Clean Tech Exam

Question 1

What is the situation with primary energy demand presently?

Answer 1

Growth requires energy

Context: Consumption expected to grow across the board (China & Asia driving in particular); OECD stable

Fuel mix is set to change significantly, moving away from coal towards renewables.

(UN wants to triple annual rate of investment within decade) to combat climate change & maintain deployment

Substantial private capital flows are required => need to match conditions that attract capital. Has to be profitable - still building relationships with the capital providers.

Question 2

What is driving the new wave of tech investment?

Answer 2

Macro: Change in financial markets, global economies, power sector => growing demand renewables.

Sector: Opportunity in power = tech advancements, lowering costs, improving track records, strong policy and disruptive technology (e.g. battery storage) => decarbonisation driven by demand.

Also, great sense of optimism and faster rate of growth due to forecast opportunity & policy push.

Half investments in energy = renewables + emerging markets now 60% projects.

Question 3

How does policy play a part?

Answer 3

Policy takes background - enabler. Crucial for risk.
Focus on what is & fiduciary responsibility.

Positive Policy: project attractiveness & investor security.

Policy uncertainties: create investment risk, retroactive policies are the most damaging.

COP21 sent ambitious signal to global markets and energy generation – consistency and clarity.

Question 4

Clean tech investment historically?

Answer 4

Historically financed: utility equity & bank debt + specialised funds.

Investments in this sector has been a sure way to lose money/got renewable energy wrong.

First wave of clean tech investment 2006-2014 = oversupply in markets (oil prices fell), subsidiaries, recession. VC clean tech did very poorly – lost money.

Previously small and complex nature of renewables the need for capital = underserved

Question 5

Risk/Return continuum & importance for clean tech?

Answer 5

One for both players and instruments. Memorise.

Variety of investors different risk appetite.

Need to improve our ability to match early stage, high risk projects, with the right investors and then hand them over to more risk averse investors further down the line.

Return can be ‘sticky’ (reverse x & y) i.e. you accept any level of risk to see the return you want to see (15-18% following crisis).

Something that looks safe can actually be risky depending on financial structuring

Question 6

General Principles for Capital Structure and debt?

Answer 6

The ideal way to finance technology infrastructure is with low-cost (low risk) debt (usually against cash flow).

But to gain debt financing, a venture will need to start with more expensive forms of financing (equity)

Introducing debt = actual ROE (capital gain/capital invested) increases immediately; R(E) goes up, applies to all financial assets (as does risk though).

Question 7

Finance Pecking Order?

Answer 7

Goes from low risk, low return to high risk, high return.

Senior Debt/Bonds
Subordinate Debt
Mezzanine
Hybrid Debt/Equity
Equity 

(VC, Growth Equity, PE, Corporate Equity, Debt)

Question 8

Optimal Discount Rate? Cost of Capital - what does it measure?

Answer 8

Every venture = optimal capital structure = lowest WACC/ theory accurately reflects total risk.

1) Measures return demanded by all providers of capital
2) Investment must offer this/higher return offer to warrant capital provider’s money
3) = opportunity cost of capital employed (for investor) – rate of return could earn elsewhere on project with same risk & capital structure
4) Signifies true DR for project after accounting for capital structure & risk.

Riding the asset down the discount rate (declining WACC) => unlocks a cost of capital that’s much lower => higher NPV – this is what you want to do.

Question 9

Estimating WACC?

Answer 9

Very difficult to do… But:

Cost of Debt = yield curve/bond prices (10 year sovereign bond) – implied return of debt of corporate bond

Debt/Equity ratio

Cost of Equity = market risk premium (CAPM) – rf + B(Rm-rf)

Question 10

Corporate vs. Project Wacc?

Answer 10

Corporate wacc not necessarily cost of capital for project within firm.

Systematic risk of project could differ from the systematic risk of firms projects.

Target capital structure of project could differ from corporate capital structure target.

Each project will have it’s own WACC & hurdle rate (risk less + risk premium).

IF project level: look at other similar projects, can’t just take the WACC of the company = think opportunity cost of capital.

