The New Business Model For Cleantech Investment

Jan 12 2009 | 12:29am ET

By Peter C. Fusaro, Chairman, Global Change Associates -- Emerging markets for environmental financial investment and trading are attracting significant investment interest but little capital as of yet.

A mere $5.18 billion was deployed for cleantech investment globally in 2007, according to the Cleantech Venture Network. U.S. energy companies committed only $4 billion for research and development and the U.S. Federal Government spent just $7.5 billion in research and development during 2007. Investment has been held up by the regulatory uncertainty of the U.S. on federal climate change legislation. That is now going to change with the incoming president and his new administration.

Traditionally, private investment has come from the venture capital world, which typically has the requisite patience to invest in projects for as long as the 10 year-life of venture capital funds. More recently, this area of investment has attracted large hedge funds. Hedge funds don’t have that much patience and usually look for more immediate arbitrage opportunities. But they are now investing in many clean energy technology projects. Private equity funds are monitoring the space but have not yet deployed much capital into this emerging market sector. The reason for this is the clean technology sector is not well researched and they can get returns from distressed asset plays rather than investing in unknown financial markets with riskier returns.

As markets change, so do investment models. The new business model that has emerged for investment in alternative energy and clean technology is a hybrid of venture capital, hedge funds and private equity. Investment is locked up for shorter periods of time—from two to four years—rather than the traditional venture capital time periods of up to 10 years. Coupled with the project orientation of the investment, there is also a dimension of credit trading for emissions, carbon and renewable energy included in this investment strategy. The blurring of the lines between hedge funds and venture capital is also being exacerbated by significant private equity participation in environmental finance.

Market Drivers Create Perfect Storm For Cleantech Investment

Three global market drivers—sustained higher energy prices, accelerated technology shifts and increased environmental concerns—form the perfect storm for clean technology investment. Falling renewable energy costs are also increasing investment opportunities in this sector as are government mandates for renewable energy deployment in 27 states. To put this clean technology market in some perspective, we must look at its origin, what is driving it and where it is headed in the foreseeable future.

This will be both a market and a regulatory drive. While there continues to be a focus on the regulatory regime, greater energy demand is pushing out cleantech products faster.

Good venture projects for the clean technology space need three elements to be successful. These are defined as: a revenue stream, a seasoned management team to grow the business, and a defined exit strategy (usually by an initial public offering, trade sale or roll up).  Building a business to scale and commercializing it is very different than funding research and development efforts that are really science projects. In fact, some of the currently funded technologies are so debt ridden that they will never be commercially viable. Moreover, their cost structure will require an ability to significantly reduce costs in order to become commercialized. They cannot depend solely on the “environmental kicker” of emissions reductions (called offsets) to a project economically viable. These are additional benefits for a business, but are not the reason for that business to exist.

Climate Change Regulation To  Boost Investment

The climate change train has finally arrived at the station. Within the next year, the U.S. will finally pass federal climate legislation. This regulatory certainty will provide the financial certainty needed for investors and companies to deploy hundreds of billions of dollars in both U.S. and global infrastructure projects.

Although we presently have mandatory greenhouse gas reduction regimes in the Northeast and West Coast, only the U.S. Senate can ratify international climate change treaties. This point of constitutional law is critical to address global climate change remediation. That development is going to unleash the capital needed to scale new technologies to profitability and for global deployment. And these technologies are not just home grown in the U.S., but will come from China, India, Israel and South Africa and Europe. We are just getting started as capital and projects begin to scale.

Climate change regulation in the U.S. will also add an extra dimension to the drive for greater energy efficiency and reduction of carbon emissions footprints.  There is clear movement of capital into “carbon finance,” but it is not very well followed in the United States.  This extra dimension of monetization of carbon credits for green project finance will increase ROI for many projects.  More energy efficiency and renewable projects will take root as technology continues to shift and the regulatory scheme for a less carbon intensive world takes hold.

This triple convergence of carbon emissions, renewables and energy efficiency offers multiple risk arbitrage opportunities as well as many revenue streams. They are obviously interrelated as in using more efficient technology reduces the emissions footprint. Similarly, using renewable energy can reduce the carbon footprint of power stations, for example. The low hanging fruit of climate change carbon reductions may be energy efficiency, but there are many opportunities to invest across a wide spectrum of technologies.

As this investment sector is getting started, a new asset class has emerged and it is called “green.” The rapidly evolving renewable energy and clean technology industry offer attractive investment opportunities. While some funds focus on early stage investment, many funds are focused on mid/later stage development and desire to provide developmental capital to fund expansion and scale of operations. There are opportunities across the value energy and environmental chain.

The new green business model is blurring the lines between hedge funds, private equity and venture capital. The arbitrage opportunities combined with the building out of new projects will lead to more incentives to invest in clean energy and clean technology.  However, this is a transition that defies a quick fix. It will take decades to remediate the environmental damage done and shift to the more environmentally benign technologies of tomorrow. But the good news is that global investors are now focused on this sector.

Peter C. Fusaro is the best selling author of What Went Wrong at Enron and is an energy industry thought leader noted for his keen insights in emerging energy and environmental markets. He co-founded the Energy Hedge Fund Center in 2004. The market is now mature enough to offer a directory of over 100 green hedge funds. For more information or to order go to www.energyhedgefunds.com


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