Liebreich: New Energy Finance Sees Year of Consolidation for Clean Energy in 2009

By Michael Liebreich
Chairman & CEO
New Energy Finance

With Barack Obama now firmly installed in the White House – after a historic US election that felt like it lasted decades – we can now declare that 2009 has truly begun. This is the time of year when we go out on a limb and predict what sort of year it is going to be. Some years are easy to call; this one is not.

What is clear is that if anyone thinks the correct strategy for 2009 is to hold tight and wait, that a few billion dollars of taxpayers’ money and an easing of the credit markets will bring a return to business as usual, they are in for a rude awakening. As usual, we try to come up with 10 fairly specific predictions, which we will revisit and mark in December.

For the past few years, the cost of clean energy has been unnaturally high, defying the experience curve because of supply-chain bottlenecks and soaring commodity prices, a seller’s market that hid all sorts of sins. But the investment surge of recent years was just starting to ease the bottlenecks when the credit crunch arrived to put the squeeze on demand. The result will be a dramatic and permanent change to the dynamics of the industry. No more silicon shortage; no more extended turbine waiting lists. Now buyers with cash to spend hold all the power. Prices will plummet towards marginal costs, and the world is going to be stunned at how cheaply the best companies can deliver clean energy and still make a profit. This is very good news for developers with access to funds, but very bad news for equipment manufacturers with poor cost positions.

On the demand side, meanwhile, the era of investing in non-economic projects for strategic or marketing reasons is over. Shareholders will not tolerate management wasting money on green-wash. Breathless announcements of carbon neutrality are sooooo 2007. But we are not going to see things come grinding to a halt, as we did in the 1970s and 1980s.

This time round there is a strong core of demand for clean energy based on firm mandates: renewable portfolio standards, renewable fuel standards, building codes, efficiency regulations and the like. There are also markets where clean energy can provide strong economic returns, even in a period of lower energy prices. Generally, these are still underwritten by a web of regulation and government support – feed-in tariffs, green certificates, subsidies, tax credits, carbon finance and so on – and this will be the case for some time. However, as the cost of clean energy now plummets, it will increasingly win on an unsubsidised basis, as it already can in the case of Brazilian ethanol, the best wind farms and many energy efficiency applications.

So this is clean energy investment, 2009 style. On the supply side, plummeting prices and the long-awaited shake-out. On the demand side, a much clearer focus on sectors, geographies and models that work.

Underlying all this, a huge dose of hope for the future. Not only are all the drivers that propelled the sector along so dramatically for the past five years still at work – climate change, energy insecurity, fossil fuel depletion, new technologies – but there are reasons why the clean energy sector can enter 2009 with a sense of optimism unmatched by any other sector of the faltering global economy.

Central bank rates are at historic lows – lower than any time since the seventeenth century in the case of the UK – but banks are still too worried about solvency to lend. But be in no doubt: a flood of money will hit the economy sooner or later. If not, there will be bailout after bailout until it does, culminating if necessary in outright nationalisation. And when lending does start to flow, clean energy projects stand to be among the early beneficiaries – they produce a reliable stream of revenues from good counter-parties, the utilities. By the middle of 2009, borrowing costs for projects should be lower than they were in the middle of 2008, and we should start to see the return of debt syndication – even if it has to be underwritten by governmental involvement.

As governments around the world have struggled to head off the worst recessionary scenarios and have found that monetary stimulus alone is not enough, they have placed clean energy at the heart of their fiscal stimulus packages – most notably the incoming US administration, with its talk of $150bn clean energy funds and at least $78bn in targeted measures for the sector. Last week, at the Masdar World Future Energy Summit in Abu Dhabi, a big cheer went up among those gathered around the television screen to listen to President Obama’s inauguration address when he mentioned harnessing “the sun and the winds and the soil” to power America’s cars and factories. The hope has to be that good intentions and soaring rhetoric will be matched quickly by concrete financial incentives.

And finally, there are high hopes that this year could see the most significant breakthrough in international climate negotiations since Rio in 1992. This is seen as the year in which we have to come to an agreement over a successor to the Kyoto Protocol if we are to avoid a disastrous hiatus before any new regime can be implemented. December’s COP/MOP meeting in Poznan, Poland was, frankly, a failure. Falling after President Obama’s election but before his inauguration, no significant progress was made.