Question 11

Hurdle Rate?

Answer 11

Rate of return/compensation on a project/investment required by the manager/investor for riskiness present.

= the risk less + risk premium

For riskier projects, IRR will be higher, = hurdle rate higher.

Compute = most important risks, how to measure, how to translate into numerical premium/or discount for hurdle rate.

Question 12

Key investment metrics?

Answer 12

NPV (accept greater than 0)

IRR = accept IRR > WACC = NPV > 0

Capital Efficiency = NPV/CAPEX – measure of value creation (helpful to rank not in isolation)

Question 13

Estimating Cash flows?

Answer 13

1) Total Cash Flow - capex
+/- change in working capital
+/- cash flows from operations
+/- salvage value or decomissioning costs.

2) EBIT * (1-TR) + depreciation – CAPEX – changes in WC (Cash+Inve+Rec-Pay)

Question 14

Opportunity Cost of Capital?

Answer 14

Best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.

Rate that should be used to discount the cash flows of a project for budgeting purposes.

Provides the conceptual foundation for a good WACC

Question 15

IRR?

Answer 15

Yield indicator.

Annualised rate analogous to common forms of investment

IRR can only work standalone if –ve cashflows preced +ve ones

Noes not consider scale of project/wealth creation

Question 16

Sources of equity finance?

Answer 16

Unlisted Equity & Listed Equity & Non-private equity

Question 17

Unlisted equity?

Answer 17

Venture Capital
• Early stage / high risk
• Target 80%+ returns
• Multiple rounds / 2-3 year exit

Private Equity
• Growth stage / medium risk • Target 15-25% returns
• Exit within 3-7 years

Infrastructure Capital/Fund
• Long-term assets with lower risk • Target 8-12% returns
• Exit after 10 years (or longer)

Question 18

Listed Equity?

Answer 18

Listed equity - Permanent capital

• Operating track record & scale / scope
• Target 7-11% returns

Question 19

Non-Private Equity?

Answer 19

Grants
• Innovation support
• Subsidised returns but small-scale

Government investment
• Possibly subsidised returns
• “Crowing Out” versus “Crowding In”

Question 20

Venture Capital - Basic Definitions?

Answer 20

Early Stage: Founders capital, Friends & Family, Competitions

Mid stage: Crowdfunding, Accelerators,Business Angels, Angel Syndicates

Between 2 & 3: Seed investors.

Late stage: VC Firms, Corporate VC, Institutional VC

Moving down this: Bigger $ & increasing influence on funding ecosystem

Question 21

What is a private equity firm?

Answer 21

PE is an investment management company comprised of General Partners that manage a PE fund.

PE fund is a pool of capital/equity raised from investors (limited partners - invest for 10 years).

The fund then seeks minority or majority control in privately held companies in their area of expertise/industry focus: have more strategic control

Question 22

Who are the limited partners/who invests?

Answer 22

High net worth individuals, Pension funds, Sovereign Wealth Funds, Financial Institutions, Insurance companies, Foundations/Endowments

Investors invest into a timeframe, the PE firm will give investors dividends and capital pay-out after.

Question 23

General practices of a PE firm?

Answer 23

PE will not take as much risk as VC.

Lower risk appetite - providing lower, more reliable returns (15-25% IRR) - 5 yrs.

Main difference growth PE & VC = technology risk;

PE deploys of tech that is commercially ready (not new)

PE used to take inefficient public companies private then make them more efficient.

Now it is about growth equity. Investing in a company that needs significant capital to grow.

Leveraged buy-out is where if you want to buy a £1bn company, using £300m equity and £700m debt from a bank, you only must give 2x return on equity and pay interest on the debt.

Question 24

How are Investments found? (4)

Answer 24

1) Strategic approach – Regulation - see where market going, invest in companies in that industry – gaps in the market – pursue (top down scan of particular industry)
2) Proprietary approach – Opportunistic approach- based on personal relations- value not otherwise created – use network to create transactions.
3) Auctions – Participation in bidding on transactions marketed by intermediary; Investment bank approaches PE with teaser, if interested sign NDA, then go to Auction. Highest bidder wins - broken auction is when bidders drop out, then you can negotiate better on price.
4) In the door – People who walk through the door. 1-year turnaround time, from walking in to getting funded. 2-3/100; third party instructions & cold calls from firms seeking capital.

