Paul Dabbar, director of global mergers and acquisitions for JP Morgan, would like to make clear that his distaste for renewable energy projects right now is nothing personal.
“I own a [Chevrolet] Volt and a hundred percent my home electricity comes from wind power, which means I have a wind-powered car,” Dabbar said at a recent panel discussion on financing energy projects. The panel was part of the larger Columbia University Energy Symposium. “I love this stuff. But there are challenges we run into on the day-to-day execution side.”
Given the explosion of natural gas supply with the development of shale reserves, the resulting low prices for gas, and ongoing policy deadlock at all levels of government, finding investment and credit for all kinds of new energy projects is a challenging game.
“It’s very, very difficult right now” to fund all sorts of energy projects, said Brian Ward, managing director of GE Energy Financial Services.
But even in these trying times, opportunities do exist. In a wide-ranging conversation that included Dabbar and Ward, as well as Deutsche Bank investment banking vice chairman Andrew Safran and Arclight senior partner Robb Turner, there were small glimmers of hope and opportunity set among the dark clouds of price instability, overproduction and continued regulatory uncertainty. As four of the nation’s largest institutional investors in natural gas and renewable energy talked for over an hour about the future of energy financing, they made it clear that there remain deals to ink and money to be made if one knows where to look. One reason: Hunger for projects with strong fundamentals is incredibly strong.
“There is a tremendous amount of capital out there trying to find the right business opportunities,” Dabbar said.
Their Big Plays
Each of the panelists participating the discussion has decades of experience in financing and running energy projects. “I’ve owned a lot of coal plants,” said Arclight’s Robb Turner. And now, “we own a lot of power plants. It’s about half of what we do.”
Given that experience, and the large bets their companies are making in the volatile energy markets, each panelist agreed that their first goal is to reduce risk. Take GE’s approach to investing in natural gas, for instance. The company has little interest in the upstream development of new wells, Ward said, because “if you miss on some wells, it’s expensive.”
With so many other companies drilling, the real opportunity lies in building the transportation systems needed to bring all that gas to market.
“Where we do play a role in oil and gas is in the infrastructure,” Ward said. “And we like that space, we think there’s an enormous opportunity. We’re looking at a lot of deals right now.”
Other panelists agreed. For the moment, firms that specialize in finding, drilling and commercializing new gas wells “are making a boatload of money,” Turner said, with “once-in-a-lifetime returns.”
But for larger investors, or funds with more distant horizons, the real money for lies in midstream shipments of oil and natural gas.
“With six million barrels a day of new oil production, if my estimate is right, that’s $200 billion of oil product a year that is domestically produced,” Ward said. “The amount of infrastructure that can support is massive. It’s hundreds of billions of dollars in infrastructure that can be placed up and down the value chain.”
Deutsche Bank is making the same bets, Safran said.
“The infrastructure is relatively immature,” said Safran. “It needs to be improved, and there’s a play there.”
Arclight has been looking to minimize risk by buying up older petrochemical reserves and converting them into producers of natural gas. That’s becoming harder to do now because so many other investors have started doing the same thing, driving up prices, Turner said.
All that purchasing activity leads to a new opportunity, however: Consolidation, especially in the Bakken shale reservoir.
“There’s a bigger interest in rolling up these teeny little working interests in the Bakken,” Turner said, “and then you can control the drilling, control the play.”
Where does all of this interest in petroleum leave these four big players when it comes to renewables? In the United States, anyway, the picture is bleak. JP Morgan is currently trying to sell three different renewables businesses, Dabbar said, including a wind and a solar enterprise.
It’s not going particularly well.
“We get basically no value,” said Dabbar. “People do not believe that the market will continue building these projects. The market is very weak now.”
If there’s any hope for renewables at all, these top strategists agreed, it’s overseas, especially in revitalizing older renewable plants. With investment in new, efficient turbines, many existing wind farms in Europe could turn a profit again.
“I think an interesting opportunity in Europe is repowering existing wind farms,” Ward said. “You could put new wind turbines on and make some pretty good money. We’re still looking at that as an idea.”
The catch is size. In addition to old technology, many European wind farms consist of just four or five turbines, which creates problems of scalability and efficiency. “They just don’t have the land space that we have here,” said Ward. There’s not a Texas.”
The Future of Gas
Regardless of these big investors’ similar decisions on how to structure their portfolios, they disagree about the long-term profits to be found in natural gas. Obviously with so much new supply coming online, prices will stay in the doldrums for years to come. That’s especially true because many companies are drilling new wells not for immediate financial returns, but because they must drill soon or watch their mineral contracts expire.
“I think the industry has often been its own worst enemy in that it can’t restrain itself from drilling,” Ward said. “You’re seeing a lot of drilling that might not take place in a purely rational environment.”