Immediately after his election, President Obama signalled his intention not just to take part in the final year of negotiations, but to play a leading role. His selections of Stephen Chu, Carol Browner, John Holdren, Lisa Jackson and Jane Lubchenco further raised expectations that he intends to take his campaign pledge seriously, and that can only be good news for the climate talks, the carbon markets and the clean energy sector.

In summary, therefore, 2009 will be characterised by a confusing mix of consolidation and optimism. It will start slowly, with project developers struggling to find banks willing to lend; with the profits that drive tax equity as rare as hens’ teeth; and with shell-shocked stock markets effectively shut for public fund-raising. There will be casualties and there will be forced marriages, as companies run out of cash. It will be a year of extraordinary volatility in all markets, and in clean energy, some sub-sectors will surge while others will wilt.

Happy New Year!

The following are our 10 detailed predictions for 2009, compiled by the New Energy Finance research, editorial and analytical teams.

1. Overall investment grows, but not by much

Last week we published our final investment figure for 2008, showing a total of $155bn, some 4.4% higher than 2007 and slightly ahead of the preview estimate we released in November. However, 2008’s growth was driven by a very strong first half; by Q4 the public markets were largely shut and asset finance was down around 25% on its peak levels in the last quarter of 2007.

We have said before that in order for carbon emissions from the energy sector to stop growing before the end of next decade, clean energy investment will have to quickly reach $450bn a year. The best we think we can hope for in 2009 is a modest step beyond 2008’s levels.

2. Public valuations recover some lost ground

Stock market valuations for clean energy companies took a fearful knock in 2008. The WilderHill New Energy Global Innovation Index (ticker symbol NEX), fell 61% on the year, and at its worst point during November was down more than 70% on the year. Since then it has rallied by about 25%, perhaps driven by an Obama bounce.

We know better than to try to predict the immediate direction of the stock market. But by the end of this year, we do expect clean energy share valuations to be higher than their levels at the start of 2009.

It won’t be a smooth ride. 2009 will see further spells of high volatility, driven by hopes of recovery and fears of disaster, unfounded rumours and real surprises. Even so, the gyrations are unlikely to be quite as manic as they were last autumn.

The IPO market may return earlier than many investors expect. There is a pipeline of attractive companies waiting in the wings, hungry for cash, and with increasingly realistic valuation expectations. Any phase of steadier share price conditions, particularly if oil prices are a bit higher and there is a decent flow of news on fiscal support for clean energy, and we may see them test the waters.

3. Consolidation-driven surge in mergers and acquisitions

Technology suppliers with good cost positions should be able to attract cash from venture capital or private equity investors, or even from the public markets, if they have a strong story to tell. But if their progress has been slower than hoped, if they don’t already have a strong industry position and they are running out of cash, they will have no choice but to try to find a buyer or go to the wall.

Meanwhile, those larger energy and engineering companies with sound balance sheets and good access to the capital markets are likely to regard this year as a not-to-be-repeated opportunity to snap up promising technologies in a growth industry at relatively low prices. On some occasions, this may mean buying assets from insolvency.

M&A activity in clean energy was $57.2bn in 2008. We do not expect to see a vastly higher figure for 2009, but we do expect to see many more deals.

4. Tough first half, strong second half for wind

The continued lack of credit finance worldwide, and tax equity in the US, means that turbine manufacturers will see sharp falls in their order backlogs for the first two quarters of 2009. Good deals will still go ahead, backed by club debt deals, but it will feel like hard work. The second half year, however, should see lending freeing up considerably, with rates dropping, leverage increasing and a return to syndicated deals.

Overall for 2009, investment in the wind sector will fall somewhat below that in 2008. It will be a difficult year for project developers. Some will run out of cash and be snapped up by utilities and a few deep-pocked private equity and hedge funds. Turbine manufacturers will feel even more pain, particularly the smaller ones and those with less competitive technology. We expect to see 2009 end with fewer players than it started and many new entrants into the industry, particularly in China, will quietly disappear without ever shipping a turbine.

By the end of the year, however, the industry will be in good shape for a return to robust growth in 2010. Turbine prices will be lower, helped by lower steel prices and the elimination of marginal players, new policy support will be in place in the US, and some ambitious projects – including some offshore mega-projects – will be ready to leave the drawing board and commence construction.

