The Big Squeeze | Energy Costs | Part 2

In the second part of our two-part series on the energy crisis, we build the case for energy cost solutions in this complex, evolving mix of risk categories. And it doesn’t come without a level of controversy.

Read part one here.

What is Our Way Out?

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Decentralised Energy and Smart Grids

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Decentralised energy generation is a mix of local energy and storage connected to the grid to supply electricity and made up of smaller renewable projects like rooftop solar, biomass and waste-to-energy plants.

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This setup reduces risk and increases energy security and supply at competitive prices. The system is stable and more efficient as there is less transmission loss, unlike a traditional setup, where power generation and consumption are far apart.

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The critical enabler for decentralised energy is the smart grid in place of existing grid infrastructure through upgradation and augmentation with intelligent data systems. A smart grid will enable the grid operators, energy suppliers, and consumers to adapt dynamically to changing conditions. For instance, if there is an increase in electricity prices, a smart grid can supply this data to consumers, who may alter their power usage if they have the flexibility. This data can also enable new technologies like vehicle-to-grid to access and supply excess energy to the grid for economic benefits. On the other hand, the system can carry out charging and other less critical activities.

Market Diversification

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Renewable energy companies also face increasing competition for contracts, with the bid prices at an all-time low for offshore wind. Solar projects in Asia have also seen low strike prices, which are difficult for projects to sustain over long periods, particularly with fixed-price contracts.

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For renewable energy projects, diversifying revenue streams could help counter the reliance on ‘energy monopolies’. Greater self-sufficiency for renewable energy generators is good news for the whole sector and benefits end-customers, as there will be more viable renewable projects offering choice and driving down prices.

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Some options to diversify revenue include energy storage for storing excess energy produced in various media such as batteries. They can sell this stored energy to the grid during peak periods and support load balancing programmes with the grid operators for enhanced revenue. The UK already had 1.3 GW of operational battery storage assets operational in 2021, with the potential to reach 16 GW in the next few years.

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Innovation in Grid Stabilisation

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Renewable energy cannot scale without sufficient innovation in the grid infrastructure. This innovation includes the areas of demand response, predictive maintenance and efficiency.

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Digital twins, a virtual replication of a physical system, can help solve the supply and demand ambiguity by better preparing industry professionals for various scenarios that could affect the grid.

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Adding Artificial Intelligence (AI) to the digital twin makes it possible to test-drive complex systems and predict where things could go wrong. This type of planning is increasingly important with today’s electrical grid, where nature is more unpredictable, and cyberattacks are commonplace.

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This technology can make the grid more efficient. AI and machine learning are being used to understand and predict demand and then make adjustments to the market demand that are beneficial to consumers and the grid simultaneously. Using AI and machine learning to boost resiliency is an extension of what the industry has been working toward for a long time.

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Power companies globally have been employing these tactics through incentive programs such as Smart Savers Texas or SmartAC in California, which incentivise customers to use energy-efficient thermostats that electric companies can control when needed. There have also been similar programmes that National Grid in the UK recently announced to counter the projected winter blackouts in 2022.

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Another innovation is using Bitcoin mining to balance the grid. ERCOT, the grid operator of Texas, acts to balance the grid. Bitcoin mining companies Riot and Marathon, among others in Texas, have an arrangement with the grid operator to help provide a flexible load on demand in exchange for an agreed compensation. The grid pays the miners to switch off during peak hours while the miners consume the excess renewable energy in the grid during other times. This arrangement helps energy suppliers generate higher revenues than planned during project installation. The structure has allowed the grid to stabilise without the high cost of stabilisation with other sources. This arrangement also benefits consumers as the potential stabilisation costs have been avoided apart from a stable electricity supply without a significant increase in electricity prices.

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Innovation in asset-level risk analysis has made huge strides in the last three years. New market entrants, such as Climate-X, can map physical risk as it relates to climate shifts, thereby supporting portfolio risk assessment and asset-level insights. Mantle Labs can process billions of pixels of imagery from multiple satellites daily to create a data cube of the earth, facilitating stories around crop health, forest changes, climate impact and human. This deep learning engine provides high-resolution analysis for risk analysis for stakeholders – investors, funders, insurers and underwriters alike. Cervest Earth Scan is an on-demand climate intelligence platform supporting asset resilience, in line with the Task Force on Climate-related Financial Disclosures (TCFD) aligned disclosure, with the aim to protect their value.

How can Innovative Capital Unlock the Barriers to Lower Consumer Energy Prices

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Renewable energy generation and infrastructure have the potential to provide a decarbonised solution to the growing energy needs of the world.

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And this will have to happen through smart generation and smart grids through data, decentralisation of energy sources and constant innovation.

