he search by equity investors for opportunities in renewable energy is occurring today on two primary fronts—electricity for power and fuel for transportation—each with a specific set of challenges. US Renewables Group manages the largest West Coast fund investing in these two distinct new energy sectors. VerdeXchange News recently spoke with the managing director of US Renewables Group, Lee Bailey, about the US Renewables Group’s efforts to find and scale renewable solutions for our country’s dependency on carbon-emitting forms of energy.
VerdeX: The U.S. Renewables Group is one of the nation’s leading equity fund managers investing in renewables. In what market sectors does your firm concentrate its capital?
Bailey: We invest in renewable energy and clean fuel projects—utility-scale power projects. US Renewables Group’s focus has been in renewable utility-scale power . For instance, we have made investments in geothermal, biomass, landfill methane, and solar thermal power projects. Geothermal takes steam from underground (largely located in the western part of the United States), using the steam to drive a turbine that generates electricity, and biomass, which uses any kind of agricultural wood waste to burn in a furnace, making steam in a boiler to drive a turbine that generates electricity. We have also looked at landfill methane, which takes underground methane in landfills to drive a reciprocating engine, and Concentrated Solar Power (CSP) with molten salt storage that takes solar thermal energy and stores it for when it is needed to heat water to generate steam to drive a steam turbine.
In all cases, these projects are utility-scale; in other words, we’re selling the power to the utility, which sells the power to customers. There’s a power purchase agreement associated with each of those projects.
The other area we focus on is clean fuel projects: ethanol, biodiesel, and fuel from waste. This is a slightly different area. One of the interesting aspects of this area is that demand is growing for transportation fuels. The reason why we have ethanol and biodiesel—and ethanol in particular—is because the Clean Air Act mandates that gasoline sold in non-attainment areas be oxygenated. The only way to do that is with ethanol.
VerdeX: Analysts have estimated that investment in renewables in 2007 reached about $148 billion, which is 60 percent over 2006 levels. Some suggest investment will triple to $450 billion by 2012 if carbon dioxide emissions are successfully regulated. How accurate are such estimates? Will the capital needed to solve climate change be available in coming years?
Bailey: Actually, I think that’s conservative. The world energy market is estimated to require $40 trillion to fund energy projects by 2030. Two-thirds of this number will be for power and one-third will be invested in transportation fuels. In order to satisfy just the renewable portfolio standards (RPS) in the U.S. power markets, now extant in 30 states, the amount of capital required to satisfy that build-out by 2018 is estimated at $20 billion. So, the capital required to satisfy the demand for renewable energy and power is basically unmet by a factor of two. In other words, there is twice as much demand for renewable energy than can be currently satisfied.
VerdeX: Many have remarked that the United States is lagging behind Europe in investment in renewables and that the deficit isn’t a result of uncertain market demand but, rather, uncertain public policies—for example, whether there will be production tax credits for wind and investment tax credits for solar. What public policy environment would provide the best incentives for more investment in clean fuels and green technology?
Bailey: Europe has taken a progressive move toward renewable energy and biofuels. The U.S. tends to lag behind European policy on renewable energy. Because we don’t have feed-in tariffs in the United States, the policy response has been to provide other financing schemes, largely using the tax code. There are a couple of ways to look at that. For example, if I’m going to build a solar plant, let’s assume it’s going to cost $100 million with some portion of that financed with investment tax credits—that’s very helpful. But if those tax credits aren’t available, whoever I’m ultimately selling the power to is going to take that into account. So, if there are investment tax credits available, they will give me a lower power purchase price because they’re going to factor in the tax credits. If they’re not available, they’re going to have to pay more for the power.
The fact that there is no coordinated renewable energy policy in the United States is a function of conflicting demands being placed on the lawmakers in Washington. The oil/gas interests have, historically, not been supportive of renewable energy and clean fuels. Doubters who don’t believe that climate change is real still participate in the policy process. As we’ve seen in other instances, there is just not a coherent approach to renewable energy, which gets sidetracked by other political issues.
We expect with the new president in office in 2009, there will be a more coherent policy. There’s pretty much a universal consensus that we need a federal policy, whether it’s a national RPS or a long-term investment tax credit scheme. You’re going to see a variety of these things enacted in ’09. Some of them will have some significant consequences on business in the U.S.
VerdeX: Give our readers a sense of how U.S. Renewables Group interprets these market signals. What market facts and trends are you looking at to predict the horizon regarding public policy incentives for renewables?
Bailey: As far as power goes, because renewable energy projects are so capital intensive, the investment tax credits as a funding scheme are absolutely essential. Loan guarantees might be required, as well, because some of these early projects don’t have technology that is market-ready. In order to take financing risk, the banks are going to want to get some help from the federal government in terms of loan guarantees. Those are two policies that are pretty essential for a massive build-out.
