US renewable energy investments heading for crash

11 January 2010

The US renewable energy industry is being hindered by unrealistic targets and flawed financing strategies, writes institutional investor Karl Miller.

About two years ago I decided to take a long, hard look at this sector to see if there was any value to be had in the assets. What I discovered was a mix of controversy and exuberance. The first relates to the subsidies the US government is offering and the second refers to our need to change the face of the carbon economy. I began in earnest to try and figure out whether there will be meaningful input in the US renewable sector, or whether it will purely become a feel-good measure.

Unfortunately, a renewable energy crash is already in process. There is difficulty in securing financing other than government hand-outs, and utilities are under pressure to meet renewable energy targets and are therefore signing contracts with little idea of how this will pan out. Many of the projects are not financeable, there are still technological difficulties and environmental issues. After all the analysis and forecasts, I came to the simple conclusion that the maths does not work.

There are clearly hundreds of renewable energy companies in existence in the US, solely due to the subsidies on offer and whose long-term viability is extremely thin. When attempting to get to a 100 from nowhere in such a short space of time, you become reliant upon multi-million dollar subsidies, which involve creating a great deal of debt. Eventually, it will fall upon the utilities to create rate increases which will in turn lead to many assets being stranded.

The fragmentation in the US is much higher than in Europe; you have essentially seven or eight utilities in the European market, but over 250 in the US, so there is a much larger distribution network to take into account. In order for this to become a success, the US must have the ability to pass through substantial increase in rates to the end-user which is about as likely as saying the US will halt its use of coal-fired plants. It isn’t going to happen. What will happen is we will be left with stranded assets across the US which will become nothing but failures.’

Unrealistic targets

The US government is involved in areas it has no expertise. What we inherited from the Bush Administration was benign and barely touched upon a direction, apart from avoiding the Kyoto Protocol. However, how can we be expected to go from zero to 100 per cent? To start with, there is not enough funding at federal level, nor are there sufficient funds at state level, and to top it all off we are not technologically developed enough.

If we take California for example, it is setting itself a 33 per cent target to be achieved in a ten-15 year time frame. It is not even unrealistic; it is just plain ludicrous. There is absolutely no way it can happen. One can only think they have been counselled by somebody who has no idea. They can continue to try and push this forward but the problem we have is that we are incurring debt to do this which will eventually need to be paid off.

To follow the current path would be to follow a route to disaster. In my opinion, the vast majority of companies engaged in technology advancement should be backed by venture capital money not government handouts.

Pressure on institutional investors

Financing should only be private. There really is no rationale for any of these companies to be public unless you are an acquisition company taking end projects and creating portfolios generating cash flow. If you are in the stage of R&D or in the venture capital phase, you should be in private hands. If there are subsidies available, you should be applying to the government as a private company because public company models do not work for an R&D machine. We are funding public companies that really should not be public and should have focused on securing venture capital money with higher rates of return.

I think there is pressure upon institutional investors to put a certain amount of capital under management in the green sector and I see that by virtue of investors I have worked. They do not necessarily believe in the investment, but are obliged to put a certain amount of capital into this area. I think it is an impractical approach and one that will fail, and has failed to a certain extent, if you look at the ethanol and biodiesel markets. Take all the ethanol and biodiesel companies which went public and you will see there are very few that are still surviving.

New US energy policy

The Democrats and the Republicans have now started to face facts and are looking for a new direction, but President Obama faces a huge problem because he started off with a vast renewable energy plan which has now been usurped by health care reforms and is sitting on the wayside. Everybody is scrambling to try and get the energy sector in order without a clear direction.

The simple fact of the matter is that we do not have a great plan and the Obama Administration is freely admitting that they do not have anybody in the White House who has any expertise or credibility in the market.

There is no question we have to reduce the carbon footprint and I am totally in support of that, but we need to do it responsibly in stages and steps. The economy is preparing itself for an influx of huge bills from the stimulus package and healthcare reforms, so we are no in position to be hasty. I think we are going to see hundreds of millions of dollars wasted. We are also going to scramble back to natural gas in 18-24 months’ time and we will continue to scoot around the coal question. Over the next 15 years we will see a handful of nuclear plants built globally and natural gas fired generation plants growing because they are efficient and have a lower carbon footprint than coal.

Europe leading the way?

Over the last ten to 20 years, Europe has systematically implemented green initiatives. What they did not do is create new technologies overnight. The US has suddenly decided that we need to be green and expects that it can just happen. It can’t. It is very simple – there are only very few areas that can achieve grid connection and therefore many will crash. The problem is that half the technologies are not commercially scalable and that is what we need. We need projects that will make a different in the net generation output of the grid and if we cannot secure that, we’re not really doing anything good for the industry or the economy but creating feel-good factors for research and development outfits.

There is absolutely no question about the fact that we are going to have to embrace natural gas as well as accept the fact that we are still 50 per cent coal and there is not really any clean coal technology that works right now. My concern is that this has become a lobbying effort rather than a practical plan. When executives like myself, who buy and sell assets, and have been doing so for years, say we are heading for disaster – then we are heading for disaster. This is not to say we do not have nice wind farms or good solar parks, what it means is that our policy and the direction the money is going, coupled with the fact that we have hundreds of new companies accepting subsidies with no hope of achieving anything successful, is just creating an abomination in the market. I think we are going to have a heap of distressed energy projects and useless projects out there very soon.

I think Europe has a different characteristic to the US because it has a different control approach. Europe has always employed much higher end rates so from that perspective, the European consumer is better indoctrinated that the US consumer. In addition, the European marketplace has taken a staged approach over the past 15 years to development in the green sector. Do I believe Europe will be a success at renewables in any meaningful way? No. I think it will be a very marginal component of the energy industry in Europe. Let us take France as a good example; the country employs 60 per cent nuclear power, with the rest made up of hydro and coal. Will a few windmills change the outlook of its energy generation? No.

We cannot leap to 20 or 30 per cent renewable generation as it puts pressure on utilities to commit to unrealistic contracts. In addition, it puts pressure on the public utilities commission to agree to either funding the activities by rate increases or deny the utilities which provides problems in the capital markets because they do not want to provide equity to utilities where rate increases have not been seen. We need to work systematically and create additions on a much slower basis and ensure that we have sufficient grid transmission for new projects. I am a fan of environmentally friendly technology, let there be no mistake, but we will not achieve it if we carry on as we are today.

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