5. A dramatic year of consolidation and falling prices for solar

We have been saying for a while that silicon will go from shortage to surplus by the end of 2009. A wave of silicon from investments in capacity over the past few years is now reaching a market freshly deprived of cheap credit. The long-awaited surplus is here, just as thin-film manufacturers have started to reach industrial scale.

As a result, we expect solar module prices to fall by anything up to 40% in 2009. Any cell or module manufacturer without good cost economics and a strong balance sheet is going to be looking for a new parent in hurry. Some new-entrant silicon producers will exit the business before even powering up their plants.

The recalibration of prices will drive strong growth in installed capacity, although dollar value will follow more sluggishly. This will provide a lifeline for solar project developers, who should find that, as long as they can access finance, which will become increasingly available as the year progresses, equity returns remain just about acceptable.

Solar installers, meanwhile, should see the first stirrings of a boom in residential and commercial demand, particularly in the US. They should not, however, make the mistake of thinking theirs will be a high-margin activity in the long term.

In solar thermal electricity generation (STEG) there will be a flight to quality, with only strong projects, developed by strong teams with strong technology, finding backers. Other projects will be quietly put on ice, waiting for an era of proven technology and cheaper debt.

6. A (relatively) quiet year for biofuels

For European and North American biofuels, the focus of the last two years has been to sort out the mistakes of the previous two years. 2008 started with a raging controversy about biofuels pricing the poor out of the food market, although in fact – as we showed – it was only a minor culprit. US ethanol producers were caught by the soaring cost of corn feedstock, and then, later, when corn fell, by tumbling gasoline prices that dragged ethanol prices down with them.

Next-generation biofuels, meanwhile, proved a lot harder to scale up than their many boosters hoped, and Europe quietly watered down its commitment to renewable fuels by imposing new and more stringent environmental conditions.

Meanwhile in Brazil, ethanol started 2008 looking like a sure bet, with a cost position and environmental footprint orders of magnitude better than its Northern Hemisphere rivals. But then it too got caught, as ambitious expansion plans fell victim to the credit crunch and the collapse of the Real. By the end of the year, new plant construction was largely on hold, distressed companies were being put out of their misery and the government was underwriting the costs of planting the sugar cane harvest.

By comparison, 2009 will seem like a quiet year. Consolidation will continue in first-generation biofuels; investment will continue in cellulosic biofuels, based both on scaling up plant sizes and on basic research. One particularly bright spot might be algae-based biofuels, which continue to show great promise, in particular perhaps being the best hope for aviation. But even there we are unlikely to see scientists shouting “eureka” and streaking naked out of the lab.

7. A hot year for geothermal

Of all renewable energy technologies, traditional geothermal – based on natural sources of steam – is the only one that can provide truly reliable base-load power allied with competitive generating costs today. Its development is limited only by the availability of suitable geothermal sites and, for the past few years, by the high cost of drilling rigs.

Surging oil prices over the past few years meant that exploration rigs were being fought over, and rates were sky high. Not any more. The collapse in oil prices during 2008 has led to a slump in exploration and development activity in the oil and gas sectors more dramatic than any slowdown in clean energy project development.

So 2009 should be the year in which the lowly geothermal sector gets its hands on drilling rigs once again, and lays the foundation for a surge in capacity over the next few years. Financial sector enthusiasm, held back temporarily by the problems of Icelandic bank Glitnir, will gather pace.

8. Choppy conditions for marine

Marine energy – wave and tidal – lags far behind wind energy on the industry maturity curve. Its supporters have long argued that its superior energy density and, in the case of tidal, better predictability, make it a more attractive bet.

There are now more than 100 entrepreneurial firms striving to develop the market-leading wave and tidal technologies of the future. A proportion will fail this year, but there will also be new entrants.

Leading firms have made decent progress with device testing and early projects, and the coming year should see data emerge on reliability, hardware costs and capacity factors. We should see some larger projects given the go-ahead during the course of the year, with Portugal, Ireland, the UK, China and Canada all pushing hard for industry leadership.