Question 25

The Typical PE process? (5)

Answer 25

1) PE fund provides equity capital, becomes a shareholder and takes one or more seats on the board. 2) Management may provide capital but mostly pledges the dedication of resources (people, intellectual property, real assets, etc.) 3) Capital commitments typically staged over time based on achievement of key milestones. 4) Exit from the investment sought as soon as possible, but no later than 10 years. 5) Exits achieved by IPO or trade sale (selling part / all of the company to e.g. utility) – IPO is not a sale – beginning of a new process = not the ultimate goal (circa 3% IPO).

Question 26

Financials of PE?

Answer 26

Fee structure – annual management fee of AUM - Most firms set minimum guarantees rate of return (5-8%) - Once exceeded, PE house shares in profit of that (10-20%) Successful due to: proprietary (opportunistic); strategic control; quick buy & sell when valuations look good...

Question 27

How is CVC different/same from Professional VC? (4)

Answer 27

PE’s biggest competition is ‘do it yourself’ direct investment of pension funds etc. setting up their own teams (CVC - google, statoil, apple etc.) 1) CVC capitalize upon information advantage within business units for deal sourcing and due diligence. 2) CVC must look for potential strategic fit with parent / parent industry – critical in deal screening. 3) CVC May be run like VC firm or like an in-house strategy unit, depending upon objectives. 4) CVC’s can work with complimentary VC firms via co-investment

Question 28

What is professional VC?

Answer 28

Subset of PE that focuses on smaller bets ($500K- 50m) in very high risk/reward co’s. Professional VC = appetite for technology risk (key difference to Growth PE) Relevant for entrepreneurial start-ups after the product or service gained an initial customer base VC tend to specialize by industry & investment size they make with companies in portfolio.

Question 29

Indicators of the cost of debt?

Answer 29

Rate (Spread, Fixed vs. Floating) Tenor (Duration of the loan) Terms (Secured vs. Unsecured, Repayment schedule, Covenants, etc) * Cost of corporate debt is relatively easy, just look up the market value/rating on corporate bonds * Project-level debt more complex (and important for renewable energy projects) – focus. Raising debt exposes to currency risk if outside home country & debt usually prices in risk.

Question 30

What is Project Financing & mainly used for?

Answer 30

Basic distinction from corporate financing is investors exposure is tied only to predictable cash flow from tangible assets of project, not company. The assets of the project are used as collateral for investment. Financing method often used in energy & infrastructure projects - Referred to as SPV/SPC(ompany) financing.

Question 31

Main advantages of Project Financing (4)?

Answer 31

Allows for higher gearing & Shared participation by joint venture partners Clarifies & isolates investment risks Ensures arm-length transactions with firm and project company

Question 32

Role of Banks in Project Financing? (3)

Answer 32

1) Advisor: market intelligence, structuring experience, selections of approach to finance market 2) Arranger/Underwriter: final structuring, market access 3) Lender/Guarantor: Provide funds, loan management role or guarantor on own account. Sometimes come together as syndicates.

Question 33

Fundamental Issues with PF?

Answer 33

Does the project make sense to all stakeholders (8): Sponsors / Contractors / Suppliers / End users / Host government / Neighbours / Environment / Society. Sponsor: resources to realise project, committed and bought in (money at risk)?

Question 34

Example risk free rates & debt ratio?

Answer 34

15% brazil, 10% India & SA, UK, USA & Germany: 5-2.5% Debt/Equity Ratio for techs (you can see PV - most mature): PV (83%); Coal Fired (75%); Biomass (70%); Wind offshore (65%); Geothermal (50%)

Question 35

Bank/Lender objectives for Project Financing?

