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Insights from the MIT Energy Finance Forum

Posted by Chad O'Connor  December 21, 2012 11:00 AM

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The recent annual MIT Energy Finance Forum gave a splendid view into the current state of energy affairs in which smart technologies using renewable energies exist in a world full of bewildering politics and hidden subsidies.

An offshore wind farm may exemplify the problem, seen from a financing perspective alone. The capital expenditure is large. But the operational costs are very small, because the fuel is free, unlike gas, coal, or nuclear.

One may argue that the financing perspective alone ignores the much more important issue of climate change. But in order to understand the energy industry, the focus must be on financial incentives. The keynote speech by Ralph Izzo, CEO of Public Service Enterprise Group, highlighted the difficulties of investing in the energy of the future. PSEG is a utility (in addition to other activities) with a portfolio of energy-generating plants, including renewables. Izzo described the environment in which PSEG invests in the future, and especially the uncertainty produced by constantly changing subsidies and regulation. Basically, uncertainty increases mis-investment, which then ends up causing higher rates for consumers. PSEG has to answer to its stockholders first of all, and climate change enters into the picture only secondarily, in the form of regulation, subsidies, and the mostly un-channeled desires of customers who care about the climate.

The Energy Finance Forum delved into the financial issues of renewable energy in some detail. The financial mechanism involving a high upfront payment we are all familiar with is the mortgage. We borrow a large sum of money and pay it back over a long period of time along with interest. As long as lenders trust borrowers to pay, further capital for mortgages will be forthcoming, and more people will benefit.

There is actually a relevant history behind this for our current problems financing renewable energy. In the 1970s, new government agencies, Ginnie Mae, Fannie Mae and Freddie Mac promoted home ownership by guaranteeing payments of bundled home mortgages. These bundles constituted a new kind of bond (a loan yielding a payment over a period of time) that could be bought and sold. As long as this is done well - and the subprime mortgage debacle shows that it can be done poorly – everybody benefited. Bonds were now available yielding a revenue stream at a well-defined risk, and buyers of such bonds, such as pension schemes, were happy. The banks originating the loans were happy because they could sell off their mortgages in chunks and be certain that they had made a profit. And borrowers were happy because more capital was forthcoming, making it easier to obtain a mortgage. Indeed, the political goal, promotion of home ownership, was achieved.

Financing a wind farm could work in the same way as a mortgage because electricity is produced constantly, producing a revenue stream that can go towards payment of a mortgage-like loan. But loans of this size are not structured as bonds. The risk of investing in wind farms is hard to gauge without a track record, and there is no equivalent of Ginnie Mae to jumpstart the process. Hence wind farms have to be financed by private equity firms that accept higher risk in exchange for higher fees. Pension funds would happily buy bonds yielding 7-8% in bulk, but for private equity financed projects such a yield is too low. Several panel speakers argued there is a legitimate role for government here to step in, provide guarantees, reduce risk and thereby facilitate the financing of renewable energy.

Tim Dee of Bank of America Merrill Lynch argued for the need to bundle loans as the solar industry has to self-finance per project, the lender has to scrutinize every project individually, and sometimes renegotiate contracts. This leads to increased cost. There is a crying need for standardized contracts. However, Dee did not think the government should guarantee loans but rather that standardized contracts should be developed under the auspices of SEIA, the Solar Energy Industries Association.

With eight panels at MIT's Energy Finance Forum there are simply too many to report on here. But one more prominent theme needs to be mentioned here: Natural gas is the 800 lb gorilla in the room of the solar energy industry. Cheap shale gas reduces the margins for the financing of renewable energy projects. In fact, Scott Nyquist of McKinsey & Company predicted that natural gas will crush everything but solar; such a prediction should not be taken lightly.

Lastly, Ernie Moniz, Director of MIT's Energy Initiative, considers “funny weather” the only thing able to shift the politics of energy. Hurricane Sandy seems to have been one more instance on that path. Until carbon based energy is made to pay for the rising costs of climate change, the financing of renewable energy will remain difficult. If Moniz is right, climate change deniers will lose support with every new weather catastrophe, and we could then end up with a carbon tax.

Arne Hessenbruch is a Danish expat and the founder of Muninsight, helping Northern European companies navigate the US energy market.

This blog is not written or edited by Boston.com or the Boston Globe.
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