The climate for investment

Tom Murley leads the renewables team at one of Europe’s most active private-equity houses. He tells Tan Copsey about finding finance in a recession, responding to regulation – and building turbines in the Swedish forest.

Tom Murley is a leading investor in the western European renewable-energy market, with extensive experience of both renewable and conventional energy projects. Working for HgCapital, a private-equity group in the United Kingdom, he has primary responsibility for a €303 million (US$389 million) fund for European renewable-power projects.

Tan Copsey: To start with, could you give me a sense of what you do?

Tom Murley: In 2002, HgCapital identified climate change and renewable energy as major investment themes. We researched these sectors and decided we wanted to invest in the deployment of the proven technologies – wind, solar, small hydro – on an industrial scale. We concluded that owning the physical assets would provide the best risk-adjusted returns for our investors. Our investors are primarily global pension funds, European, UK and American – very long-term capital that governments want to attract to this sector to build a low carbon energy future.

TC: Could you give me an example of a particular success story?

TM: The investment for which we have received the most recognition was Havsnas, the largest onshore wind farm in Sweden and through which we opened the Swedish wind-energy sector to real project finance. Havsnas has just come on line.

Virtually all Scandinavian power generation, renewable or conventional, had been owned by state-owned utilities – Vattenfall, Fortum, StatKraft. We went into a market that had no history of long-term bank financing for this kind of project. There was also a new support system – Sweden has a green-certificate system [a national trading scheme in which certificates proving that certain electricity comes from renewable power are bought and sold] – based on the UK model.

We had to analyse the green certificate market from the ground up, something which had not been adequately done before. We developed proprietary forecasts and a view of where pricing was heading. We hedged for the power in the Nord Pool market [this allows electricity producers and retailers to secure the price of a volatile commodity] Sweden is not like the UK where utilities will sign 15 year power-purchase agreement. One has to enter the Nord Pool market.

We had to put together construction of a very complex project with our partners. There are 48 turbines on this project in a very remote, forested location. We built 50 kilometres of internal roads, lay 35 kilometres of underground cabling and string 20 kilometres of above ground high-tension grip cabling. We built a major substation connecting the high-voltage grid and put up 48 turbines, each one of which has a 700 tonne concrete foundation. All in the middle of the forest, in the middle of Sweden, where things like the medevac [medical evacuation] helicopter, should someone get injured, is two hours away. It is significant infrastructure in a very remote location.

A lot of people think that building wind farms is easy. That it is kind of “plug and play”. This is on a scale that is probably as complex as you get until you move into offshore wind. We had to put all of those elements together and bring banks to a market that had never known project financing and we did that in about four months. It really was innovative, ground-breaking financing. The project had a two year construction period and was handed over on July 9 on budget. It is operating and we’re making money. It is a real example of how the renewables industry is moving from a small industry to a larger, much more sophisticated industry.

TC: These are very difficult economic times and the upfront costs for renewable energy are much larger than traditional forms of energy. How do you finance these projects in a recession?

TM: In our view, we finance these projects the same way as when we’re not in a recession. What we have always focused on are the highest quality projects. We don’t take technology risks, we’re not going to use the latest wind turbine. We seek to invest in better resource. So we don’t do solar in Germany. They have a wonderful feed-in tariff, but there’s not that much sunshine. We believe the long-term value is with the resource, whether it is wind, sun or water. So we look to invest in better resources and put the best possible equipment on that.

What we’ve always done is to work to fairly conservative financial and contractual structures that mitigate and properly allocate risk. So, for example, in Sweden when we were building the large wind-farm, the main construction crane – 700 tonnes, 120 metre boom– basically fell off the road. Whether it was a driver error or whether the road collapsed underneath it, no one really knows. There are only three such cranes in Europe. We had structures with a contractor so we got one of the replacement cranes on site within three weeks. This is important because you can’t erect these turbines past December in Sweden. You have to do this in the summer and the fall months.

For that quality proposition there has always been, and there always will be, a banking market.

TC: Obviously government policy and regulation is very important in this sector. How does that affect what you do?

TM: The entire energy sector – renewable, conventional, oil, gas, nuclear – it’s all policy driven and is subsidised. If you’ve been a long-term player in this sector you realise that you have to incorporate regular interface with governments and politicians. Policy is always evolutionary, so the changes we’re seeing today don’t particularly bother me.

You have to take a step back and say what is the purpose of the current renewable energy policies and low-carbon policies? It is twofold. First, to give renewables a share of the market and growth space, while we appropriately price conventional electricity. Second, to try to bring this industry to commercial scale so we can reduce its costs and it can become competitive. When you price in the true cost of conventional power, and then you match that with driving down the cost of renewable power, at some point the two will meet and the technologies will no longer require subsidy.

That will still take a long time, but if you take a look at the solar PV sector, for example, we’re actually seeing success. Germany, Spain and to a lesser extent Italy, said they wanted a solar PV industry. They wanted the jobs, the manufacturing, they wanted the scale, they wanted more of this on the grid. So what did they do? They put out an incentive. What happened was the industry responded brilliantly. The PV industry dramatically increased manufacturing capacity and efficiency over the last few years. We are seeing thin-film. We are seeing greater efficiency in crystalline panels. All of that has contributed to a 60% drop in the price of solar panels over the last two and a half years. It is probably going to drop another 20% to 30% over the coming two or three years. And in that scenario it is absolutely appropriate for governments to start reducing the solar tariff because the upfront capital cost has been halved. This is how this policy is supposed to work.

TC: You have experience in energy markets around the world. What’s different about investing in Europe in comparison to the United States and China?

TM: Let’s take the United States and western Europe versus China, Latin America and emerging markets. Europe and the United States offer a history of legal enforceability of rights, stability of regulation, an openness of markets to foreign investment and a respect of foreign investment that has not always existed in other markets. Clearly some are getting better. China has done things before that have been harmful to foreign investment. In Latin America, promises to maintain tariffs to foreign investors in the electricity sector have failed to materialise at certain times.

What I can really contrast are Europe and the United States. The United States likes to promote investment through tax-breaks and this has been particularly true in the renewable sector. So the support scheme comes in the form of tax credits and right now it is also coming in the form of grants because there are fewer people who can use the tax credits.

In Europe the support comes above the line – we get paid more for the electricity. In the US the support comes below the line – this means you get paid the same amount for electricity but they take away the tax burden for you.

What that means is the United States, because of the way the tax credit system works, attracts a smaller pool of potential capital. To take advantage of the tax credit, you have to be a US income tax payer and have taxable income to offset the tax credit. This is why large financial houses like AIG, John Hancock or even Goldman Sachs were owning wind-farms – because they would take the tax credits and offset their investment banking or insurance income with the tax credits.

But it also means that large parts of the institutional investor market, including pension funds, can’t invest in America because they don’t pay any income tax and so a tax credit isn’t any good to them. Foreign investors typically have very little US income so this system also doesn’t work particularly well for them. In Europe, because this support comes in the form of enhanced revenues, you can have a much broader investment pool. So you have pension funds, individuals, corporates, utilities. Europe is able to access a much deeper and broader pool of capital.

Tan Copsey is development manager at chinadialogue.

Tom Murley
leads the renewable energy team at HgCapital.

Homepage image from HgCapital