Listen to the podcast:
The worldwide financial crisis has upended the energy industry, slashing oil prices by two thirds and bedeviling financing for wind, solar and other renewable-energy projects.
But it’s not all doom and gloom. From Big Oil to renewable-energy startups, energy industry players who spoke at the recent Wharton Energy Conference reported that they are hustling to find a silver lining in today’s trying conditions.
Experts in renewable-energy sources bemoan the effects of the credit crisis, which has made financing for new ventures scarce. Loans that can be obtained come with very restrictive covenants. Public companies have found it nearly impossible to raise money by selling bonds or new shares of stock, and private-capital sources have shriveled as well.
According to Jason Hicks, managing director of Washington, D.C.-based Persimmon Tree Capital Management — which makes private investments in companies that develop renewable fuels, energy conservation systems and environmentally friendly technology — the values of privately held firms tend to adjust more slowly than those of public ones. With price drops lagging the falling market, his firm is now very conservative about new investments in private companies. “It’s just going to take awhile for the pricing to come down to where we feel comfortable making those investments,” he said. Hicks sat on a panel titled, “Opportunities in the Global Power Industry.”
‘Volatility Is Our Friend’
Despite the difficulties, a number of conference speakers noted that energy volatility has underscored one of the chief benefits of wind, solar and geothermal energy: The fuel is free, making it easier for producers to plan, and it attracts customers who want steady prices. “Price security is valuable,” said Hicks. Because of this, investment in renewable energy, especially wind, will continue even if traditional fuels like oil and coal remain cheap, he predicted.
“Volatility is our friend,” argued Stephen Chazen, president and chief financial officer of Los Angeles-based Occidental Petroleum, the fourth-largest U.S. oil and gas company. Chazen said that oil firms try to acquire resources like oil fields when prices are low, and exploit them when prices are high. “When [the market] is volatile, people are forced to sell out. That’s where you get these better deals…. I had no idea what to do with $145 oil,” he added, referring to oil’s peak per-barrel price last summer. At that price, owners of oil reserves will not sell, at least not at affordable prices, he noted, but good opportunities are easier to come by with prices at $40 to $50. “If it were $145 per barrel forever, it would be a crummy business.” Today, oil is hovering around $50 a barrel.
But falling oil prices are not as damaging to the oil producers as many outsiders assume, Occidental’s Chazen said, since the biggest single production cost is the energy used for pumping and other purposes. With the “lifting cost” down to around $10 a barrel, oil could be profitable at $20 a barrel, although that price would be too low to encourage much new investment in the industry, he noted.
Last summer, high prices for fossil fuels spurred interest in renewable energy, such as electricity produced from wind, solar panels and geothermal sources. Wind is growing fastest, since turbines require less government subsidy than other renewables to be financially viable. But most renewable sources need some subsidy, which typically comes via tax benefits, and renewable-energy providers generally need large amounts of outside capital, since many firms are not mature or profitable enough to generate cash to fund expansion on their own.
Amid the financial and economic crisis, financing is tougher to get, according to Jacob Susman, founder of OwnEnergy, a wind farm developer headquartered in Brooklyn, N.Y. “Entrepreneurship in energy is … always going to be a little different than in some other sectors” because of this need to link with big sources of capital.
Solar and wind firms that do not earn enough to use all the tax benefits they qualify for can sell the excess “tax equity” to investors. But because of the financial crisis, many of the big buyers — such as investment banks — have pulled back or withdrawn from this market. Other funding sources have tightened as well.
In recent years, 18 or 19 well-capitalized players have dominated this market; now there are just five, according to John A. Carson, senior vice president in finance at Terra-Gen Power, a developer of geothermal, wind and solar power with offices in Reno, Nev., and New York. “That market has broken up over the past few months,” he noted, citing withdrawals by Wachovia Bank, Morgan Stanley and other firms.
Still, several speakers saw an upside to the financing downturn.
“There’s a potentially very positive outcome, which is recalibrating the industry’s growth,” Susman said, adding that the federal government may step in to help with financing as it looks for ways to stimulate the economy. Washington could expand financing options for renewable energy by modifying the tax-equity legislation to make it easier for ordinary investors to participate, he said.