As far as fuel is concerned, you’ve got a number of issues with corn-based ethanol. First of all, the current high price of corn. It’s a commodity, it trades, it does not correlate with oil and gas, and there are demands for corn, like food and other by-products that have a very high national priority There are going to be some alternatives to corn use in ethanol, whether it’s sugar cane or some other cellulosic feedstock. We’re going to see the federal government taking a more active role in finding alternatives with clean tech research for cellulosic. I think the farmers, who have a significant lobby in the U.S., are still going to maintain a pretty strong presence for growing lots of corn. I don’t see us moving away from corn-based ethanol any time soon.
VerdeX: Which utilities have you found are the most proactive in generating renewable power? What barriers typically block the aspirations of the utility regulators to increase the use of renewable energy?
Bailey: If you want to build a new renewable power project (wherever it is, it doesn’t matter), there are a bunch of things you need. You need land and you need an interconnection to the grid. Getting an interconnection to the grid is extraordinarily difficult because the transmission capabilities in the U.S. have been so under-invested in over the last 30 years that many areas are at 98 percent. Even if you found a place and a project with financing, the likelihood of being able to put your power on the transmission grid is significantly reduced.
As a result, over the last several years, as these utilities have signed contracts, the people in the queue who have agreed to sell power from their projects are never going to build their projects because they can’t get the financing or it’s not proven technology. The utilities have been trying to play ball with the regulators by saying, “All right, we’ll try to buy renewable energy.” They announce an RFP, people respond, the utilities grant them a power purchase agreement, they get in the queue, but it doesn’t get built.
People coming along now, who maybe have a higher likelihood of getting a project done, can’t get in the transmission queue. These are real-life problems associated with any renewable energy developer that have to be solved, and it’s going to take federal and state leadership to solve these issues.
For example, I am told PG&E has land, they have huge demand for electricity, they’ve committed publicly to buying more renewable energy, but someone else has to solve the transmission problem; that’s not something they can solve. San Diego Gas and Electric—again, the same thing. They have expressed a real interest and are working hard to try to find ways to get more renewables online, but it’s always been hard to find good, scaleable renewable projects. Biomass just isn’t very large. A 25-megawatt plant is large.
Geothermal—there’s a total of 1,200 megawatts in the state of California, if you combine Calpine and NCPA. Landfill methane is peanuts. There is no large-scale solar, for the most part, and the problem with wind and solar is that they’re intermittent, so you can’t rely upon them for base load.
VerdeX: Turning to alternative fuels, where are the attractive investment opportunities in fuels for US Renewables Group?
Bailey: As I said earlier, we need to move away from corn-based ethanol. That’s going to be either sugar cane-based or cellulosic-based. As I like to say, the United States is the Saudi Arabia of waste. If we can find ways to convert the waste that is stored in landfills into fuel, we will have made major inroads. That is a major initiative that a number of companies, including our own, have invested in and will continue to invest in.
Brazil has developed a very robust market in sugar cane-based ethanol, and, in fact, it’s much more effective and efficient to convert sugar cane or sugars to ethanol than it is to convert the corn-based sugars to ethanol. So, we’re going to see efforts worldwide to make fuel from sources other than corn and other crops that compete with the food supply.
VerdeX: What are a few of the quality owner-operators and fuel developers that U.S. Renewables Group has invested in?
Bailey: Integrated Energy Management is a group that we put together when we bought Bottle Rock, which is a geothermal plant. They’re now working with us to develop other geothermal opportunities. ThermaSource is a geothermal drilling company that we’ve invested in. They develop and do the drilling on geothermal projects. Calpine, after emerging from bankruptcy, is a first-rate developer. We’ve worked with some biomass developers on the East Coast who have located land and completed permits. They’re not household names, but these are people who have been at large energy companies, at utilities, and have gone off to be power developers. AES is another well-known developer who we’ve worked with on a couple of their projects, as well.
One of our first (and only) corn based ethanol investments was ASA Biofuels, a company that we invested in, along with American Capital and Laminar Direct, which are large funds on the East Coast. That deal included six projects to make more than 600 million gallons of ethanol. We tried to lock in the cost for making a gallon of ethanol and the feedstock to make these projects profitable. We were eventually bought out by a larger ethanol producer who could help with the scale-up required to make the ethanol business successful. There are other ethanol and biodiesel developers out there. Essentially, the developer does all the work of getting the land and the permits. Then they come to us and look for financing. So, we rely upon developers to do a lot of that initial work, and then they get paid, of course, a development fee.
VerdeX: Lastly, public equity markets have not been as kind to renewables companies in 2008 as they’ve been in the last few years. So, if IPOs are not currently the means to realize a return on one’s investment, what alternatives for monetizing value for investors are you anticipating?
Bailey: In order to succeed in the renewable energy build-out, we must stop building more coal. In my view, the renewable energy build-out is really the power business, because what are the alternatives to satisfying our increased demand for electricity? We might see some nuclear, but that’s 15 years away. We need to build more projects with a combination of renewables in order to keep pace with the demand for electricity. There’s going to be biomass, geothermal, solar, and wind.
What utilities want is scale. They want large. I predict they will be prepared to pay for scale. The exit opportunity is to build renewable energy projects at scale, and sell them to the utilities that need them to satisfy the RPS requirements. •••