All of this will sort itself out soon, some panelists argued, partly because demand will steadily grow. Given the abundance of natural gas reserves in the U.S., Ward said, it’s inevitable that power plants and industrial users will convert to gas power in the next few years, which will help stabilize prices.
In addition, some North American facilities built years ago to import natural gas are being converted for export, Dabbar said, raising the prospect of a new, global market for liquefied natural gas that heretofore has never existed. Demand is especially strong in Asia, where last year’s tsunami and the resulting power plant disaster in Fukushima, Japan, is causing governments and private investors to explore alternatives to nuclear energy.
“It is an interesting question of whether gas markets will evolve into a global market,” Safran said.
Even this thin silver lining requires some additional grey highlights, however. That’s because in addition to its massive natural gas reserves, the U.S. is also unique globally because private landowners also control mineral rights. In most other countries, government controls underground reserves, which makes negotiating for access to those reserves a far more complicated and time-consuming prospect.
That could postpone the development of truly global trade in natural gas indefinitely.
“If the company comes to you and says, ‘I’ll make you a millionaire overnight,’ what do you do? You say, ‘Where do I sign?’” said Ward. “Most of the world its not like that.”
Turner looks at this set of facts and concludes that the price differential between gas and crude is not going away anytime soon, leaving this period of arbitrage to drag on for years. “If you take a five- to seven-year investment horizon, we’re very bearish on natural gas,” said Turner.
No Renewables Renewal
Outside of building transportation infrastructure, the macroeconomic forecast for natural gas investments looks bleak. The outlook for renewables is even bleaker. GE owns $4 to $5 billion in renewables projects, especially concentrated in wind farms. Even with that large ownership stake, and all the technological advances in recent years to improve the efficiency of wind and solar, “It’s very, very difficult right now,” Ward conceded. “They’re very difficult to justify on a purely economic basis.”
The list of reasons why is long and well-known. The only way to raise capital for a renewable energy project right now is to win long-term contracts to deliver electricity for 20 or 25 years. But with so much price instability in the market, “that is very difficult to get right now,” Ward said.
Uncertainty over whether federal production tax credits will continue, and whether cash-strapped states can maintain their aggressive push into renewable electricity, create other barriers, said Dabbar of JP Morgan, which together with GE control 80 percent of the wind tax credit market.
During the Q&A session, one audience member asked the question on many environmentalists’ minds lately, about whether expanding the rules governing Master Limited Partnerships to turn them into funding mechanisms for renewable projects might help turn things around. Even if such a change passes Congress, Safran doubts it will have much immediate effect because “the underlying fundamentals and the ability to run a business profitably still has to come into play,” he said.
The other variable that makes it difficult to finance renewable energy right now is the simple variability of renewables. In addition to uncertainty about energy prices and government policy, “you still have to have the wind,” Turner said. With even just a slight drop in capacity, say from 35 percent to 32 percent, “your cash flow can go down dramatically. So you’ve got to structure them right to take account for the variability of the wind.”
So far, the federal government’s main role has been to create even more uncertainty, not less, which only adds to the challenges, said Safran.
“In my previous life I ran a renewables business,” the Deutsche Bank leader said. “And without clear-cut policy directives from Washington, the industry is going to continue to languish.”
Policy Risks Continue
From natural gas to solar and wind, the most vexing variable in whether energy projects will succeed or fail is government policy, all four panelists agreed. “You can look at every risk and you can maneuver around it,” Turner said. “The one thing you can never, ever hedge is policy risk. My dream would be if I didn’t have to worry about that.”
In the natural gas industry, how will the deadlock over pipelines between the Obama administration and Congressional Republicans be resolved? Will states with large reserves such as New York relax their drilling bans, or will states such as Wyoming – where fracking-related chemicals seem to be turning up in drinking water supplies – create new bans of their own? Will foreign investors be allowed to buy stakes in reserves that many American political leaders view as critical to our national security?
“All of these different variables, if you just look at one of them, not that big a deal,” Dabbar said. “But if you add up all of them, I think that’s what’s holding back the opportunity.”
That policy risk is restrained, at least somewhat, by the fact that so far the federal government and most states have remained silent on fracking. Nor have recent concerns that President Obama’s re-election might mean an end to favorable taxation under Master Limited Partnerships panned out.
“Despite a lot of recent comments that maybe were going to come under a lot more regulations in the shale drilling area,” Ward said, so far “the government has not really prevented this from happening.”
Inaction has negative consequences, too. The lingering question over whether renewable tax credits will be reauthorized is “the nail in the coffin” for funding new renewable projects, Ward said.
Without clearly defined rules, energy investors will be left to ferret out the limited areas of opportunity in markets constrained by uncertainty.
“It would be nice to clean up tall the problems because the list [of unresolved policy issues is quite long,” Dabbar said. Solving any one of them “would kickstart things faster.”