For any necessary project the biggest question is simple: is enough being spent on it? Certainly, money alone is not enough – good management and organisation can make each dollar stretch further, and the right intentions must be there if there is to be any chance of success. But these count for nothing without resources. Where large-scale effort is needed to develop and deploy new technological capabilities, money makes it all happen.
So, looking at the issue of environmental sustainability, is enough investment flowing? And what do we define as enough?
Some crude calculations point to the scale of the task. Until recently, the rule of thumb in the coal industry was that investment in new capacity cost about $1m per megawatt. Incorporating spending on research and development, the greater cost of alternative energy sources, and the need for entirely new infrastructure, $2-3m per megawatt might be required to replace existing energy sources with renewables. Given that the world currently consumes 15 million megawatts annually and is expected to consume two to three times that by 2050, $60-130trn of investment might be required.
According to the IPCC, in order to put us on track to get 80 percent of our energy from renewables by 2050, the world needs to invest $12trn over the next two decades.
Extrapolating to 100 percent of energy and the entire time period to 2050, assuming greater spending as the target date approaches, we come to a number of perhaps $40trn. Other bodies have estimated that $50trn will be needed.
Taking our estimate of the requirement as $80trn, we face an average annual spend of $2trn for 40 years. This is equivalent to spending about three percent of current global GDP every year. In a typical year, the total of all forms of investment across all sectors is about 20 percent of world GDP – and this number varies by a percent or so from year to year. The amounts needed for clean energy are daunting, but not out of reach – provided we start now.
There is, however, a long way to go. Global investment in renewable energy reached just over $200bn in 2010, a tenth of what is needed. This is on an exponential trend – up from $160bn the year before, and a mere $6bn in 1995. If such momentum continues, we should hit the required rate of investment by 2020. But without more government help, this trend is unlikely to continue. New industries often show spectacular rates of growth at first, but slow down when they are bigger. To ensure favourable development, we must understand the industry’s investment trends.
Where to spend
Bloomberg research shows the breakdown of investment in 2009. Two percent of new investment was in venture capital; 11 percent in equipment manufacture, financed via a mixture of private equity and capital market investment; a further 11 percent in small-scale distributed power generation; 15 percent in corporate and government R&D; and 61 percent in large-scale power generation, funded by project or asset financing.
Europe received 37 percent of investment from the financial sector, China took 25 percent and North America (principally the US) got 24 percent. Wind received 45 percent of investment, solar 25 and biofuels 14.
Corporations spend slightly more than governments on R&D. Both pure-play renewable energy firms such as Suzlon, Vestas and First Solar, and general engineering firms such as Siemens and Sharp, are involved. GE is breaking into solar power in a big way, thanks to its investment in research. It is starting to manufacture cadmium telluride thin film solar cells that can achieve 13 percent efficiency – three percent better than the industry average – and is opening a manufacturing facility that will be the largest in the world. The company expects to halve the cost of manufacture over a few years and may come to play a leading role in solar as it does already in wind.
In getting promising research through to practical application, the Bloomberg data may suggest that venture capital investment is a bottleneck. The reality is that venture capital investment is small-scale compared to other investment (less than two percent of all US investment in 2007), and many exciting funds are active in clean-tech venture capital.
Emerald Technology Ventures manages €300m of investment across a range of clean-tech ventures encompassing renewable energy, water purification and advanced materials. Its investments include Pelamis Wave Power, an Edinburgh-based firm producing wave-power harvesters that consist of huge cylindrical sections joined end-to-end, capable of flexing relative to one another, with hydraulics at the joints to capture the energy of wave-induced movement. These have been tested for Scottish Power and E.ON, and have been deployed in a small wave farm off the coast of Portugal.
Vantage Point Venture Partners has invested around $1bn in technologies ranging from solar cells and lithium-ion batteries to domestic energy efficiency. Generation Investment Management has invested $700m. Larger private equity and venture capital firms such as Blackrock and 3i have also established a presence in clean-tech investment; and PE players such as Climate Change Capital, Guinness Asset Management, and DIF support investment in ventures using more mature technologies.
How to spend
When it comes to exploiting the most mature technologies, project and asset finance are by far the most important investment vehicle. Project finance involves special purpose vehicles (SPVs) set up to build and operate a particular piece of utility-scale generation infrastructure. One or several industrial firms act as sponsors for the project and provide some of the equity capital, but the revenues of the SPV are ring-fenced so as to ensure they are available to repay all investors, while limiting the liability of sponsors in the event the project fails. The whole enterprise may operate under a government concession or with subsidies or tax breaks to support the earnings of the SPV.
Projects are planned so the total debt and equity invested are less than time-discounted earnings by a sufficient margin to support adequate returns. Given ring-fencing, an adequate buffer can be maintained between assets and liabilities to avoid default. The main danger is that the available wind or sunlight is less than expected: electricity produced (and revenue earned) is proportional to the cube of wind speed – meaning that 10 percent less wind generates 27 percent less power.
Private equity funds provide some of the equity capital for project SPVs, while banks provide the debt financing which represents the bulk of the investment. Usually one bank acts as the lead or arranger, hiring the relevant engineering and legal experts, with the investment then being split up between a syndicate of lenders. Leading players in this space globally include Santander, BNP Paribas, BBVA, BDNES of Brazil and the European Investment Bank. The UK is considering setting up a green investment bank of its own. Barclays, HSBC, JP Morgan and other big banks play a major role in project finance generally, but only a small proportion of this in renewables.
Everything possible needs to be done to support project financing of renewables, particularly given that fiscal politics may preclude purely public investment in coming years. There is a danger that new liquidity requirements for banks will militate against project finance investment, which tends to be long-term and illiquid. This needs to be avoided, especially considering that the underlying default risk of such projects can be minimised.
The geographical distribution of renewables investment reflects Europe’s successful initiatives to support the sector; despite the continent’s fiscal troubles, this support should not be reduced. The prominence of Chinese investment is more recent, and reflects a government push to compete in leading industries. If the US and China get into prestige-led competition in this area, so much the better for the industry.
In terms of technologies, it is natural that wind presently takes the lion’s share, since it is the most mature technique for harvesting renewable energy. Going forward, we would expect wind to be overtaken by solar; and for solar and wind generation, and technologies for energy storage, transmission and efficiency, to represent the main areas of investment. The current prominence of biofuels reflects misguided US subsidies for corn ethanol, which is inefficient and competes with food. This investment should focus more on other biofuels, such as those derived from waste or algae.
The industry is growing in broadly the right way and at sufficient speed; but we need to maintain momentum through more intensive government support for research and development into clean electricity, alongside higher taxes for emitting carbon.
