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— Analysis —
"It's like a yo-yo," says Texas billionaire T. Boone Pickens, arguing that the dangers of relying on foreign oil is hardly a new concept -- just one that gets pushed to the back burner once an energy crisis subsides and gasoline prices fall. "The problem is," he says, "we don't have the oil."
-- See related energy stories: -- Oil slick Private equity investors could play a role in helping fix the problem, at least somewhat, as cash-strapped biofuel, wind and solar developers increasingly turn to sponsors for capital. For his part, Pickens has pushed hard to boost private and public investment in renewable energy. In July, he unveiled a plan to produce 20% of U.S. electricity from wind, replacing natural gas as a power-generation source. Natural gas would instead be developed as a clean transportation fuel for heavy trucks and fleet vehicles, reducing dependence on foreign oil by one-third in 10 years. Obama is expected to make alternative energy a priority within the first few months of office, says Sanjay Shrestha, an analyst with Lazard Capital Markets LLC. Obama has pledged $150 billion to the sector over 10 years, considerably more than administrations past. Moreover, he is expected to create a federal renewable portfolio standard, or RPS, mandating 10% of our electricity come from sources such as wind and solar by 2012, and as much as 25% by 2025. The renewable sector certainly could use a lift. Lazard's alternative energy index tumbled 51% last year; its solar index fell 70%, and its ethanol index is down a stunning 95%. "There was too much hype," says Richard Kauffman, CEO of private equity and venture capital firm Good Energies Inc. During the good times, market excesses were partly to blame as technologies that ordinarily might not have been funded were. In addition to an overabundance of liquidity, some deals were priced based on the soaring cost of oil last year, leaving them badly bruised when crude took a steep and unexpected dive. The exuberance left the ethanol sector particularly distressed, with its largest producer, VeraSun Energy Corp., falling into bankruptcy last year. The Sioux Falls, S.D., company, which accounts for 14% of the total ethanol production capacity in the U.S., filed for Chapter 11 at the end of October. Others also fell over the edge as margins were crushed by high corn prices, oil's dive and overbuilding, causing a U.S. glut. Gateway Ethanol LLC of Pratt, Kan., and Freedom Fuels LLC of Mason City, Iowa, each filed for bankruptcy last fall. More recently, in January, Northeast Biofuels LP sought Chapter 11 protection after a series of costly construction delays. Ethanol is "a great public policy for Middle West economic development activity," but not a great energy deal, says Michael McMahon, co-founder of New York private equity firm Pine Brook Road Partners LLC. It takes so much energy to produce a single gallon that "you might only break even." Their distress has made them a bargain -- but buyer beware. "They're selling at a discount for a reason," he says, adding that little can be done to improve margins. However, new legislation mandating an increased use of biofuels could help offset the supply imbalance, sources say. That might create some relief for a producer such as Aventine Renewable Energy Holdings Inc., which in November had to suspend construction of one of its biorefineries. New York private equity firm Metalmark Capital LLC still owns a small stake in the Pekin, Ill., company, which went public at $43 a share in 2006 when investors were flocking to the biofuel. Its stock now trades around 51 cents, and the company looks to be on the brink of default. On Jan. 14, Moody's Investors Service lowered Aventine's corporate family rating to Caa2, from B3, citing its inability to secure alternative sources of financing to improve its liquidity. With the public markets largely shut down, companies now have few capital sources, says Paul Ho of Teaneck, N.J., private equity firm Hudson Clean Energy Partners. Hudson has been "just inundated" with deal proposals from across the renewable sector, including biofuel. "We've been getting a couple of inquiries a day," he says. Although the ethanol industry's margins are suffering from the glut, the U.S. Energy Information Administration has reported that it will not be able to meet the mandate to produce 36 billion gallons of biofuels by 2022. Increasing the mandate -- as Obama during his campaign promised he would do by lifting the target to 60 billion gallons of biofuels a year by 2030 -- could help pull the industry out of its troubles in the long term. But without the development of cellulosic ethanol, produced from plant matter such as switch grass or wood chips, it might not get there. Blackstone Group LP's new green technology fund has invested in such an ethanol producer. In December, Blackstone Cleantech Venture Partners LP was part of a group that pumped $40 million in Coskata Inc., a Warrenville, Ill., company claiming it can produce ethanol for less than $1 per gallon by using feedstock that does not compete with food crops. Its use of cellulosic matter, municipal solid waste and old tires even attracted a cash infusion from struggling auto giant General Motors Corp. earlier last year. GM took part in a $19.5 million investment in the startup, a move made in light of plans to boost the number of flex-fuel vehicles it produces to run on ordinary gasoline or a blend consisting of as much as 85% ethanol. In the U.S., GM already has more than 3 million flex-fuel models on the road