Answer 35

Debt: Low risk, low return (fees and interest) Want: * Clear definition of project and cash flows * Priority access to cash flows * Being repaid on time and in full * Removal of risk from project * Guarantees from as many people as they can Clean tech: Will see that sponsor has money invested, off-take arrangements & base-case/downside scenario first.

Question 36

What do the sponsor/owners want from project financing?

Answer 36

Equity: High risk, high return (lots of upside potential) What do sponsors want: * High gearing * Low cost of debt * Minimise upfront cash paid * Restrict lenders recourse to project assets. * Maintain asset flexibility, ability to sell project.

Question 37

Estimating the expected return on equity?

Answer 37

Graphs. If your project cost of equity is lower than your overall company R(E) you will reject these lower risk projects; whilst you will accept the higher risk ones. => getting this number wrong repeatedly will cause you to fail to exist – profit is relative to the opportunity cost of capital. If wacc = 10% and investment return = 6% = negative return.

Question 38

Why is the cost of capital so important?

Answer 38

Determines the price of any asset – anything that has utility – embedded in it is a discount rate = the time value of money and risk.

Question 39

How to calculate the expected rate of return on equity for a new investment project?

Answer 39

Two major schools of thought (pricing models): 1) CAPM (and many variants) 2) Arbitrage Pricing Theory 3) Recovery Theorem Expected returns vary through time due to risk aversion – measuring that requires that you have a good variable for tracking risk aversion, or good models to, we don’t.

Question 40

How does CAPM work?

Answer 40

Most common: R(E) = Rf + B(rm – rf) – latter is the equity risk premium. B = beta of industry – a levered beta immediately increases the cost of equity. (Policy makers use this to guide provision of subsidies - higher the DR, more subsidies are given.) Basic insight: Lower the Beta, the lower the systematic risk. B < 1 means that asset has less systematic risk than the market/ assets with betas higher than 1, demand higher returns than what is offered on the market.

Question 41

Advantages of CAPM

Answer 41

Advantages: * Simple to use * Explicitly adjusts for systematic risk * Talks about β which is useful because it expresses the notion that volatility matters (more debt, higher volatility of returns)

Question 42

Disadvantages of CAPM

Answer 42

Disadvantages (5) * Rf changes daily, creating volatility * Rm is the sum of capital gains and dividends for market. This could be negative. * Backward looking, not representative of future. * Inability to borrow at Rf rate. * Difficult to get proper project β.

Question 43

How does the insight about volatility makes sense in relation to CAPM?

Answer 43

Volatility = statistical measure of return dispersion. Measured by using the standard deviation of returns or variance between returns (e.g. to a market index). Increased volatility = increased risk = increased required return How much return per unit of volatility; - Temporal: looking at short term inefficiencies vs. long term efficient markets. => Estimating equity risk premium correctly is extraordinarily difficult, not impossible.

Question 44

Problems with using CAPM for real asset pricing?

Answer 44

CAPM was never thought of for the purposes of assets – only constructed for corporates – violated in real asset investing = A = Assumption R = Reality A: Trivial transaction costs R: High transaction costs limit feasibility of arbitrage; irreversibility of investments A: Asset returns are normally distributed R: Asset return distributions unknown; “fat-tails” and skewed distributions A: There is a market portfolio available to all investors R: Strategic goals and industry norms limit the scope of potential investments A: Investors have homogenous expectations about asset returns R: Investors have heterogenous expectations, driven by inherent diversity

Question 45

What do you do given CAPM is not sufficient?

Answer 45

Intelligent approach = develop own/bespoke multi-factor asset pricing model; Or recognise inherent uncertainty & limit its effects (in real asset investment decisions) by: - Scenario analysis - Conduct monte carlo based sensitivity analysis - Consider using a real options approach Sensitivity you just change one thing, scenario you change multiple things (difference). Real options: Certainty equivalent cashflows - strip out risk from the cashflow, so the discount rate you use must be de-risked. All = takes pressure off of getting number exactly right – play with cash flow rather than discount rate.

Question 46

Arbitrage Pricing Theory?

