Southeast Asia’s renewables: Ignored no more?

The Journey to renewable energy in Southeast Asia has been long one for Singapore-based clean energy specialist Armstrong Asset Management. The private equity player has been following the sector since 2005 - when it started to see the formation of a supportive legal and regulatory framework but there wasn't sufficient LP interest in a specialist cleantech vehicle.

Investor appetite changed three years later when the Asian Development Bank (ADB) - now one of the leading LPs in Southeast Asia's cleantech funds - launched its dedicated sustainable energy investment program. However, the 2008 global financial crisis prolonged Armstrong's wait and it wasn't until quite recently that the firm finally launched its maiden fund with a target size of $150 million.

The ongoing interest in Southeast Asian cleantech from Armstrong and a few others can largely be explained by ambitious government clean energy targets. At the same time, an immature investment environment, a heavy reliance on state-driven incentives and the generally smaller scale of projects have created obvious obstacles for private equity and venture capital players.

"We have seen lots of opportunities in Southeast Asia because it is a segment largely untapped," says Toru Kubo, principal climate change specialist and head of the carbon market program at the ADB. "However, the investment ecosystem doesn't really exist and there has been a vacuum in the venture capital space."

Energy demands

There is no denying that Southeast Asia is becoming a significant energy consumer on the back of strong economic growth. Since 1990, energy demand in the region has doubled and is expected to grow by another 76% by 2030. To accommodate these needs against a backdrop of high oil prices and concerns on fossil fuel combustion, governments have pushed for expansion of the renewable energy sector.

Hydro, geothermal, biomass and biogas are currently the most popular segment. According to a recent report by Ipsos Business Consulting, hydro accounted for approximately 38% of the total installed renewable energy capacity in 2010, followed by geothermal (32%) and biomass & biogas (29%). However, if plans drawn up by the region's governments are strictly followed, the solar and wind shares will increase substantially to 12% and 18%, respectively, by 2030 from their current negligible levels. This will drag down the market share of the top three.

"The available renewable resources in Southeast Asia are significant and remain largely unexploited, with realizable potential being about 12 times the current deployment," Andrew Affleck, managing partner of Armstrong Asset Management, tells AVCJ. "We are particularly excited by the prospects for solar investments in Thailand and Malaysia."

According to official targets, Indonesia, Malaysia, Thailand, the Philippines and Vietnam will install an additional 32 gigawatts in renewable energy capacity between 2012 and 2025. This represents more than $70 billion of investment, most of which is expected to come from the private sector. Thailand has also established a 10-year renewable energy development plan, which aims to increase the renewable share of total energy consumption to 25% by 2021. Fossil-based fuels currently account for more than 90%.

Financial incentives are undoubtedly in a state of flux as governments figure out how to meet their ambitious targets. Tax holidays, subsidies, power purchase programs and feed-in-tariffs (FiTs) - a tariff structure that pays energy producers premium rates - feature strongly in wefforts to attract more private sector involvement in Southeast Asian countries.

Policy support was instrumental in persuading Partners Group to invest in Wind Energy, a Thai firm that provides utility-scale wind farms, alongside corporate investors Chubu Electric Power Company, Ratchaburi Electric Generating and Demco. The wind farms are currently protected by power purchase agreements for small power producers granted by the Electricity Generating Authority of Thailand. An FiT is also available to certain projects during the first 10 years of operation.

For the same reason, Middle East & Asia Capital Partners (MEACP), which was set up by Mumtaz Khan, former manager of the $730 million Islamic Development Bank Infrastructure Fund, also rolled out a $500 million vehicle for clean energy ventures in Southeast Asia.

"The fund doesn't invest in technology, manufacturing and carbon, but only focuses on renewable power generation as they are supported by power purchase agreements and FiTs," says Khan. "In most cases, returns can be higher than traditional thermal power generation projects."

Small investments

As in many developed countries, cleantech investments tend to start small, so government incentives often focus on facilitating early-stage eco-friendly projects rather than creating an ecosystem for a pipeline of larger enterprises.

For example, the Thai government implemented the Very Small Power Producer Program (VSPP) in the early 2000s to promote investment in privately-owned renewable energy projects of up to 10 megawatts of energy. These providers link directly to either the Metropolitan Electricity Authority (MEA), which provides electricity to consumers in Bangkok and its surrounding areas, or the Provincial Electricity Authority (PEA), which provides electricity to the rest of the country.

