BNEF Chief Executive Michael Liebreich VIP Comment: clean energy's puberty years - bewildering and irreversible

CLEAN ENERGY’S PUBERTY YEARS – BEWILDERING AND IRREVERSIBLE


“Between the idea
And the reality
Between the motion and the act
Falls the Shadow”

TS Eliot, The Hollow Men, 1925

These are difficult years for the clean energy sector. A few years ago the
industry seemed to be entering a golden age of limitless growth and
infinite potential, the arrival of a new Aquarian age of progressive
environmental business. Barack Obama prophesied that his election as
president would herald the moment “when the rise of the oceans would
begin to slow, when our climate would begin to heal”.

The arrival of the global financial crisis, coinciding with the failed
Copenhagen climate talks, put an end to all that. For a while it looked
like the sector might escape Armageddon, pivoting from sunlit optimism to
industrial planning, co-opting the world’s stimulus programmes with talk
of green jobs and shovel-ready
projects.

Over the past two years, however, the full challenge facing the sector has
been revealed. The Wilderhill New Energy Global Innovation Index, or NEX,
which tracks 96 clean energy stocks worldwide, has underperformed the S&P
500 by 53 percent since the end of 2010. The sector is dotted with the
wreckage of former darlings like Q-Cells SE, Solyndra LLC, Solar Millennium
AG and Evergreen Solar Inc. Even leading companies like Vestas Wind Systems
A/S, Hoku Corp and Panasonic Corp. are having to lay off staff.

The U.S. wind industry is facing the likely expiry of its Production Tax
Credit at the end of this year just as it tries to climb a wall of cheap
unconventional gas. In Europe, feed-in tariffs are being reduced or
removed. In every sector there is more manufacturing capacity than there is
demand.

Is this the inevitable end of every clean energy boom? Was the whole
cleantech thing just a bubble? Are we now back in the new normal?

The answer to all of these is no. What we are seeing is an industry in
transition. Six different transitions, in fact, all happening at once. Each
one on its own challenging, all together, painful. But six transitions
which will see the emergence in due course of a fully mature and
competitive clean energy sector.

ECONOMICS

The first transition relates to the economics of clean energy.

In the past, the cost of clean energy was so much higher than fossil
alternatives that project developers based investment decisions largely on
the generosity of subsidies or support mechanisms available in any
location. Now, as a result of dramatic recent reductions in clean energy
costs, the industry is shifting towards one where revenue from power sales
– and therefore the level of electricity prices and the quality of
renewable resources – drive investment.

Latin America is arguably leading the way, with capacity being built in
Brazil, Chile and Mexico on the basis either of market electricity prices,
or of auctions in which wind has actually out-bid fossil fuel opponents
such as gas-fired generation. Among the large projects recently financed in
that region without Europeanstyle subsidies, Macquarie Mexican
Infrastructure Fund in February tied up $693 million in debt for its Marena
396-megawatt wind project in Mexico, and in May, Siemens AG landed a
contract for turbines for a 115-megawatt wind project north of Santiago in
Chile. In March, Mexican industrial conglomerate Grupo Musa said it was
developing a $1.4
billion photovoltaic project in Baja California to reduce – yes, reduce -
its power bills.

Spain will be an acid test of the appetite for non-subsidized clean power.
Two years ago the Spanish government made retroactive changes to the
feed-in tariff regime; now the sector is being threatened with new taxes.
However, some developers are bouncing back by announcing huge PV projects
made economic – they hope – by tumbling hardware costs and high
electricity prices, rather than by subsidies. In May, for instance, German
companies Wuerth Solar GmbH & Co. and Gehrlicher Solar AG said they planned
to build PV parks of 287 megawatts in Murcia and 250 megawatts in
Extremadura respectively. Their plan, contingent on government approval, is
for construction to start in
2013-2014.

In solar, we are already at the point where small-scale, residential PV can
produce power at a levelized cost below the retail electricity price in
several important countries – including Germany, Denmark, Italy, Spain
and Australia. This does not mean that it is economic for households to go
off-grid and generate all their power from rooftop PV, but the economic
case is there for panels to produce at least a proportion of total needs.
Geothermal power and waste-to-energy have been fully competitive for some
time.