Carson agreed that the energy market downturn has spurred some valuable rethinking. Energy experts are now taking a more rigorous look at purported energy and environmental savings from renewables, trying to include all the costs and pollution that go into production, transportation and use. It is no longer given, for example, that America’s oil-dependence and pollution problems can be solved by making ethanol from corn, Carson pointed out. “We’re all doing a collective, ‘What were we thinking?’ on that.” In another example, he pointed to a project in The Netherlands to make electricity from renewable wood pellets. While it sounded environmentally responsible, the wood came from pine trees in the U.S. state of Georgia, and the pellets traveled by train, ship and truck, each burning fossil fuels. “That was five or six steps too complicated for me.”
A period of rethinking also could help dispel some of the myths about renewables, clearing the way for smarter investment, Susman said. “There’s somewhat of a perception that investing in technology is … going to drive all the changes that we see toward renewables in coming years. In fact, consumers will be the driving force, as they demand renewables and legislation to support these energy sources.” Unfortunately, he added, economic worries are now cutting into consumers’ willingness to pay a premium to go green.
A second myth: Startup firms will lead the charge to renewable energy. Such firms will indeed play a key role, “but we also need people sitting at Morgan Stanley, at Chevron and at the Department of Energy,” Susman suggested. Without these players, the industry will not get the regulatory and financial support it will need.
Finally, he noted, many people mistakenly believe money has been falling off the trees to support development of renewable energy sources. This wasn’t true even before the economic crisis. Since most renewable energy cannot currently be produced as cheaply as fossil fuels, the industry’s growth will depend on consumers paying higher prices. Susman said he prefers a system, such as a carbon tax that would raise the cost of coal, oil and other environmentally damaging fuels, so renewables would be more competitive. “We, as consumers, need to start stepping up and paying for the environmental degradation that those forms of energy caused.”
Spare Room in the Bowling Alley
While public attention tends to dwell on the big stories — such as the collapse in oil prices or the shriveling of financing — conference speakers noted that energy firms are extremely diverse, and firms that specialize in energy investing continue to find opportunities that look promising even in tough times.
Paul Holland, managing director of Foundation Capital, a venture capital firm in Menlo Park, Calif., that has backed numerous clean-technology firms, said Foundation was an early investor in Silver Spring Networks, which has products such as smart electric meters that use the Internet to allow utilities and their customers to consume electricity more efficiently. In its early days, Silver Spring operated in space rented from a bowling alley. Foundation, unable to find other investors, wrote a string of million-dollar checks on faith in the firm’s long-term future. Now, Silver Spring, based in Redwood City, Calif., boasts major customers such as Florida Power & Light. “If there’s a message in this, it’s that you never know.”
Experienced energy investors can also nudge young firms into new, potentially more profitable directions, said William D. Lese, managing director of Braemar Energy Ventures, a New York venture capital company that invests in energy technology firms. Braemar is working with a firm that aims to improve capacitors (devices that store energy). Because the company had trouble getting funding, it wanted to move quickly to produce small capacitors for sale in the Far East. But with Braemar’s help, it refocused on developing large devices that could be of far greater value even if they took longer to bring to market.
Holland and Lese participated in the conference’s “Investing in Clean Technology” panel, which covered diverse approaches that investment firms use to decide which startups to back. Raj Pai, managing director of Global Environment Fund (GEF), a private equity firm in Chevy Chase, Md., which invests in environmental and clean energy companies, said GEF tends to focus less on game-changing technology than on solid business prospects. “We tend not to make technology bets so much as market bets,” he noted. GEF likes firms that are within a few years of surviving without borrowing.
Advanced Technology Ventures, which invests in Internet technology, healthcare and clean technology, focuses on firms that will soon be able to survive without government subsidy. Vice president Dharmesh Thakker said the firm, which has offices in Palo Alto, Calif., and Waltham, Mass., seeks to moderate risk by investing in firms with products or services that have a variety of applications for multiple markets.
According to several panelists, it is unwise for anyone in the energy industry to pin their hopes on high fuel prices. They do not use the derivatives markets to hedge against fuel price changes, but use other strategies to counter that risk. Lese’s firm invested in a company with a new technology useful in the cosmetics industry as well as the oil industry, giving it a kind of diversification. Utilities are on a “jihad of efficiency,” Holland said, so that products like smart electric meters should continue to sell even if fuel prices fall.
What will fuel prices do? Pai predicted oil could climb to $80 a barrel this year, Holland said $45, with other panelists predicting a similar range but none confident that any prediction would hold. “It’s a commodity,” Holland said. “It goes up and it goes down. Don’t base your career on the price of a commodity.”