Answer 46

𝑘"=𝑟f+𝛽1*RF1+𝛽2*RF2,+𝛽3*RF3-+𝛽4*RF4 + alpha (everything omitted from model). Decompose equity risk premium into different composite risk factors with beta loading factor for each. (CAPM only one value of risk Beta) More sophisticated investors. Theory states? In no arbitrage world you can't sell risk and make money => priced correctly => model sums the risk factors evident in cost of capital. Risk factors are picked/chosen/figured out: GDP, unemployment, oil etc. Run regressions to get Beta’s. Gains validity but loses standardisation/consistency/idea about correctness - only revealed after witnessing returs and with time – depending on how it matches up. Fama French (3 factor model) which seems to explain a lot & is commonly used.

Question 47

What does the recovery theorem state?

Answer 47

Making a lot of progress - based around put options/call options (right to, but no obligation to, buy asset). How much as a premium with right to buy that stock in the future? As the cost of capital is the driver of those pricings, you can extract that pricing kernel from the pricing of those assets. Taking on data sets and recovering the cost of capital out of that data.

Question 48

What is a real options analysis?

Answer 48

Based on the idea that DCF models may under-estimate value, when management has choices: To delay or expand investment To adjust or alter production To abandon the investment early stage Real options usually imply a premium to DCF estimates

Question 49

Real options valuation/binomial tree (look at graph)?

Answer 49

- Contingent on value of underlying assets - Characteristics of the option itself - Probability + interest rates (you assign probabilities to the respective NPV’s of certain events occurring in terms of real project in an eventuality tree) – way to think about risk sequentially in exercising investment decisions/options. Allows to see immediate value creation.

Question 50

What is the difference in setting WACC between public and private institutions?

Answer 50

Private sector companies: operate in markets & the board decides on rate of the underlying assets vs. Public sector – you get the regulator whom decides rate of return & wacc’s for that sector (water 3.85; openreach, 4.9; Heathrow 4.66)

Question 51

How to implement investing in hybrid public/private initiatives?

Answer 51

Create a financial framework for selecting investments. Challenge = assessing the opportunity cost of capital employed, i.e. the rate of return investors are earning elsewhere on projects with same risk and capital structure. This means key challenge is to determine optimal WACC for new, innovative investment projects.

Question 52

Example of the Green Investment Bank with investment and WACC?

Answer 52

Vision/Task: Green and Profitable Crowding in Capital Owned by the UK Government, the opportunity cost of capital could be how the government sets “market rates of return” in regulated sectors. Public sector helped crowd in investment by going first. GIB is getting privatized – worry won’t take on the same level of risk; instead pursue the same kinds of returns as traditional investment banks… (legislation key).

Question 53

Deciding on a WACC in a public/private initiative?

Answer 53

GIB private company - UK gov as sole shareholder => defining opportunity cost of capital is tricky. Another way to think about this could be how the gov sets “market rates of return in regulated sectors”; or (relative/real valuation): 1) Comparable (infrastructure funds, developers, growth P/E) 2) Fundamental Analysis: asset pricing, create cost of capital yourself that compensated for the risk of the project...

Question 54

Pricing CAPM outside home country?

Answer 54

Options for pricing capital when you are not investing in your home country: Int. CAPM: US CAPM + adjustment (interest rate/forex adjustment) Local CAPM: Nigerian CAPM + adjustment + Beta ERP

Question 55

Prioritizing between what technologies?

Answer 55

Onshore/Offshore Wind; Solar PV; Solar thermal; Geothermal; liquid Biofuels; Biomass to power; wave/tidal More mature technologies get higher debt/equity.

Question 56

How do you decide on investment/prioritize between and think about investments?

Answer 56

Look at what's commercially viable. No matter approach: challenge is always the same - investors must estimate financial payoff by forecasting cash flows & estimating discount rate. Then; + Scalability; IRR; align technology with core capabilities; Technological Advancements + Chose an investment that is a step in the value chain that is attractive to the investor. + Internal/External considerations You also have to get the shareholders to buy into the idea/renewable agency. Otherwise, catastrophic share price drops…

Question 57

Stakeholder Theory (8)?

