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Renewable energy - a light in the gloom

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Al Gore has done his bit to raise awareness of the need to reduce our reliance on carbon fuels. And energy independence was a key debating point during the presidential elections in the USA. So it should surprise no-one that the clean energy sector is poised for strong growth. What may have escaped the casual observer is that the sector has genuinely come of age in terms of the technologies employed and the policies implemented by governments over the years since the Kyoto agreement. Now the stars are aligned for highly attractive investment opportunities.

Technologies for the development of solar, wind, biomass and hydro are now well-established and proven, reducing risks for investors in power generation assets based on these technologies. Government policy is supporting this growth. A Directive by the EU compels European governments to achieve a 20% weight of renewable energy within total energy consumption by 2020. If we consider that, as of 2005, only 8.5% of energy consumption was from renewable sources, it is clear that growth in renewable energy over the next decade is in effect guaranteed by the force of law. 

Australia, New Zealand and Japan, as so-called Annex I countries under the Kyoto protocol, have committed to certain targets for lowering green-house gas emissions over the period 2008-2012, while non-Annex I countries of -mostly- emerging Asia are able to obtain certified emission reduction credits on environment-friendly CDM projects which can be sold to Annex I countries for good revenue. Combine this with other favorable policies for clean energy such as feed-in tariffs (government-guaranteed prices for the clean energy put on the grid by the power generator), tax incentives, subsidies and mandatory off-take arrangements, it makes for a favorable cocktail where investment in a solar power station or a wind-farm can generate long-term, stable, inflation-adjusted, government guaranteed cash-flows.

As the debate on energy independence in the US presidential election suggests, the move towards renewable energy is not solely driven by environmental concerns. Clearly the wish to lower dependency on energy supplies from unfriendly nations is another important driver towards alternatives. The latest tensions between Russia and Georgia with its potential repercussions for the energy supply via the Caucasus have brought this point home to policymakers in Europe as well.

Meanwhile investors have slowly started to appreciate the potential opportunity provided by the renewable energy sector as not only a responsible, but also a money-making proposition. In Japan, power companies, trading houses and the government-sponsored banks traditionally involved in project finance have been first movers in taking an interest in the risk capital of renewable energy projects often setting up dedicated subsidiaries to engage in project development of solar projects and wind-farms. Eurus Energy for example, 60% owned by Tepco and 40% by the Toyota-group trading firm Toyota Tsusho, has nearly 1500 MWatts of wind-park capacity in operation, half of which in Europe, making it a power-house in more than one sense. In solar, the prominent Japanese manufacturers (Sharp, Kyocera and Sanyo appear in the top five global market share league table for solar cells), appear to be considering whether the low barriers to entry and thinning margins of the solar cell industry could argue for further downstream diversification into developing and operating solar parks.

Meanwhile, it remains to be seen whether the renewable energy investment theme will catch on with the main-stream institutional investor community in Japan. Investment in renewable power generating assets usually takes the form of private equity where investors give up liquidity for the volatility that comes with listed markets. Innovative pension funds elsewhere have clearly moved fast while the spoils are rich, as can be gauged for example from a glance through the 2007 annual report of Dutch pension giant APG. Together with PFZW, the second largest Dutch pension fund, APG committed EUR 500mln to the Ampere Equity Fund which takes equity stakes in tens of renewable energy projects in Western Europe. Private equity and, to a lesser extent, general infrastructure have found a place in Japanese institutional portfolios but especially the former category has started to feel the credit pinch as deal flow is slowing down in mainstream markets and capital commitments remain un-drawn. The financing conditions for renewable energy projects however have hardly moved since the credit crisis broke out due the low risk nature of the cash-flows as they are government guaranteed: a typical solar project can still issue debt of up to 85% of project value at costs of around 1.5% over the risk-free rate. Project IRRs of close to 10% without the volatility expected in other parts of financial markets will conceivably entice Japanese institutions to take a fresh look at this pocket of growth and stability in what otherwise remain challenging times for investors.

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