The coming revolution in global electric power
By Kfir Abutbul, Peter S Burke, Chanse Barnes, & Nahal N Bahri
As more focus is directed toward refurbishing aging power infrastructure, creating reliable and resilient power distribution networks and transitioning into cleaner, renewable sources of power generation in connection with the increasing urgency of a low-carbon energy future, there is growing demand and interest by potential capital sources to support and finance renewable power investments going beyond traditional energy-focused investors. In particular, traditional or “generalist” private equity investors are becoming increasingly important players in the renewable power sector, especially as barriers to entry into the market have decreased by the development of partnerships with operator-platforms and other structures. Further, we believe that the role of private equity in the transition of the power sector is vitally important as the industry has proven itself to be an efficient source of capital and growth to other industries, and we expect existing public debt pressures and extended timelines many governments are faced with in construction and development of renewable power projects in many parts of the world will encourage accelerating private equity investments in the power sector. In light of this heightened attention given to the power sector by private equity firms which may not have focused on energy assets historically, we have prepared this practical guide on important issues and considerations when investing in this sector, with a focus on financing new platform investments. One likely consequence of the recent U.S. presidential election is that there will be even more investment in and political support for renewable sources in the power sector.
First, it is important to understand the general state of the power sector and why private equity firms are increasingly interested in investing in the industry. The U.S. electricity industry boasts the largest power system in the world with close to 900,000 MW of capacity. This system, consisting of multiple power grids (and increasingly, micro-grids), creates, transmits and delivers electricity to homes and businesses throughout the U.S. A consistent, reliable power network is necessary for continued economic development, especially as the population continues to grow and with it, energy needs. The financing, construction and support of a reliable power network is even more important in emerging markets and developing economies where demand is increasing even more rapidly, and where it will continue to be challenged by the potential impact of carbon emissions that are expected to be generated from existing power generation sources. On the other hand, power supply continues to lag demand in many areas, including in some parts of the U.S. This fact, coupled with continued national and world population growth and the importance of a reliable power grid to prosperity, means that the demand for power will only grow, presenting a long-term opportunity for investment returns and relatively rapid deployment of capital.
Increased demand is only one of the many reasons why private equity firms are becoming more interested in the power sector. Another factor is the growing attention given to environmental, social and governance (“ESG”) issues and how ESG can drive value. Asset managers are increasingly being asked to meet ESG disclosure requirements and performance expectations set out by the investors they report to. ESG issues of particular relevance to the power sector include pollution reduction, energy conservation and development of a low-carbon energy economy. In fact, many investors already believe that investing in new power generation technologies will assist them in meeting ESG goals. It has been further reported that many investors are focused on resilience and reliability of the power grid, which has come into greater focus especially in light of the very active hurricane season that parts of the country has faced this year, along with an increased number of other extreme weather events in California and elsewhere. We see this increased interest in our practice regularly and we have advised clients on a variety of matters in the space, including recently representing a client with respect to its financing of the development of specified and future battery storage projects in the United States through a combination of debt and equity financing.
Increased activity in the power sector is also attributable to more traditional market forces driving further deployment of capital to the renewable power market. These include decreases in the cost of capital for renewable investments and technological innovations leading to considerable increases in the generation capacity and grid reliability of renewable power assets. All of these factors contribute to investors having more predictable (and better, historically) returns when compared to other energy-related industries that are heavily impacted by the cost and revenue basis of oil and gas exploration and production, which have suffered greatly this year, in part due to the COVID-19 pandemic.
Finally, as has been well documented in recent years, there is over a trillion dollars available to be invested by private equity firms. Asset managers are looking for different asset classes that can produce quality returns and the power sector, with its anticipated growth in demand in the coming years, will likely remain an attractive area for investment.