Cleantech: Moving beyond subsidies

Nicholas Parker, co-founder of the Cleantech Group, and the man who claims to have first coined the term "cleantech," was equivocal in summing up the state of the sector at this year's AVCJ Forum: "The best of times and the worst of times."

Perhaps better described as an investment theme as opposed to a sector, cleantech straddles industries ranging from renewable energy to waste management. While 2011 stood out as a comparatively strong year, with cleantech accounting for 3.5% of all private equity investment in Asia, 2012 has been dismal. Investment stands as just $1 billion, less than half last year's total. There were 43 deals and their combined value made up 2% of PE investment in the region.

On the plus side, institutions like the International Finance Corporation (IFC), the World Bank's investment arm, remain upbeat about cleantech and are looking to increase their exposure.

"The future is here and the future is relatively bright for cleantech," says Nikunj Jinsi, global head of clean technology at IFC. Jinsi oversaw around $ 1.7 billion of investment in cleantech worldwide in each of the last two years and IFC wants to dedicate 20% of the $20 billion it invests globally to "climate smart" technologies.

While large multilateral institutions are highly favored as LPs, some fund managers argue that their participation is a double-edged sword. Cleantech suffers from an image problem with many investors put off by its apparent dependence on subsidies and government handouts. In this context, ties to the World Bank don't necessarily help.

"The public face of cleantech, unfortunately, is subsidies." said Christiaan Kaptein, head of private equity for Asia at Robeco. "I think bankruptcies like that of Solyndra [the solar panel manufacturers that shut down after receiving a $535 million loan from the US government] are not helping the sector's image. And then the reality is subsidies are a part of cleantech."
Renewable energy is the part of cleantech most closely associated with subsidies, in Asia and elsewhere. Yet global fossil fuel consumption subsidies reached $523 billion in 2011, up 30% year-on-year, compared to $88 billion in renewable subsidies.

The crux of the debate, however, isn't which sectors receive subsidies, but which sectors actually need them. According to the International Energy Agency, a combination of government incentives, falling costs, rising fossil fuel prices and, in some cases, carbon pricing, will push the renewable share of electricity generation grow from its current 20% to 31% by 2035. Have subsidies, therefore, done their job?

"Subsidies are becoming less and less needed," says Ron Mahabir, co-founder and managing director of Asia Cleantech Capital, who believes subsidies should be limited early-stage technologies. "When we started in 2006, solar modules were more than $5 plus per watt; today the average is $0.50 per watt."

Solar power is indeed a good example of power generation becoming so efficient that governments have begun to scale back their support. China, the world's biggest solar panel producer, reduced subsidies awarded to solar projects by 21% to RMB 5.5 ($0.87) per watt. The decision was based on a 75% drop in the cost of solar panel components in the last two years.

"Over the next 10 years, we will see solar becoming even more cost effective" says Andrew Affleck, managing partner at cleantech-focused GP Armstrong Asset Management. "With the average cleantech PE fund designed over a 10-12 year period, these opportunities will be a real driver. Costs relating to equipment supply, engineering procurement practices, HR management, quality control and installation are all continuing to decline."

Affleck hopes that solar can shed the need for subsidies and thereby become a more attractive proposition for investors looking to get into the cleantech space. To put it another way, the perception problems would be defeated.

Policy support

However, government policy has been just as important as subsidies in encouraging would-be renewables investors. The combination of urbanization and industrialization has seen energy demand soar in emerging Asia in the last two decades and the pace of growth is expected to remain high. Recognizing the challenges they face in terms of sustainable development, governments have responded by setting themselves renewable energy targets.

Indonesia wants 17% of its power to come from renewable sources within 10 years, compared to the current 10%; Thailand is targeting 25% from a base of 13%, while Malaysia wants to jump from 3% to 11%. India and China have both set targets for 2020: the former wants 15% of its power to come from renewable, up from 10%, while the latter is looking to go from 8% to 15%.

