Green Energy: When Public Funds Dry Up

The law of unintended consequences is alive and well in the green energy industry. To spur cleantech spending, create green jobs, and reduce uncertainty for private investors, governments worldwide have poured billions into the sector. Yet as policymakers start planning cutbacks in those subsidies, renewables developers are in a mad rush to lock in state support and profits before the tap is turned off.

This has created exactly the market volatility that governments were trying to avoid. Uncertainty over the scale and timing of cutbacks is distorting business plans, causing some energy companies to pull back while others accelerate plans. "Developers want to start projects as fast as possible," says Tim Warham, a director on the economic team at consultancy Deloitte in London. "They know the opportunity for super profits won't be around forever."

The global investment pot available for green energy is enormous. After allocating a combined total of $25 billion in stimulus money last year, countries around the world are expected to supply a further $60 billion in 2010, according to figures from Bloomberg New Energy Finance. Spain and Germany—two of Europe's greatest proponents of green energy—together have put aside a total of nearly $13 billion to fund projects.

State backing should spur an additional $140 billion in private capital to enter the sector over the same two-year period, estimates Bloomberg New Energy Finance. That includes U.S. wind and solar power developers, who can claim a 30% cash rebate from the federal government on projects under construction by the end of this year.

"it's the survival of the fittest"

In Europe, above-market electricity prices mandated by governments for green energy supplies—known as "feed-in tariffs"—also have triggered private investment. Italy, which offers some of the continent's highest such subsidies, will install enough new solar panels this year to generate about 1 gigawatt of electricity, says Cassidy DeLine, a solar analyst at Emerging Energy Research in Cambridge, Mass. That's more than the output of a large coal-fired power plant, and nearly double the total installed in all of Italy last year. "There's a boom across the industry," DeLine says.

Yet with governments confronting bulging budget deficits, lush public support can't last, says Deloitte's Warham. The result may force some green-energy developers to curtail their investment plans. Even though green energy is gaining scale and becoming more competitive with conventional sources, many wind farms and solar parks would be unprofitable without access to subsidies.

Lower returns on investment may lead to widespread consolidation in the industry. Deep-pocketed investors, especially utilities that currently rely on conventional energy sources, could scoop up renewables projects from developers looking to offload money-losing investments, according to Warham. "Consolidation is inevitable; it's the survival of the fittest," he says.

One trend bound to help the survivors is the falling cost of clean energy technology. Emerging Energy Research calculates that prices for everything from wind turbine blades to the polysilicon used in solar cells have fallen by up to 40% in the last 12 months. Financing for new energy projects, meanwhile, is starting to warm up after the credit crunch's deep freeze. Ethan Zindler, head of U.S. research at Bloomberg New Energy Finance, says some banks are angling for a piece of the government subsidy pie. Funding "isn't back to where it was, but it's on the mend," he says.

Germany's 15% cut in solar park funds

Still, many green energy projects don't add up without public backing. The next 18 months will be crucial as subsidies come under increasing political and budgetary scrutiny. In the U.S., for instance, federal grants for solar and wind projects are set to be cut by the end of the year, while funding for such other renewables as geothermal and biomass may be trimmed in the next two years.

The same pattern holds in other countries. On Mar. 3, German ministers agreed to a 15% reduction in subsidies for solar parks built after July 2010. The Czech government is mulling a 30% cut next year. And in Italy, support for solar projects has already reached its annual limit and could be cut 25% in 2011, estimates Emerging Energy Research's DeLine. "Technology costs dropped a lot more than expected, which gave companies much higher returns than governments initially predicted," she says.

For some owners of green energy projects—especially financial investors who counted on subsidies to produce higher returns—the reduction in government backing signals that it's time to sell out. Ronan O'Regan, a director in the London energy team at consultancy PricewaterhouseCoopers (PwC), predicts that utilities or manufacturers of green energy equipment could be among the likeliest buyers.

Utilities, which spent almost $16 billion on renewables acquisitions last year, face stringent government targets on carbon emissions and green sourcing, which can be met only through buying existing renewables projects. Makers of green energy equipment such as wind turbines or solar cells are looking to diversify across the industry in search of new revenue, including buying into projects that use their gear. "They can live off lower returns than the financial players," says PwC's O'Regan.

That scenario played out last month for Boston-based private equity firm Denham Capital. The company—which has $4.3 billion under management—and a group of other investors sold their stakes in European renewables developer SunRay Renewable Energy to California solar panel manufacturer SunPower (SPWRA) for $277 million. For Denham partner Scott Mackin, the pending cuts in wind and solar subsidies have limited the returns that first attracted him to the market. "The economics of investing just aren't that compelling," he says.

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