To capitalize on such opportunities, MEACP targets an average ticket size of $10 million, with a majority of energy projects around 10 MW. Armstrong has similar objectives, with investments ranging from $5 million to $15 million. "If you are looking at projects that are larger than 10 MW in Thailand's solar and Indonesia's hydro sectors, you are required to negotiate a power purchase agreement on an individual basis, which could take longer to agree on terms and potentially be less attractive financially," Armstrong's Affleck says.

Although the immature LP base in Southeast Asia means there is greater reliance on foreign capital, large overseas investors are still reluctant to back small vehicles. Multilateral institutions, which back clean energy for public interest reasons, continue to feature prominently.

According to AVCJ Research, nine cleantech funds cover Southeast Asia - with target sizes ranging from $75 million to $500 million - have been launched in the last five years. None has reached a final close, despite participation from the ADB, the International Finance Corporation (IFC) and the Overseas Private Investment Corporation (OPIC). Similarly, the region has only seen 11 private equity-backed transactions during the same period, with a total value of $129 million. This represents one fifth of the total private equity spending in Southeast Asia's consumer market in 2011.

No track records

Another obstacle is that cleantech GPs - many of who are first-time fundraisers - find it difficult to persuade investors to commit capital when no one has an established track record in the sector. Even large-cap pan-Asia funds, which have the capacity to allocate a certain portion to clean energy, prefer to invest in less complicated areas that are more closely aligned with consumer growth.

"There is a mismatch between LPs and GPs but people should understand clean energy is more conducive to a specialized team rather than large players," says MEACP's Khan. "If you have a $1 billion fund, you cannot possibly do a $10 million investment as you will need to devote the same amount of time and effort for smaller investments."

Apart from a tough fundraising environment, clean technology in Southeast Asia - as well as in many parts of the world - remains a political play, largely dependent on public interest and heavily backed by governments and non-profit organizations. It is still questionable whether such government incentives are transparent, sustainable and effective enough to attract private equity investors with long-term horizons.

"Government incentives undoubtedly enable a market of certain size for renewable energy, which helps the diffusion of technologies," says ADB's Kubo. "However, these technologies might not attract sufficient capital domestically and need support through measures such as government R&D and public-private-partnerships, which are not happening so much here when compared to China or India."

As Southeast Asia still lacks an ecosystem for advanced innovations, Armstrong's Affleck says his fund will only back proven technologies, as market observers have indicated that it is neither necessary nor advisable to take technology risk.

"There have been a number of high profile business failures further up the chain in relation to businesses involved in the manufacturing of solar panels in Europe and the US," says Affleck. "In practice, competitive forces, primarily from lower cost manufacturing in China, have however led to substantial reductions in panel prices and increased opportunities for solar power generation projects."

Nevertheless, until technologies advance to an extent that renewable energy becomes economically sustainable and conventional energy prices increase to a level at which renewable becomes relatively less expensive, industry participants expect renewable energy to remain uncertain and government-dependent.

"Investors are still skeptical towards alternative energy because the sector hardly has a track record and is more policy-driven," says Peter Kennedy, head of CLSA Capital Partners' $200 million Clean Resources Fund. "We largely stay away from energy but focus on more market-driven clean resources sector such as water, sustainable agriculture and recycling."

Consolidation

Whether a fund is investing into renewable energy or other clean resources, managers generally agree that it is important to deploy an aggregation strategy, whereby small projects can be scaled up to an extent that allows investment realization, whether it is an IPO or a trade sale.

"Investors come in and they need to make sure there are plenty of investment options," says ADB's Kubo. "The capital markets in some countries in Southeast Asia still lack maturity and depth, meaning the region is not providing sufficient exit opportunities for investments."

To secure potential exits, some GPs have looked into partnering with large corporates in China or India or forming joint venture with local players in Southeast Asia. Others are also in the process of consolidating various small projects to form larger companies.

MEACP Clean Energy Fund is a case in point. It is creating its own EPC (engineering, procurement and construction) contractor that will construct small operational renewable projects with a view to subsequently bundling them together and the selling the consolidated asset to large-scale energy corporations from the US, Europe, South Korea and China.

The private equity player is also nearing completion of an investment in biomass and hydro projects in Asia. "If you have a 6 MW hydro project, clearly it cannot go public," says Khan. "But if you add ten of them together, all of the sudden you get 60 MW and now it becomes attractive."

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• Topics
• Cleantech
• Southeast Asia
• Cleantech
• Asian Development Bank
• IFC
• Armstrong Asset Management
• Middle East & Asia Capital Partners