Alternative equity

Green investing has long been the purview of venture capitalists but a number of potentially game-changing global trends are converging to put private equity in an advantageous position for entering the renewable energy market.

First, the need for sustainable energy infrastructure is massive and global. In the emerging economies that are likely to grow dramatically over the next two decades, infrastructure is embryonic. In much of the developed world, infrastructure is decaying. Developing countries will need to build; developed countries will need to rebuild. Even with oil prices falling below $40 per barrel -- far less than a third of its $147 peak in July -- the appetite for renewable energy, both politically and philosophically, remains substantial.

Second, solutions that have worked in the past are insufficient to address the massive energy infrastructure needs of the future. Credit dislocation, among other factors, is encumbering traditional capital structures in this asset-­intensive industry. Further, governments are looking to privatize solutions to their energy problems to shift assets off their balance sheets. Meanwhile, the decision horizon of many traditional infrastructure managers -- whether geared to election cycles (appointed managers) or to quarterly reports (public companies) -- is not conducive to economically rational decisions for infrastructure investing vs. maintaining vs. disregarding.

Third, private equity is emerging as one of the most efficient means for addressing the massive demand and for providing more workable solutions. As public-private partnerships become increasingly common, infrastructure financing constructs once deemed exotic will become increasingly typical. In addition, PE firms are adept at identifying new value propositions and assembling the components of value to realize them. In energy and infrastructure, such value propositions can be achieved by bundling of disparate links of the value chain along the design/build/operate/maintain/bill/ load manage/hedge spectrum.

Because PE-backed enterprises are relatively free of the pressure of shifting politics or quarterly earnings, they can establish and operate within the rational time horizons that the scope and nature of these investments require. Further, taking on technology risk, as venture capitalists do, is no longer necessary because large-scale opportunities exist in integrating off-the-shelf technologies to allow the complete outsourcing of alternative energy services.

Fourth, the return expectations for PE have come down, as has the perceived risk of infrastructure relative to other opportunities, particularly in a bear market. And within E&I, the appetite is greatest for renewable energy, with investors yearning to participate in value creation in this space.

The opportunity for PE in green energy and infrastructure is significant and growing. However, two caveats are in order, one regarding strategy and one regarding talent.

Although the needs for renewable energy are geographically pervasive, their regulatory and environmental texture is highly local, making universal solutions hard to come by. Consequently, the scalable platform investment approach private equity investors historically favor will have to evolve to fit this new market. PE firms, fundamentally, will have to get comfortable gauging regulatory risk.

Moreover, success will in part depend upon the ability of private equity firms to find managers and operating partners who possess the requisite skills and mindset demanded by this rapidly evolving and demanding sector. They should not only bring experience in specific areas like solar, wind and hydro, but also possess detailed knowledge of commodity and regulatory markets. They must take a distinctly "nonutility" attitude and embrace performance dashboards, operational and financial key performance indicators and the rigors of working with PE investors. Above all, they will emphatically reject the notion that an inherent conflict exists between being green and being profitable.

Christoph Lueneburger leads the global sustainability practice at Egon Zehnder International.