Answer 57

Communities Customers Conservations groups/consumer advocates Providers of Capital (equity & debt) Employees Regulators Suppliers Shareholders Exceeds the boundary of the organisation.

Question 58

What are the challenges of intrapreneurship? Stuck in their ways...

Answer 58

Innovation potential within large companies depends upon numerous factors, many beyond the control of company managers. Established corporations, have a large number of vested interests that don’t often care about long term strategy. Working to change a large organization means embracing and working with entrenched (ingrained) interests.

Question 59

What is the Project Development Cycle of Renewables and where do investors invest?

Answer 59

Several different stages of projects + differing risks => different appeal to different investors; but: Long term assets with typically declining risk profiles Upfront costs – heavily weighted to the initial stages A – Development (corporates: on balance sheet funding - utilities & some independent developers)/ some PE/ some renewable infra) - 1 – 10 years - High risk of failure: Planning, Land, Design, Funding B – Construction (On balance sheet - corporates/PE/some infra funds/few institutional/project finance debt) - 1 – 10 years - Construction risks: Schedule, Cost C – Operations (whole range) - 20+ years - Operating risks: Availability risk, Demand risk, Price risk, terminal value

Question 60

What is the green bond markets current state?

Answer 60

Growing fast & broadening – 2016 – 4th consecutive record year issuance + doubled in size (corporate issuance). Market = $170bn end 2016. Political push globally: 2016 transformational in terms of policy: G20 = climate financing = potential structural tool to jump start growth in a low growth, low inflation environment – leaders agreed to support. China & Emerging: great illustration of supportive gov. policy from China => astronomical rise to greatest issuer of this year – major player.

Question 61

Define a green bond? (3)

Answer 61

Self-declaring market with 3 requirements: 1. Assign proceeds of bonds solely for financing of projects to improve/protect environment 2. Declare bonds green before issuance 3. Commit to level of transparency & reporting on bonds use of proceeds

Question 62

What are eligible green projects for green bonds?

Answer 62

Many existing guidelines; The: green bond principles – currently most widely used guidelines describe 9 different categories of suitable projects.

Question 63

Types of green bonds?

Answer 63

Diversified by issuer type; mostly focused on investment grade credit quality & developed markets. Generally oversubscribed (demand outpaces supply) & premiums of green bonds have been growing over time.

Question 64

What is the appeal of green bonds for investors/issuers?

Answer 64

Offers a stable, rated & liquid investment with long duration. For issuers, green bonds = tap into $100 trillion pool of patient private capital managed by global institutional fixed-income investors.

Question 65

Why are credit agencies important?

Answer 65

Independent credit ratings are hugely important for risk perceptions. Provides perspective on creditworthiness of an entity/or debt it issues. - Directly impact price of bond - riskier => needs to offer higher rate of return.

Question 66

What is the role of credit agencies in relation to the green bond market?

Answer 66

Transparency and confidence into sustainable infrastructure investment. Define value of ‘green’ for capital market. Go beyond existing assessment tools to add local, sector specific view: score based on weighted approach of: transparency, governance, mitigation & adaptation, risks... Standardisation of 'green' - investors don't like ambiguity. Uptake of bonds directly linked to rating - linked to proven tech = only matter of time + even institutional investors can solely rely on rating when no team.

Question 67

What is the role of crowdfunding in energy infrastructure?

Answer 67

Can it help cover a looming investment shortfall? Required investment in UK “Green” sectors over next two decades £bn’s: 2020: max 45 - min 21 2030: max 70 - min 30

Question 68

What are the four main crowdfunding models?

Answer 68

1. Donations model 2. Rewards model 3. Equity model 4. Lending model

Question 69

Recent trends in crowdfunding/type/geography/growth?