The second transition involves the impact of renewables on the wider power
sector. For a long time, wind and solar were so tiny in terms of power
contribution that they had a negligible impact on wholesale power prices.
Now,in places as far apart as Germany and Texas, the percentage of
renewable generation has reached a point at which it is starting to move
prices, changing the returns for conventional as well as for clean energy
generators.

In Texas on June 22, wind power output reached 8.4 gigawatts, a new record.
Wind was supplying 17.6 percent of the total system load at one point,
thanks to high winds. That was far from a U.S. state record: on April 15,
wind met 57 percent of Colorado’s power needs. In Germany on May 25,
solar power generated a massive 22 gigawatts of electricity per hour,
enough to meet 50 percent of national electricity demand. Such peaks of
renewable supply put extreme downward pressure on spot power prices,
because the marginal cost of production from fuel-free technologies is
zero. In fact, the Texas wind surge pushed electricity prices in the Texas
West Hub below zero for 2.5 hours, something that has also been seen in
Denmark and Germany; in the U.K., wind farms in similar situations have
been paid to stop generating.

In one sense, this development is good for renewables, as it demonstrates
to a skeptical public that investment in clean energy can result in lower,
rather than higher, power prices. In another sense, it is not so good,
because it begs the question of how countries can maintain a stable power
system when intermittent generation depresses power prices and makes them
so volatile.

Policy-makers have a range of tools to deal with the issue, the main one
being to bring in incentives to maintain peaking capacity. Generators need
to know that it is worth their while building capacity – often in the
form of gas generators – which can quickly be switched on when the wind
does not blow and the sun does not shine. Other tools include incentives
for storage technologies such as batteries and pumped hydro, investment in
demand response, and interconnection with neighbouring countries. All of
this will require a new, more sophisticated mind-set from regulators. A
mistake can create windfall profits or slam the brakes on investment, or
both, and it is a high-stakes game, keeping the lights on as old nuclear
and coal capacity is retired. It will take a while until regulators
everywhere figure out how to play this new game, and in the meantime the
clean energy sector has to tread carefully.

Transition three relates to the emergence of a mature supply chain, one
which will be dominated by sophisticated industrial players with advanced
capabilities in quality assurance, cost engineering and investment
planning.

In the early years of the century, as clean energy took off, its technology
providers were nimble start-ups, long on vision and technology, but short
on operational skills. During the go-go years, there was enough market
demand and enough capital for these companies to survive. No longer. There
is a clear trend for major industrials to take the lead in clean energy
markets. Any small players who are not on the steepest of learning curves
are not going to make it.

ACQUISITIONS

Some of the majors are getting into clean energy by opportunistic
acquisition. First movers were General Electric Co., with its 2002
acquisition of Enron Corp’s wind business and Siemens, with its take-over
of Bonus Energy A/S in 2004. Some component makers too have fallen into
larger hands, including gearbox maker Hansen Transmissions International
NV, bought by ZF Friedrichshafen AG last summer. However, in wind,
acquisitions have not been the preferred route so far. While there has been
plenty of talk about possible takeovers of major players like Vestas,
Suzlon Energy Ltd. and Gamesa Corp. Technologica SA, there have been no
formal offers yet. Enercon GmbH too was on the target list until this year,
when its founder announced his intention to place his shares in a
foundation. Offshore pioneer Bard Holding GmbH has been looking for some
time to find a buyer. Meanwhile engineering giants like Mitsubishi Heavy
Industries Ltd. and the Korean shipbuilding players now moving into
offshore wind have so far opted to build their own operations, rather than
make acquisitions.

