Climate change has been on investment banks’ radar screens for more than a decade. But the promise of high returns from the renewable energy sector has until recently failed to materialise.
Progress has been hindered by regulatory tussles about emissions, unproven technologies, weak performance from some public companies, difficulty in valuations and patchy investor demand.
However, investment bankers expect this year to be the one when the sector delivers. They spent the past 12 months building their teams to take advantage of the well-financed wave of companies focused on emissions technologies, clean coal and other forms of new energy technologies.
John Cavalier, head of alternative energy investment banking at Credit Suisse, said: “Some people say this is a bubble and a fad. We know this is for real and people need to understand that climate change is a scientific reality. We believe the drivers today are permanent drivers.”
Andrew Safran, global head of energy, power and chemicals investment banking at Citigroup, said: “The alternative energy sectors, while not huge today, will become important for us.”
Most of the large banks, including Morgan Stanley, Citigroup, Merrill Lynch, Credit Suisse and Goldman Sachs, have between 10 and 20 full-time staff devoted to the sector. The heads of these groups have proceeded with caution and despite a few hires, such as the move of Jim Metcalfe from Lehman to UBS, most staffing has come from internal moves.
Citigroup started a renewable energy task force 18 months ago. Credit Suisse and Merrill Lynch have created bank-wide committees to oversee clean technology efforts that range from Asia to the US and include sectors such as utilities, industrials and food and beverage.
The banks are also making principal investments in the sector and boosting their carbon emissions trading desks.
Parker Weil, co-head of the Americas energy and power group at Merrill Lynch, said: “Co-ordination is critical to ensure the firm is consistent in the technology bets we make around the world.”
Factors boosting the importance of clean technology include the rising price of oil, which touched $100 a barrel last week, the high cost of building coal and nuclear plants and the political focus on global warming.
Even the US, with the Lieberman-Warner climate change bill, and China, with Premier Wen Jiabao’s vow to plough $300bn (€204bn) into energy-efficient and environmental-friendly sectors, are beginning to join the global consensus on measures to tackle climate change.
But Europe remains the standard-bearer, according to Kevin Genieser, head of the alternative energy practice at Morgan Stanley. He said: “Europe took the lead in developing clean energy technologies, which were much more accepted there. Europe was quick to recognise the potential for growth.”
Between 2002 and 2006, clean technology investing tripled to $63.3bn, according to New Energy Finance, an industry research group. Weil said: “My sense is the sector will continue growing, supported by the tremendous amount of capital that has been raised by funds looking to invest in renewable energy.”
A fund from Riverstone, a private equity company specialising in the energy and power sectors, is looking to raise up to $4bn, according to market sources.
Tim Kingston, head of power and renewable energy investment banking at Goldman Sachs, said: “We recognised early on the importance of clean energy, particularly as it relates to clients across several industries, including utilities, unregulated energy, technology and general industrial.
“We are also involved with the venture capital community in California to help further develop opportunities.”
There is more worldwide recognition of climate-change issues as well as a greater financial infrastructure to support it. The large investment banks are working with exchanges to support markets for renewable energy.
Last month, the New York Mercantile Exchange created the Green Exchange to provide futures, options and swap contracts for markets focused on climate change and renewable energy.
The venture includes Morgan Stanley, Credit Suisse, JP Morgan, Merrill Lynch, Tudor Investment, Icap, Constellation Energy and Evolution Markets. The market will start trading in the first quarter and is expected to be an official exchange within a year.
In addition, Credit Suisse is launching the Credit Suisse Global Alternative Energy Index this month. Last year, new energy companies launched equity offerings, including initial public offerings totalling $20.8bn, triple the volume in 2006, according to investment banking research provider Dealogic. That reversed a three-year trend in which equities volumes for clean technology companies fell steadily.
Cavalier said: “When you have growth rates of 35% to 40% annually in solar and wind and you see about $75bn in capital spent last year growing to $100bn, you sense there is going to be a large amount of capital markets activity to fund the growth rate.”
Investor demand appears to be improving globally for public financings. In December, the $6bn IPO of alternative energy spin-off Iberdrola Renovables was 1.5 times subscribed by international institutions and sold 65% of the offering to institutional investors outside Spain.
Yingli Green Energy held a $173.6m follow-on and a $150m convertibles offering in December 2007; the follow-on was priced 182% above the IPO price from six months earlier. The convert lured 115 investors who made the offering seven times subscribed, according to the bookrunners.
But it is rare to find companies seasoned enough to go public. Safran said: “In mature businesses, you are valuing a lot of companies at a multiple of cashflow. In the alternative energy sector, you do not have cashflow because the companies are in their infancy or growing.”
The sector is small and highly fragmented. The market capitalisation of the renewable energy sector is less than $1.3 trillion, according to Morgan Stanley. Renewable energy makes up less than 10% of the revenues from the energy groups of most investment banks.
In addition, the technologies have impediments. There is a backlog for manufacturers of wind turbines, for example. Ethanol is too corrosive to ship through pipelines. Geothermal power from geysers cannot travel far. Solar power is waiting for more efficient fuel cells. And coal gasification is an unproven technology.
Performance has been variable among sectors. While ethanol was a notable bust, solar companies have performed better. Credit Suisse said the market capitalisation for pure-play solar companies has jumped from $1bn in 2004 to $118.3bn.
The bank estimated the wind sector, which has been developing for more than 10 years in Europe and about five years in the US, could bring in annual revenues of $10bn to $12bn, most in commercial-bank debt.
Weil said: “Many projects will be funded through increased equity component, tax credits and more expensive debt. Increased debt costs of 100 to 200 basis points will decrease the equity returns of some of these projects but the overall need for renewable energy will justify the investment.
Most of the popular sub-sectors do not rely on debt, however. Throughout last year, the breakdown of investment banking revenues by product is confined to equities and M&A but includes debt funding.
Between 2005 and 2007 Credit Suisse’s renewable energy team underwrote 14 debt financings, advised on 13 M&A deals and worked on 20 follow-ons and IPOs. Citigroup’s team has done 15 transactions in M&A and equity.
No bank dominates the renewable energy sectors. The top five advisers in renewable energy mergers in 2007 were Goldman Sachs, Citigroup, Deutsche Bank, Lexicon Partners and ING, according to Dealogic.
In the pitchbook that Credit Suisse provides to clients, the bank ranks itself among the top three leaders on deals worth more than $50m, holding court at the top of solar volume with Morgan Stanley, wind volumes with Goldman Sachs and ABN Amro and biofuels between Morgan Stanley and UBS.
The global nature of the business provides an opening for banks that might be listed in the second-tier in M&A and equities. ING, Dresdner Kleinwort and ABN Amro appear prominently in alternatives because of the importance of the Netherlands and Germany to the wind, solar and biofuel sectors.