Answer 69

From 2.7bn in 2012 to 34.4 bn in 2015 Type (bns): Lending (25.1); Donations (2.85); Rewards (2.68); Equity (2.56); Hybrid (811m); Royalty (405m) Geography Largest – North America, Asia, Europe Smallest – South America, Australia, Africa Growth Asia (210%); Africa (101%); Europe 98; North America 82; Aus (59); SA 50%

Question 70

What’s driving crowdfunding (5)

Answer 70

1) Growing number of business models based on ‘disintermediation’ 2) Platform technologies (e.g. internet, blockchain) opening the floodgates to an age of transactions without institutions 3) The age of low-interest rates and a hunt for higher returns 4) Increasing retail bank fees and charges 5) Changing consumer preferences

Question 71

What does the opportunity look like? (from 2010 – 2020)

Answer 71

Financial economy = financial holdings up 49% to 500trillion; financial assets up 50% to 900trillion Real Economy = asset base up 43% to 300trillion; total GDP up 43% to 90trillion. Making investments accessible to investors as financial assets (packaging important liquidity) = $600 trillion financial capital = 3x more than stock of real assets underpinning economy.

Question 72

Role of Institutional investors

Answer 72

Pension funds/insurance companies - seek investments that match their long-term obligations to policyholders: Risk averse, low return - stable cash flows (6-8%) Bonds/real estate Sit on huge amounts of capital = pressure to invest in green projects (yeildcos & green bonds facilitate) Want 3 things: liquidity, diversification, yield ...

Question 73

What did the financial crisis contribute to doing for renewables?

Answer 73

1) Desire to raise debt from capital markets (Green bonds from institutional investors); 2) Preference for real assets by institutional investors; 3) Investors seeking yields (even gov bonds not really). + Low interest rates: low cost of capital Bank liquidity: banks willing to lend for longer

Question 74

What are YeildCos?

Answer 74

Company that generates cash from group of assets and pays investors back as dividends - acts as a bond (4-5%) - Portfolio of operating renewables floated via IPO. - Stable cash flows, attractive in low interest environment - Theoretically sound & liquid - Overcome transaction costs to renewables (know how) Mixed performance US - added risk back in/overpriced/tanked

Question 75

What are infrastructure funds?

Answer 75

Also takes money from institutional investors but invests in specific projects (roads/airports) (9-13% IRR). Development/Constructions phase of renewables = maybe unsuitable - risks too high - this is changing with proven techs.

Question 76

Deal/Investment Process

Answer 76

1) Opportunities sourced 2) Evaluated against IRR/yield 3) Deal structured with debt/equity 4) due-diligence with scrutiny of risk factors - capital often competing... Need to make this attractive.

Question 77

What are the key considerations for renewable investment relating to risk/reward?

Answer 77

Ecosystem of finance across entire risk-reward spectrum. All want to understand risks & mitigate - legally/financial structuring 1) Track record & performance of similar deals 2) Policy & regulatory risk - also key category in policy driven energy markets.

Question 78

What are the respective investors after/appeal to?

Answer 78

VC: Starts up new tech (50% IRR) - still more risky stuff. Growth PE: mature/proven tech (15-25%) Infra funds: proven tech, low risk assets, no construction risk (9-13 IRR) Public Equity: Proven tech - low risk predictable yeild (6-8 IRR) Institutional: proven tech; yeildcos/green bonds (6-7) Bank/mezz: leverage proven tech Senior Debt: proven tech, established company Most technology now licences though & everyday consumer can now invest in clean energy stocks.

Question 79

Where renewables fit in on capital markets?

Answer 79

attractive to institutional due to: - stable cash flows - low correlation other asset classes - relatively low risk (other infrastructure) - Scalability

Question 80

Where renewables fit in on capital markets? Types of financial assets?

Answer 80

Attractive to institutional due to: 1) stable cash flows 2) low correlation other asset classes 3) relatively low risk (other infrastructure) 4) scalability As asset class (it's a subcategory within several different asset classes). Green Bonds, YeildCo's, Asset backed securities (packaging geo power stations, boifuel, solar facilities etc.), REITS (real estate investment funds) - Direct link to capital markets

Question 81

Cost of Capital for renewables

Answer 81

Many have reached grid parity - nonetheless, cost of capital typically higher for renewables than other => less profitable... Project seeking finance - depends on finance it can attract + each finance source will have own hurdle rate (not as simple as saying one will invest & one won't down to risks of project).