In PV, there have been some acquisitions of module-making specialists by
industrial groups, including Robert Bosch GmbH’s takeover of ErSol Solar
Energy AG in 2008 and Total SA’s purchase of 60 percent of SunPower Corp.
last summer, though neither of those buyers is thought to be particularly
enamored with their deals. Meanwhile most of the other PV supply chain
manufacturers, from Suntech Power Holdings Co. to Trina Solar Ltd. and SMA
Solar Technology AG to Renewable Energy Corp., remain – for the moment
– in the hands of investors, rather than large corporate owners.
Production of silicon is split between specialists and major players.
Suppliers of production equipment have seen some M&A activity, with Meyer
Burger Technology AG buying Roth & Rau AG in 2011. Some of the most
significant industrial groups entering the solar market have chosen to do
so organically, rather than by acquisition – most recently GE with its
thin-film announcement last year, and Foxconn Technology Co Ltd, the
Taiwanese contract manufacturer plotting its entry into the module
business.

In some of the secondary areas of clean energy outside wind and solar,
industrial giants have been more prepared to make acquisitions. In solar
thermal, Siemens has mopped up niche players such as manufacturer and
developer Solel Solar Systems and thermal receiver firm Archimede Solar
Energy, while Areva SA absorbed Ausra Inc. In the fledgling area of marine
power, as we wrote in this column last month, the likes of Siemens, ABB
Ltd, Andritz AG, Rolls-Royce Holdings Plc and Alstom SA have bought into
specialist device makers.

In biofuels, enzyme producer Verenium Corp has gradually seen its next
generation biofuel assets acquired by BP Plc. Likewise, DuPont Co. bought
enzyme company Danisco A/S last year.

In smart grid in 2011, Toshiba Corp. bought electronic metering leader
Landis+Gyr AG, and Schneider Electric SA took over distribution management
software provider Telvent GIT SA. Then, Eaton Corp. acquired electrical
grid equipment maker Cooper Industries Plc in May this year; more recently,
Siemens snapped up Senergy Sistemas de Medicao SA, a smart-metering
business previously owned by Brazilian company Nansen SA Instrumentos de
Precisao; and ABB purchased wireless communications firm Tropos Networks
Inc, in order to gain control of the latter’s GridCom mesh networking
technology.

Other areas have been slower to consolidate through acquisition, including
batteries, where growth in manufacturing capacity has run far ahead of
demand, particularly among companies hoping to serve the electric vehicle
sector. Startups and relatively small technology players remain prominent,
though their difficulties are obvious – as exemplified by the
bankruptcies of Valence Technology Inc. and Ener1 Inc. This month saw
China's largest auto parts company, Wanxiang Group Corp., sign a
non-binding memorandum of understanding for a multi-stage deal that could
see it ultimately acquiring 80% of troubled A123 Systems Inc. The deal is
subject to all conditions being met for each stage, and Wanxiang exercising
all of its options for each stage. However, it can only be a matter of time
before the battery sector too is dominated by the big boys.

Whether they grow their clean energy businesses organically or by
acquisition, the shift of supply from independent specialists to major
industrials will have profound effects. Costs will continue to come down as
these companies bring their formidable purchasing and operational skills to
bear. These suppliers have real balance-sheet power – they can promise
long-term service contracts and stand behind their products with meaningful
warranties; they may even be able to extend vendor finance to smaller
customers. And major engineering companies have powerful friends – they
can draw on webs of alliances and play the lobbying game in a way that
start-ups can only dream about. Once the big engineering companies are in
the driving seat, the world of clean energy will be a very different place.

ADVANCED TRANSPORTATION

The fourth ongoing clean energy transition relates to advanced
transportation. We are still very much in the calm before the storm. The
modern pioneers of the electric drive-trains, Toyota Motor Corp. and Tesla
Motors Inc., have been followed by the nimbler giants, Mitsubishi Corp.,
General Motors Co. and Renault Nissan. But 2013 will see a veritable flood
of new electric and plug-in hybrid models from major manufacturers –
Bayerische Motoren Werke AG, Volkswagen AG, Daimler AG, Ford, Fiat SpA,
Honda Motor Co. and so on. Every car company is now betting in some way on
electric; even Chrysler Group LLC is experimenting with a hybrid Dodge Ram.

