Strategic flexibility, immediate-term valuation stability and incoming regulation are among factors giving private equity investors an edge over their competitors when it comes to striking renewable energy asset deals.
While rising interest rates are affecting a financial hits of North American renewable energy and infrastructure developers and electric utilities, the private equity experts S&P Global Commodity Insights spoke with said they are yet to see a material impact on private capital costs or deal activity.
.
|
Replacing some deal leverage with equity, increasing power purchase agreement prices becoming more flexible regarding exit strategy and looking ahead to take advantage of additional production and investment tax credits in the Inflation Reduction Act are among the ways in which large private equity investors are navigating the current environment.
On rising rates, Steven Kantowitz, partner at Energy Impact Partners LP, said: "At a high level it makes the cost of debt more expensive and it makes our ability to achieve a certain levered rate of return more difficult." But Energy Impact Partners, or EIP, can afford to be patient and has a lot more flexibility than the traditional three- to five- or six-year investment holding period, he said in an interview.
In November 2022, EIP closed its oversubscribed EIP Deep Decarbonization Frontier Fund I LP at $485 million. It had already invested in companies like storage firm Form Energy Inc. and battery provider Rondo Energy Inc.
ArcLight Capital Partners LLC can be similarly flexible with its holding period, partner Carter Ward said, but this may not be necessary in the short term since private equity firms "have not seen a sea change in the way that assets are being valued on the equity side." The firm took renewable natural gas producer Opal Fuels Inc. public in July by merging with a special purpose acquisition company.
Higher returns
Even if valuations do decline, the energy transition's growth and value opportunities will continue to boost the amount of private capital chasing renewable energy and infrastructure deals. Rising prices for renewable energy power purchase agreements, or PPAs, are helping private equity firms protect returns in a high interest rate environment.
Average U.S. prices for large-scale solar rose 30.3% year over year to $42.21/MWh in third-quarter 2022, while wind PPA jumped 37.4% to $49.66/MWh, according to an October 2022 LevelTen Energy Inc. report.
While some utility and generation development companies are struggling to manage high interest rates and inflated material prices, private equity firms see steeper PPA prices as a net benefit.
"The revenue side is also increasing," Norton Rose Fulbright energy infrastructure attorney Todd Alexander said in an interview. "The returns that they committed to achieving for their limited partners were based on a lower interest rate environment, so that doesn't mean that they will ignore the fact that they can potentially get higher returns now."
For Brookfield Asset Management Inc., higher power prices locked in now will last for over a decade.
"If you look at our existing renewable energy fleet, 90% of our [investments] are project-level based and they've got 12 years of life remaining, so we're pretty well-protected from increasing interest rates in our existing portfolio," Julian Thomas, a managing director and head of strategic initiatives in the firm's renewable power and transition group, said.
The firm struck the second-highest deal in the sector in 2022 with the acquisition of Scout Clean Energy LLC for $1 billion, S&P Global Market Intelligence data shows, and closed a $15 billion energy transition fund in June 2022.
Tax credit game changer
New and ongoing tax incentives for renewable energy development as well as bonus credits for domestic projects in low-income and coal-mining communities should help blunt some of the negative impact of rising borrowing costs.
"Private equity opportunities were good before the [Inflation Reduction Act], now they're fantastic" and "turbocharged," Norton Rose Fulbright's Alexander said.
Previously, developers of large wind and solar installations could only monetize tax credits from the U.S. government by selling them to large financial firms and other companies with significant tax liabilities, creating partnerships that owned projects. The federal climate package now allows developers to convert tax credits into cash payments themselves by selling the credits to corporate entities unaffiliated with their projects, opening the door for direct ownership and potentially creating extra income from unused credits.
The most "exciting" part of the Inflation Reduction Act is "the transparency of monetizing these benefits," ArcLight's Ward said.
The legislation will also create additional opportunities for private capital by pushing for domestic supply chains alongside those credits and opening up the manufacturing sector for investment, Alexander said, citing First Solar Inc.'s plans to build a $1 billion factory in the southeastern U.S. to construct thin-film photovoltaic panels, and a joint venture between General Motors Co. and LG Energy Solution Ltd. planning a $2.6 billion lithium-ion battery factory in Michigan.
For existing private equity investments, the incentives may accelerate and expand development.
"We have an ability to probably get increased throughput from our [100-GW] development pipeline, i.e., projects that may have been ... earlier-stage can probably become more advanced," Brookfield's Thomas said, adding that the firm could even increase that pipeline.
Funding and dealmaking
The number of renewables and clean tech funds launched either under larger fund families or by spinouts from private equity firms or hedge funds increased over the past year, Jeremy Swan, a principal in project finance adviser CohnReznick LLP's financial sponsors and services practice, said in an interview.
Brookfield's Thomas said that rising interest rates give the private equity giant an edge over competitors with less access to favorable cost of capital.
"A lot of the smaller developers [are] struggling with inflation and interest rates, and projects are being in some cases abandoned by other developers where we haven't really backed away from developing projects at all and in fact it's helped us."
Some businesses, such as composite utility pole manufacturer RS Technologies Inc., which in 2022 received C$150 million in funding from EIP, require no leverage at all, Kantowitz said. The company already provides self-extinguishing poles to Southern California utilities as part of state utility regulators' wildfire mitigation plan.
Large private equity firms continued to strike deals in 2022 despite the deteriorating macroeconomic outlook. JP Morgan's investment management arm's leveraged buyout of South Jersey Industries Inc. for nearly $8 billion, announced in February last year, was 2022's biggest private acquisition in the sector, according to S&P Global Market Intelligence data.
Looking forward, a growing number of U.S. investor-owned utilities, including Dominion Energy Inc., Duke Energy Corp. and FirstEnergy Corp., are considering selling — or actively shopping for — renewable assets or minority stakes in regulated subsidiaries to minimize future external capital market needs, creating possible buying opportunities in 2023.
S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.