Governments have introduced a variety of initiatives to facilitate private investment in cleantech, including feed-in-tariffs, which among other things provide payments to small-scale green energy producers, tax breaks for energy companies and guaranteed electricity grid access for projects.
"Governments are learning how to improve policies that put place over the last five years," says Armstrong's Affleck. "Different departments are better communicating with each other and they are learning quickly using benchmarks from Europe and North America."

Thailand was the first country in Southeast Asia to encourage investment in large-scale solar power parks and has just completed the Solarta 3MW Sai Sena Solar Park in Ayutthaya, which is seen as a model project for the region. Private equity has subsequently taken an interest, with Singapore-based GP Equis Funds Group paying $200 million for a portfolio of Thailand solar energy assets last August.

Malaysia, meanwhile, has introduced non-financial support mechanisms such as power purchase agreements between electricity providers and buyers, and by investing in infrastructure to provide grid access.
In China, hydropower has gone beyond the need for subsidies completely. The industry has played a major role in government electrification programs for rural areas, but it still represents an opportunity for the private sector because the costs of small- and medium-sized hydropower assets - typically below 100 megawatts - are relatively low.

"I would say we are an anti-subsidy business because if I look our current portfolio, our single largest investment has been in small hydro power," says Dirk Long, founder and managing director of Olympus Capital, which invested $120 million in Zhaoheng Hydropower earlier this year.

Zhaoheng, which currently owns and operates small- and medium-sized hydropower assets with a total installed capacity of over 600 MW, provides power to China's emerging provinces and survives without cash incentives. "It works because it is the lowest cost source of power and gets the lowest tariff and it happens to works very well in the rural area we operate in," Long adds.

Then and now

Some GPs draw comparisons between cleantech today and the internet sector in the wake of the 2001 tech bubble bursting. While many investors have been turned off by early losses, as technology develops there is the potential of decent returns.

Furthermore, it is hoped that with time misunderstandings of the cleantech opportunity will clear. In recent years, certain segments have suffered from chronic overcapacity problems as investors rushed in without much thought to the scope and growth potential of the companies they were backing. In this sense, the fact that many GPs have withdrawn from the sector in recent years represents an opportunity for those who have dry powder.

"You want to be investing when the sector is in distress, not when everyone is clamoring for an opportunity, driving the prices up," says Asia Cleantech Capital's Muhabir. "It is a no brainer. Since 2006 this has been by far the biggest macro economic opportunity of our lifetime."

 

SIDEBAR: Cleantech investors - A changing LP base?

While no LP in their right mind would put money into a sector unless they expected a decent return, those investing in cleantech are often pursuing something more than just financial gain. The question for cleantech-focused private equity firms looking to raise their next funds is can they attract capital from outside of this narrowly defined group?

Armstrong Asset Management, which focuses on renewable energy project, reached a $60 million first close on its maiden South East Asia Clean Energy Fund last May. According to Andrew Affleck, managing partner at the firm, more than 50% of funding for private equity in the space is likely to come from development finance institutions such as the International Finance Corporation, the German Development Bank and the European Investment Bank. Each has a mandate to support emerging markets and sectors connected to climate change.

For many larger institutional LPs, cleantech is still a sector to avoid. "If you were to poll a group of LPs you would most likely find that many of them would like to invest more in this sector but are put off because there aren't enough GPs they feel comfortable with," says Affleck. "A fund like ours, because we are a new team that has come together, is still seen as a new fund, regardless of our individual experience."

Ron Muhabir for Asia Cleantech Alternate adds that family offices also typically account for a large part of cleantech-focused GPs' investor bases for similar reasons to the development finance institutions. "In general in Asia, the role of family office is increasing," he says. "They understand where the world is headed, they have a longer term view, and they want to have a positive impact. Most institutional investors are thinking on an annual basis and are looking to make absolute returns."

However, Armstrong's Affleck says he is optimistic that, as larger institutions such as IFC become more active in the space, it will set a precedent other investors. "That is the objective is to make investments where there is at the time not enough capital, they set a benchmark and if successful, more private capital comes into the space and their role is reduced," he says.

 

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