Electric vehicle sales are increasing, though from a modest base. Bloomberg
New Energy Finance estimates that sales of EVs worldwide in the first half
of 2012 were more than 45,000, equivalent to nearly 90 percent of the
figure for the whole of 2011. This will not be enough to meet the 320,000
unit target auto manufacturers had aimed for in 2012, but each new model
brings an advertising budget, each sale adds to the pressure to grow the
charging network. Increased volume means lithium-ion battery prices are
falling steeply, and are set to go on dropping. The market appears to have
self-sustaining momentum, aided by the same $100 oil price that is also
fuelling interest in natural gas-fuelled vehicles. A tipping point, at some
stage, beckons, provided there is no strong reversal of current policy
priorities.

In due course the uptake of electric vehicles will have a substantial
impact on fuel use and transport patterns, as well as on electricity demand
and the architecture of the grid. But for the moment, all this lies beyond
the imagination of most road users, and beyond the investment horizon of
most companies. The clean energy industry can do little more than wait and
hope.

The fifth transition that the sector is navigating relates to biofuels
moving from first-generation to next-generation. Bloomberg New Energy
Finance forecasts that world biofuel output will increase threefold between
now and 2030 – reaching 558 billion litres per year. More importantly,
the mix may change completely: in 2010, next-generation feedstock such as
cellulosic biomass residues and dedicated energy crops accounted for less
than 1 percent of total biofuel production; by 2030 this could be as high
as 60 percent, if technology improves, and costs fall, as much as the
industry hopes.

Next-generation biofuels have been attracting the lion’s share of venture
capital and private equity going into the renewable fuels sector for over
five years now. According to our data, first-generation biofuels such as
corn ethanol and rapeseed biodiesel attracted $1.2 billion in 2006, against
just $216 million for next-generation fuels based on converting non-food
crops and waste. By 2010, the tables had been turned completely, first-gen
attracting $84 million against next-gen’s $606 million. In 2011, it was a
mere $14 million for first-gen and $802 million for the next-gen.

Indeed next-gen biofuels has been one of the few areas of clean energy to
enjoy a rising tide of money from the recession-battered VC/PE industry.
Venture funds have not been funding the likes of algae-based fuels maker
Sapphire Energy Inc., which landed $144 million in the second quarter of
this year, out of the goodness of their hearts. They have been doing it
because they perceive the potential for substantial industry growth. So
have the likes of Royal Dutch Shell Plc, BP and Exxon Mobil Corp, which
have also been heavy investors in the sector. Our analysis, published
during the World Economic Forum in Davos this year with the support of
Novozymes A/S, shows that using 17.5 percent of agricultural waste in eight
regions of the world could supply 50 percent of the world’s transport
fuels. In a few years, we will be seeing a battle royal for the future of
transportation between next-gen biofuels and electrification. But not quite
yet.

The sixth and final transition is the one I wrote about in this column in
June – the shift from a narrow to a broad geographical base. A few years
ago, investing in clean energy meant investing in Europe, Brazil or North
America. Then came China and Korea. Now, new Latin American countries are
in play, from Chile and Mexico to Nicaragua and Panama, which did so well
in the inaugural ClimateScope index we released with the Inter-American
Development Bank at Rio+20. Last year, India was the fastest-growing major
clean energy market, and its recent black-outs will give manufacturers new
incentives to secure their own power. Since the Fukushima nuclear accident,
Japan is back in the clean energy game. With solar power now fully
competitive with kerosene and diesel, Africa is
waking up, as is the Middle East.

At the beginning of this sixth transition, clean energy was a rich-man’s
game, restricted to wealthy democracies willing to buy indulgences to
assuage the guilt of fossil-fuel reliance. At the end of it, clean energy
will be simply another part of the energy mix, available in some form
anywhere in the world, economic, ubiquitous, attractive.

This is the real narrative behind the growing pains of today’s clean
energy industry. The great clean energy squeeze of 2010-2012 does not
herald the end of the sector. Just as the disappearance of 497 U.S. car
companies between 1903 and 2000 did not herald the end of the automobile.
Just as the bursting of the dotcom bubble did not herald the end of the
Internet and the collapse of telecoms valuations did not herald the end of
the mobile phone industry.

Six transitions. Six painful processes, which together will reveal the
mature form of the clean energy industry. Clean energy is dead. Long live
clean energy!

By Michael Liebreich
Chief Executive
Bloomberg New Energy Finance