and says it wants to make half its production flex-fuel capable by 2012. Wind and solar developers find it harder to fund their projects through debt or tax equity investments, which involve an income tax break from the government. The biggest tax equity investors, Lehman Brothers Holdings Inc., American International Group Inc., GE Energy Financial Services and major banks, have disappeared or been sidelined in the wake of Wall Street's meltdown. Yet to produce twice as much renewable energy in three years, the $5.5 billion tax equity market would have to double this year, triple next year and increase fivefold in 2011, Rhone Resch, CEO of the Solar Energy Industries Association, said in a conference call Jan. 9. That will be hard to achieve, considering the number of investors has dwindled to five from 20 after the deep economic crisis wiped out profits and decreased tax liability. In fact, only a few of the top 10 players are still active, sources say, including J.P. Morgan Chase & Co. and Union Bank of California. With financing dried up, "we have to work harder," says Brad Nordholm, CEO of Starwood Energy Group Global LLC. In January, Starwood said it bought a majority interest in Nautilus Solar Energy LLC. The Chatham, N.J., target develops retail and utility-scale solar electric systems with a project pipeline consisting of more than 500 megawatts of power. "We're seeing a rapid drop in pricing in solar" that is approaching the cost of natural gas-fired power plants, says Nordholm, who, despite the financial crisis, is bullish on the industry's prospects. Nautilus didn't need to raise capital but agreed with Starwood that now is the time "to get bigger, faster." At the end of 2008, the SEIA estimates that the U.S. had around 4,400 megawatts of solar power installed, an addition of about 1000 megawatts from the year before. More recent data from the SEIA had not been released by press time, but many of the largest renewable energy investments in 2008 involved utility-scale solar power developers, according to research firm Dealogic. In September, for instance, SolarReserve obtained $140 million of funding led by Citi Alternative Investments' renewable energy private equity group and Good Energies; Google Inc. co-invested for a $130 million stake in eSolar Inc. in April; that same month, Stirling Energy Systems Inc., a Phoenix developer of utility-scale solar powered electricity generation plants, said it was getting $100 million from NTR plc. Government subsidy is necessary to keep up the pace of investment in clean energy. "Private industry can't do it by itself," says Mark Metts, a partner at Jones Day. In October, attachments to the $700 billion Troubled Asset Relief Program extended renewable energy tax equity credits for eight years and production tax credits for just one year. The "hit or miss" nature of PTCs for the wind industry, which come up for renewal every year or two, makes it tougher for private equity to commit long-term capital. Obama is expected to give them more certainty, however, by creating a five-year PTC. Still, development may fall off if the credits are not made refundable, insists Denise Bode, CEO of the American Wind Energy Association. She warned in the call with Resch that without refundability the country could experience a 50% reduction in wind starts this year -- a stark reversal of the trend over the past several years. The wind industry now generates about 1.5% of U.S. electricity, installing a record 8,358 megawatts last year for a total 25,170. Now, there's a further 8,000 megawatts of capacity under development, but with the financial markets largely shut down, those projects will be tough to complete. So far this year, private equity investors have stepped in to help develop the nation's enormous wind corridor, which runs from Texas to the Canadian border. For instance, ArcLight Capital Partners LLC portfolio company Terra-Gen Power LLC said Jan. 8 that it purchased six wind projects in five states from Airstream Energy LLC. The wind farms, in Wyoming, Nebraska, Colorado, Kansas and New Mexico, are expected to generate 2,500 megawatts of power. Pickens, meanwhile, is behind plans to build the world's biggest wind farm in Texas, capable of generating 4,000 megawatts of power. His Dallas-based Mesa Power LLP said in May that it ordered 667 wind turbines from General Electric Co. for the first phase of its massive project, which is expected to encounter an initial cost of $2 billion and generate 1,000 megawatts of power. What isn't clear is how quickly such a feat can be accomplished, given the difficult financing environment. But whatever delays the renewable sector has hit and faces yet, the 80-year-old Oracle of Oil takes them in stride. As he puts it, "Don't rush the monkey and you'll get a better show." Mesa, he adds, won't have its wind turbines until 2011 -- maybe by then the market will have picked back up and his show can get started. |
Now that President Obama has entered the White House, some investors think the grass will get a lot greener. After all, his economic stimulus plan calls for renewable energy production to double over three years -- a bold pursuit, given that oil prices have plunged and the country is amid one of the worst financial crises in U.S. history. Last summer, when crude reached $147 a barrel, the need for alternative fuel was an easy sell to private and public investors alike. But now that oil and natural gas prices have plunged, the economics behind deals have changed and the pace of development is threatened. 
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