Entrepreneurship in the Renewable Energy (RE) industry is different from "old economy" and high growth sectors viz. media and healthcare. It is yet considered a sunrise industry, with technology development largely funded by governments and multi-lateral agencies. R & D intensive technology development ventures in RE are perceived as being high-risk with long-gestation periods, and hence are frequently shunned by private equity investors, who prefer to make market bets as opposed to technology bets.
RE based power generation projects, given their predetermined generation capacities and the regulated tariffs for the power sold, yield stable and (range-bound /) predictable cash-flows, while equity investors routinely seek out opportunities for blockbuster upside revenues and valuations. Even as carbon market related accruals were slated to have made important contributions in the early years of implementing the Kyoto protocol, in recent years, the ruling prices have been tepid with revenues often falling short of transaction costs, thus dissuading activity in this sector. Essentially, equity investments into RE projects behave as fixed-income securities with fairly predictable returns and deterministic valuations.
Simultaneously, RE power generation initiatives are high risk ventures, especially in developing countries, compared to the other opportunities available to potential investors. In emerging economies, where power trading mechanisms are underdeveloped, where electricity utilities tend to be monopolies and reform tends to be slow, the power generated is generally supplied to a single buyer (a “monopsony ”), for the foreseeable project horizon. The electricity utility thus represents the greatest source or risk, in both, remaining solvent and in its willingness to pay for the power generated.
Project viability also hinges on the sustained availability and pricing of complementary inputs including land and water and on the continuation of crucial tax holidays and other fiscal and policy incentives, each of which is subject to significant uncertainty.
In addition to the invested capital, private equity (PE) investors are slated to contribute management skills required to structure and operate sophisticated financial instruments and risk-share mechanisms which, in theory, help enhance project returns and to mitigate risk. Given a greater breadth of perspective relative to the typical project sponsor, PE managers are believed to be better placed to syndicate competitively priced project debt. Most significantly, PE investors seek to benefit from Double Taxation Avoidance treaties (DTAA) and Free Trade Agreements (FTA) to route investments into respective destinations ( “treaty shopping ”) at lowest possible total cost.
Given consistency in the policy environment and given the technical feasibility of the proposed venture itself, the viability of PE investments into RE projects hinges crucially on the PE fund managers' ability to reduce the average cost of funds for the project, while simultaneously lowering the risk levels through appropriately instituted mitigation measures.