The following article first appeared in the December 2008 edition of AsianInvestor magazine. Each month we offer online a feature from the magazine. To subscribe for more in-depth industry analysis that you can't find on our website, please send an e-mail to: [email protected]
Investment in environmental technology and clean energy was a headline maker just a few months ago, on the back of high fossil fuel prices, climate change and wars in the Middle East. Since then the credit crisis has pushed the quest for environmental alpha into the background.
Whilst folk may be concentrating less on saving the planet in preference to saving their own personal environment, investment in green themes and clean energy was always based on hard money-making objectives in the line of producing sustainable returns.
Investors are looking up the wrong end of 30% falls to the value of green portfolios this year. That is because the environment sector is capital intensive and in the crunch it got hit. Liquidity has dried up for environmental projects, which tend to be enormously expensive to build.
Many clean-energy companies are at early stages of development and have found it hard to find funds. Venture capital and private equity investment in the space totaled $4.4 billion in the third quarter of 2008, a fall of 24% from the second quarter. The credit crisis has played havoc with the debt-laden and subsidy-driven renewable energy sector.
"Most environmental infrastructure plays are leveraged 70:30. It costs a massive amount to build these things," says Glenn Fung, the portfolio manager of the Verde Fund in Hong Kong. The Verde Fund is 5% long and goes 10% long or short maximum net exposure, but the fund is down double digits for 2008. "There are lots of value plays, at 15 year lows in terms of value. Those entering now can get into deals at very good price levels."
The second big black hole has been the fall in the oil price. As the oil price has tumbled to less than half of its peak levels it has meant that people are less interested in buying clean energy, which was meant to serve as a substitute. The propensity to invest in new energy sources has started to erode.
The China Growth Opportunities Fund allocates 70% to energy and clean technology, so it has not been as badly impacted as many funds. The main hit been from listed water stocks, because as project finance dries up these struggle to expand, and their valuations have tanked in line with the general stock market.
"When people are losing their jobs, companies are going bankrupt and asset prices are falling, the environment tends to get pushed to the sidelines, especially when the cost of oil more than halves," says Simon Littlewood, who runs the China Growth Opportunities Fund. "The interesting angle is how the clean-tech sector is now being heralded by politicians like Barack Obama and Gordon Brown as the big job creator, the next wave of growth for Western economies. The question is where the funding will come from?"
President-elect Obama is promising emissions cuts of 80% by 2050, but offers no goals for 2020. He and similarly minded politicians such as Australian prime minister Kevin Rudd are motivated by energy security as well as more altruistic environmental concerns. However, given the state of the financial sector and the huge amount of distressed assets available to anyone looking to invest money, it is going to take a lot of government and state involvement to drive the sector forward, nudging the investors towards key specific environmental sub-sectors.
"Governments and politicians need to take the lead in driving green investments through regulation," says Joost Bergsma, the head of clean energy at Fortis Investments. "This is both a national as well as a local responsibility. Local governments can be somewhat slow in approving investments and this bottleneck needs resolution."
It is already the case that governments have acted as by far the main promoter of environmental investment. Ethanol and petrol substitute investment remain driven by governments, and as an experimental business, subsidies are still vital.
The gloomy atmosphere doesn't mean that entrepreneurs are not pressing ahead with their green projects. PT FirstFruits is an Indonesian firm planning to produce green bio-ethanol from the nipah palm, which is grown in plantations in Papua, Indonesia. The feedstock for ethanol production varies from sugar cane, sugar beet and other agricultural products. Producing the sugar-rich Nipah Palm sap is price-competitive compared to the cost of using, say, sugar cane, palm oil, Jatropha or Arenga palm to create ethanol. Costs of production equate to approximately $0.10 per litre, with a sale price of $0.71 per litre.
With this level of margin, it means that ethanol production is less affected by the lower crude oil price, as would be the case with oil sands, a field in which operating costs are a lot higher, making that investment decision more marginal.
"For investors in our project, we have been looking to high-net-worth individuals in Brunei, Hong Kong, and Japan, plus we've been talking to private-equity houses," says Yan Mandari, majority owner of PT FirstFruits. "We chose this route rather than Indonesian commercial banks, which don't have a lot of credibility in this area. Right now it is incredibly difficult to get funding from an Indonesian bank for a project such as this."
On the private-equity side there is a full spectrum of investment opportunities ranging from risky new technology venture capital, through to more solid infrastructure such as power stations.
On the listed side there are very large companies, for example Shell, BP, and Veolia Environment, which are active in clean technologies, but as that accounts for just a small part of their revenues; these are not pure clean-energy investments. Purer plays include solar panel manufacturers such as Suntech, Suzlon Energy (which makes wind turbines), or China High Speed Transmission (a maker of gears for wind transmission equipment). These companies tend to be smaller and subject to far more volatility. To short that end of the sector is difficult because of a dearth of liquid borrowable stocks, so hedge funds have found it hard to profit from their stock price falls.
Capital funding is drying up, but also the dislocation of markets is affecting firms in other ways, even those companies with solid order books. The shares of China High Speed Transmission fell 50% in two days during October when it ran into trouble on its convertible bond-hedging program, having offered the bonds with put protection that proved to be out of the money.
So where are the clean energy funds looking for the future?
"Converting waste to energy via incineration has additional potential as an environmental investment theme," says Andrew Pidden, CIO of Clean Resources Asia, which runs long only and long/short clean energy and water funds. "Forestry also looks interesting, as and when subsidies are forthcoming for leaving forests intact instead of cutting them down."
He also cites hybrid technology as benefiting as electricity or biofuels replace oil in transport, as well as the cutting edge of generating fuel from algae.
The green investment space has come to an impasse. Take cars. Gas guzzlers like sports utility vehicles (known in Britain as 'Chelsea tractors') continue to sell below cost. The death of the Humvee may yet be premature as oil prices tumble. Investment into alternative energy has abated. Yet the long-term trend for oil prices must be upward, once China gets its growth story back on track. In China, coal is trading at $130 per ton, down from the peak of $154 per ton but well above the long-term average price of $70.
This means the old methods and fuel sources are proving more lucrative to investors than the new alternatives.
Utilities and power used to be regarded in investment circles as a 'defensive' area of the market. To the extent that clean energy has tried to affix itself to that sector, then given the performance of 2008, it can hardly be defined as defensive. In the Asian market, investors simply perceived alternative-energy stocks them as China-related mid caps and sold them off.
Here's the rub: in spite of all the green initiatives, investment dollars, subsidies and carbon-credit change incentives, the world's population is still belching out more carbon into the skies every year. None of the good intentions have paid off.
"Sadly, the credit incentives might seem good, and be well intentioned," says Hong Kong-based scientist Dr Martin Williams, "but they are clearly woefully inadequate when it comes to tackling climate change, as are all other measures adopted so far."
There's still a mountain to climb, and whether you're an investor, or just a person inhaling the pollution, the message is that dirty energy still rules.