One can argue that, when it comes to renewable energy investments, the prevailing view in the market is that renewables are the new social infrastructure. That is to say, government-backed operational renewable energy projects are now best positioned to offer the same kind of yield and long-term cashflows that public-private partnerships (PPPs) used to provide for low-risk infrastructure investors.
That’s true for a significant part of the renewable energy market, but it doesn’t tell the full story. We want to call your attention to the less clear-cut half of the renewables market – the one that allows fund managers with the right strategy and risk appetite to extract double-digit returns even from operational assets.
At the moment – and given the spectacular rise of the YieldCos – operational assets, especially in developed countries, seem to have been written off as a source of high returns. But that’s only true of straightforward operational assets that are fundamentally in good shape.
And there are a significant number of assets out there in less than ideal shape. They may in fact comprise about half the market, according to one fund manager’s estimate, although they are not readily visible, because their owners don’t usually want to call attention to them and most reported deals tend to fall on the unproblematic side of the fence.
So what exactly are we talking about? We are referring to operational assets with second-tier wind turbines, for example, or that use a mixture of solar panels from all over the world. Or assets with un-streamlined operations & maintenance (O&M) contracts – or worse, no O&M contracts. Assets that have merchant positions for the power offtake. And assets in ill financial health, either because the equity is under water or because they were overleveraged.
Conventional wisdom dictates that your options are limited if you want higher returns in the renewables sector(s). You can take on construction/development risk; you can focus on aggregating fragmented assets into larger, more cost-effective platforms; or you can head to the power hungry emerging markets – if you can stomach the risk – where renewables are often cost-competitive with regular energy sources, often unsubsidised.
But there are plenty of operational assets out there, even in developed markets, which need work. “Not distressed assets – just stressed,” as one fund manager elegantly put it. Certainly such assets need an active manager, though, with the willingness and the ability to handle some of the above-mentioned risks. Asset managers that, perhaps, have more of a private equity-style, operationally minded approach to the asset class.
The more important question is: can LPs be persuaded to care about an operationally-focused renewable energy strategy that privileges returns over yield? Returns are certainly not what’s been driving the YieldCos and the pensions and insurance companies that are investing directly in the operational side of the asset class. For them, renewable energy is a much-welcome yield play in a low interest-rate world.
Of course, the yield versus returns theme is part of a much larger discussion about what LPs really want out of their investments. But if it’s true that renewables can be the new social infrastructure, it’s also true they can be quite a bit more than that. They just need the right fund manager to prove it.