megawatts of electricity a year – enough to power about 575,000 homes. 

Wind: can be infrastructure

On the face of it, the so-called Alta-Oak Creek Mojave Project would seem like a non-starter for risk-averse infrastructure investors. After all, the project may or may not be completed on time, it may or may not cost as much as Terra-Gen has forecast and, ultimately, the wind may or may not blow. 

But judging by Terra-Gen’s latest backer, Global Infrastructure Partners (GIP) – the global private equity firm looking to invest $5.64 billion on essential assets with conservative risk profiles – renewable energy and infrastructure-style investing may not be as mutually exclusive as they seem. 

Indeed, the very reason for choosing this issue of InfrastructureInvestor to focus on the topic of so-called “green” infrastructure – environmentally-friendly assets that clean-up or cut down on the use of carbon-based fuels – is because infrastructure investors have been increasingly demonstrating that this is a sector they can invest in.  

Bloomberg New Energy Finance, a consulting firm, counted $145 billion of new investment in renewable energy in 2009 and predicts $200 billion in 2010. But even as the sector keeps growing, infrastructure investors are concerned with only a small sliver of potential opportunities that meet their strict criteria. And, as many fund managers will candidly confess, even these opportunities can be difficult to find and would most likely not be there were it not for strong regulatory and government tailwinds.  

Infrastructure investors typically seek out assets with predictable cashflows and attractive risk-adjusted returns. That means solid businesses with proven cash-generation ability and little in the way of market, regulatory or technology risks that would diminish those cash flows over time. 

So predictable   

Terra-Gen fit the bill, says GIP founding partner Jonathan Bram, because the company already owns 831 megawatts of operational wind, solar and geothermal power plants, all of which have power purchase agreements with creditworthy utilities for a weighted average length of 16.5 years. So there was already a very meaningful level of cash flow predictability. 

Terra-Gen also has a significant amount of predictable near-term growth, having already contracted 1,550 megawatts of wind generation from the Alta project to a local utility. When the final development milestones are met, and the first phases of Alta are financed and enter construction, GIP’s convertible preferred security will convert into common equity. This structure enabled GIP to avoid assuming near-term development risk, and focus on the project’s long-term contracted cash flows.  

Bram is confident Terra-Gen has a management team capable of delivering on this growth plan. But for GIP, strong management is merely the “cherry on top” of any investment.  “As infrastructure investors, you can’t really ascribe an enormous amount of value to management. ‘This is a great team, and they’re going to develop wonderful things’ is not an investment thesis for an investor like GIP,” Bram says. You need real assets that will deliver cash today and into the future. 

Hence the great frustration: “Even my second-grade daughter knows that renewables are big,” says Bram. “But the great difficulty for infrastructure investors like ourselves is to find good opportunities to make solid investments into the space that are consistent with our mandate.” 

Pricing premium   

Still, there are some out there. Mark Weisdorf, the head of JPMorgan’s Asset Management Infrastructure Investment team, has been able to find two such investments so far. Flip through some press releases and you’ll find that in 2007 his firm took a 33 percent stake in Zephyr Investments, owner of 17 UK wind farms, in a £145 million deal. And in 2009, it followed up with a 37 percent interest in Coastal Winds, a portfolio of three wind farms in Oregon, Texas and New York, for $700 million. 

These investments, says Wiesdorf, are “very compatible” with his group’s infrastructure style of investment. Zephyr sells the majority of its electric output to a large UK electricity utility in accordance with a long-term power purchase agreement. The remainder goes into a government-regulated electricity pool where, thanks to government rules that require utilities to purchase 30 percent of their energy from renewable sources by 2025, they exact a nice pricing premium over traditional energy sources.  

Same with Coastal: one of its wind farms sells its output in accordance with a long-term contract, while the other two sell to local electricity pools. Weisdorf has hedged the prices for more than 10 years each.  

“The effect is the same: very predictable, almost no-volatility returns,” he says. And that is exactly what his investors want. “This is not a venture fund. Our investors are not looking to us to invest in cleantech.” 

Neither are they looking for Weisdorf to take on greenfield risk or the risk associated with building new assets. So don’t look for him to finance the construction of a brand new wind farm, unless the new development pipeline is very small. By this he means “five to 10, no more than 10 percent of the portfolio every year”, before hastily adding: “And you would be paying very little if anything for that development pipeline.” 

Some infrastructure investors aren’t paying anything for any green infrastructure, period. Bob Hellman, chief executive officer of San Francisco-based American Infrastructure MLP Funds, a $350 million family of private investment funds focused on natural resource, infrastructure and real property, says his firm is always looking at green infrastructure but has yet to become convinced that it is a suitable investment target for private capital. 

“We revisit the economies of wind, solar, various bio-fuel projects every year to see if they generate reliable private returns,” he says. “They’re not market-driven economics. They’re largely reliant on the largesse of the federal government,” he adds. And he’s not ready to take a punt on the whims of Congress, so for now there is no place for green infrastructure in his portfolio. 

Just like PPPs 

Others have more faith in governmental largesse. Wim Blaase, one of the co-founders of DIF, a Netherlands-based fund infrastructure and renewable energy investor, admits that “you need some form of support to make it happen”. But that doesn’t scare him away from investing in the sector. Instead, it makes renewables akin to DIF’s other investment strategy – public-private partnerships – where the firm contracts with government entities to provide essential public services in exchange for agreed-upon fees. 

“I think in general the cash flows are stable and conservative in both asset categories Much more stable, for instance, than if you invest in a port, airport or toll road, where you have revenue or volume risk,” he says.  

Renewables and public-private partnerships are seen as sufficiently similar, in fact, that DIF is now raising a fund that can invest in both. Previously, it invested in public-private partnerships through a dedicated fund, the €150 million DIF PPP Fund, and in renewables through the €134 million DIF Renewable Energy Fund. Its newest fund, DIF Infrastructure II, targeting €500 million, will have a one-third allocation to renewables and two-thirds to public-private partnerships. 

“We explained to [existing DIF] investors and also potential [new] investors that these asset classes are more or less similar, at least from a risk perspective and return perspective. And most of them agreed,” he says. Indeed, Dutch pension funds Pensioenfonds DSM Nederland and Stichting Pensioenfonds Sabic as well as the European Investment Bank have now invested in all three of DIF’s funds.  

On the whole, limited partners are unlikely to shun an infrastructure fund for investing in renewables or other green assets. The challenge, as in GIP’s indirect backing of Tehachapi, will be to structure deals in a way that’s appropriate for infrastructure investors.   

“You have to be very selective and each one of these opportunities is obviously infinitely complex,” says Bram.