We may see some big energy equipment providers making a play for the more advanced start-ups, as they position themselves to scoop up some of the fiscal largesse that will be showered on the sector. And some start-ups may not mind being targeted, because scaling up will mean raising ever large dollops of cash, and building wave farms is more fun than doing investor road-shows.

9. “Digital energy” grabs the spotlight

Smart meters have begun to get a lot of attention over the past few years. If consumers know what drives their electricity use, the theory goes, they will consume less energy. At the same time utilities will be able to match supply and demand, and read meters remotely. But the changes we need to see go far beyond just smart meters. There is no way we can reach aggressive targets of 50% and 80% renewable electricity without a fully smart grid: you can feed a few percent of renewable energy into the current grid without too many problems; go beyond that, however, and the network becomes unstable. The smart grid is about load balancing, network optimisation, fault detection, intelligent dispatching.

Even that, however, does not fully capture the scale of the transformation that we are calling digital energy, which will be analogous to the transformation which swept through media and telecoms over the past two decades. From beginning to end, infrastructure is going to switch from largely analogue to largely digital. The resulting data volume is going to go up by many, many orders of magnitude.

The spread of digital energy will have profound implications not just for utilities and meter manufacturers, but for telecoms network providers, mobile phone operators, software companies, sensor manufacturers and many others. Even the car industry will be drawn in, as plug-in hybrids become pervasive and have to be integrated. The profundity of the challenge is not well understood – certainly not in the business and policy communities. Huge value will be created and destroyed. That is why New Energy Finance is kicking off a one-year Digital Energy Research Consortium to bring together senior executives from all of the industries likely to be affected, and we welcome interested participants.

Back to 2009. This year will see interest soar in smart metering and the smart grid. The draft Obama plan includes no less than $11bn for smart grid investment. Overall, venture capital will grow fastest, as investors realise that digital energy represents an investment opportunity that is not only huge, but plays to their traditional skills in software development – unlike many of the other investments that they have made and which are now burning a hole in their cash piles.

10. Clumsy climate change compromise in Copenhagen

2009 is the year everyone on the international climate change negotiation scene has been waiting for – billed as a make-or-break year for a new deal if there is to be a smooth succession after Kyoto falls away in 2012. It is also the year when there is finally a new face in the White House to return the US to the negotiating table.

While we certainly expect the Obama administration to take a much more constructive line than its predecessor, we find it hard to be entirely optimistic about a good new deal emerging in 2009. The recent COP/MOP meeting in Poznan ended with little to show, not just because Obama was not there, but because the process is bogged down in the minutiae of all the issues that have been lumped into the pot over the 16 years since the Rio Summit. Sadly this is an inevitable outcome of such a complex set of instruments.

We might see the emergence of a deal in Copenhagen, but if we do, sadly, it is likely to be either an ugly compromise, or something that can be spun as a deal but in truth might not go much beyond the position papers released by the G8 in Gleneagles or the Bali roadmap. It is entirely possible that Copenhagen simply ends without agreement – the Doha Round of world trade negotiations were also up against a deadline and ended in failure. Either way, it is highly likely that 2009 will finish without a full picture emerging of the successor regime to Kyoto, and that uncertainty will continue into 2010.

But a successor to Kyoto is not the only show in town. A more likely outcome will be a set of unilateral commitments to reducing emissions bound together by a common agreement on the Clean Development Mechanism. The EU has already committed to targets to 2020 and Australia is putting in place similar targets which we expect to be formally signed off in 2009. In the US with Obama in power we expect Congress to make more rapid progress towards a federal cap-and-trade system, although in truth no legislation is likely to be passed until 2010. What does emerge is almost certainly going to be lenient in its early years so as not to threaten coal and heavy industrial interests, and with large emitters excused from buying permits for several years. But beyond that the targets will get tougher. As is often the way with political commitments, shuffling the tough targets into the future is an easy route to take as it avoids any near-term pain to the current administration.

Of course it is possible that President Obama and his new team will put something dramatic on the table, something that really changes the shape of the negotiations in Copenhagen in 2009. Otherwise we are likely to see the gradual emergence in 2009 of a consensus amongst developed countries of incremental commitments in the near term coupled with more ambitious targets set sufficiently far into the future to avoid harsh costs in the short term – and of course to enable incumbent politicians to put off the evil hour.

So those are our 10 predictions for 2009. We will stand accountable for them in December.

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