Question 82

What are the key risks that are particularly important in the due diligence process and how can they be mitigated? (4)

Answer 82

1. Country & Financial risks (macro & political). 2. Policy and regulatory (KEY - stable regime needs to be in place for any project and regu. for licenses etc.) 3. Technical and project specific (O&M agreements) 4. Market risk Hedge against those possible (currency)

Question 83

What are the key technical and project specific risks? (5)

Answer 83

1) construction (delays, damanges), 2) tech (maturity), 3) environment (impact assessment), 4) O&M (repair/staff), 5) market (price, subsidies, new entrants) ``` Tech risk: O&M aggreements Commodity risk (market): PPA's / FiT's (feed in tariffs) ```

Question 84

Next for renewables to make even risk-averse feel comfortable?

Answer 84

Policy risks, proven technologies, stability in wholesale electricity prices, storage technologies...

Question 85

Corporates Utilities

Answer 85

Electric utilities/oil & gas/consumer facing industries - suffering from disruptive market conditions and a transition from their core competencies... + strained balance sheets due to changing energy industry

Question 86

Strategic Investors

Answer 86

Market participants (project developers, utilities, specialises funds) - tight pairing between renewables and core line of business - most knowledge. Don't have scale of financial resource at disposal to meet scale challenge

Question 87

Attracting non-conventional investor capital to renewables/infrastructure?

Answer 87

Shouldn't be seen as replacing strategic investors/utilities or infra funds, but complementary. They want liquid assets = why packaging: yeildco's and green bonds are so important!

Question 88

Projet Finance in Emerging Markets?

Answer 88

Project finance more difficult - lack of funds due to the underlying: - unpredictable asymmetric risks with unfavourable results Symmetrical risks (can be +) construction, business, forex, inflation, interest - these can be mitigated/hedged. Asymmetric (only - ): environment, accident, political, breach of contract - more likely in emerging markets.

Question 89

Investment in Africa?

Answer 89

Access and affordability (pay 20% of income to electricity) - 600 m w/o electricity. Demand up by 80% 2030. - Linear relationship energy consumption & GDP - Task: capital evenly absorbed across continent - Uneven focus on off-grid, micro application - none for industrial application (private money key to evolve). - Difficulty to mitigate risks to create enabling environment that is the problem. Not capital/interest. - Basically illustrates the importance for host country to enable environment that attracts FDI. Solution: harmonize, subsidiarity, readiness (adress political & regulatory risks) and address access, affordability and utility credit in holistic manner.

Question 90

Development/Multilateral banks role in emerging market investment?

Answer 90

Emerging & frontier markets are higher risk from capital market perspective. Most equity deployed alongside development/multilateral banks. Provide tranches of equity into privately managed funds to increase confidence and attract equity investors (crowd in). Help to overcome hurdles. Provision of PRI & PRG (WB) = more efficient use of resources than loan - don't require reimbursement of public capital - often not at all!!

Question 91

Risk management tools for emerging economies?

Answer 91

Provided by public financial institutions = reduce financing costs & mobilise money. Tools are under-utilised, despite proven - difficulty with scaling (transaction costs & design). Examined in context of project finance for hydro in Uganda - raised unprecedented loans/PE in low economy country. Simultaneous different risk mitigation instruments provided by world bank group & development bank: 1) Partial Risk Guarantee (PRG) 2) Political Risk Insurance (PRI) => drive private investment & reduce cost of renewables in developing (less expensive equity).

Question 92

Ultimate Tool Kit for attracting finance to developing

Answer 92

Risk mitigation by host country + development bank + partial risk guarantee and political risk insurance (world bank) => cheaper cost of capital & cheaper electricity. + Financial ties between WB and host country => risk profile down for lenders and investors. PRI & PRG significantly reduces expected probability of political risk event (revision of PPA) => higher expected returns.

Question 93

Clean Tech investment today?

Answer 93

Now: Institutional & in house teams understanding technology. Now it’s a different story – all technologies bar rooftop solar PV is deep in development process, having got licences etc.