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Any incremental capital for an infrastructure project needs to support return on impact and return on investment.

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Thankfully finance is drawing closer to ‘understanding’ asset-level data in ways that were not feasible or possible earlier. This intelligence means that capital release can be monitored for its impact on operational performance, the environment, supply chains and the communities that interact with it.

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Capital allocators should look at projects demonstrating the greatest transparency in their mid to long-term impact. Renewable energy projects have a greater propensity to adhere to this scrutiny, given the types of data intelligence that can be captured and monitored regularly. For example, Remote control centres monitor and maintain Offshore wind assets through a mix of Artificial intelligence and Machine learning from their control centres.

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While infrastructure financing has been the go-to source for renewable energy, there is a need for new mechanisms to raise funds, invest, monitor, evaluate, and distribute the gains to investors. They should also be replicable at scale and with managed risk in proportion to the return requirements.

Source: Redsand Ventures intelligence and market research

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Traditionally, developers financed renewable projects through a mix of debt and equity. The sources were project finance, development finance, and bank debt or bonds. While these sources will continue to play a prominent role, developers must consider other emerging funding mechanisms and structures as energy cost solutions.

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Green Bonds

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Green bonds are debt securities issued to finance projects with environmental benefits, such as renewable energy projects. They are also called climate bonds. Green bonds usually have lower spreads and carry a lower coupon rate than a corporate bond or debt. In some countries, governments also offer tax incentives for investors to attract more interest.  

In the last few years, Green Bonds have contributed significantly to financing debt for renewable projects. According to the Climate Bonds Initiative, green bond issuances have crossed US$ 2 trillion since 2006 and over US$ 333bn in 2022 alone.

YieldCos / REITs

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Yieldcos are usually publicly traded companies that own operational renewable energy assets, such as solar and wind power plants. They are structured to pay out a high percentage of cash flows to shareholders in the form of dividends, which makes them an attractive investment for yield-seeking investors. Yieldcos are special purpose entities formed by a project developer into which they transfer the assets as they become operational. This structure reduces the risk for the investors in those projects as they have stable cash flows from power purchase agreements (PPA) and offer liquidity through public markets.  

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Crowdfunding / DAO structures

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Some renewable projects have used Crowdfunding platforms such as Kickstarter and Indiegogo. These platforms allow individuals to invest small amounts of money in a project, usually smaller-scale projects such as solar panel installations on a single building or a small community solar project.

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Another funding structure developers could use for funding is Decentralised Autonomous Organisations or DAOs, which have become a popular mechanism for crypto and Defi projects. The DAO structure can help the project developer to raise funds from across the world and also for investors to receive the returns in real-time. This model has already been tested to be highly cost-effective in fundraising and distributing returns. DAO funding can also be cheaper than expensive debt during the pre-operational stage. While this mechanism is still preliminary, it is increasingly finding adoption in real estate and other real-world applications.

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Energy Service Companies (ESCOs)

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Energy Service Companies (ESCOs) provide financing for energy efficiency and renewable energy projects, typically through long-term contracts with building owners or government entities. The ESCO finances, designs, builds and operates the project, and the customer agrees to purchase the energy generated by the project over a period of time.

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Pension Funds in Renewable Energy

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If we look at renewable energy projects, the nature of returns and longevity is ideally suited to a significant part of the investment universe, pension funds. These pension funds typically invest in a portfolio of assets, of which most are expected to be stable, long term and low-risk assets. Pension funds have invested indirectly in renewable energy projects through structured instruments like infrastructure and private equity funds. The performance and the return profile for these investments are dependent on the fund manager’s capabilities to identify, invest and generate returns from suitable projects. Moreover, the returns to pension funds are after the fees paid to the fund manager, so the net returns may not be attractive enough to finance the burgeoning deficit in some of the largest pension funds. As pension funds in the developed world have been increasingly pushed by their stakeholder to move towards cleaner assets, they have been trying to find better opportunities to maximise their returns and impact.

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One of the energy cost solutions to these problems could be pension funds investing directly in renewable energy projects. But several factors currently make it difficult for them to do so. These include lack of familiarity, risk assessment, lack of standardisation across investments, illiquidity, limited track record and trust issues. They also must invest across several projects to avoid concentration and reduce the risk in individual investments. Many pension funds lack the human and technical resources to source and assess new opportunities and monitor portfolio investments individually at the project level.  

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Energy Cost Solutions Abound – if Capital Sources Can Adjust

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In short, a mix of patient capital sources has the potential to help achieve the necessary scale, profitability, and impact measurement.

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More capital needs to flow into the renewable energy sector for it to be emancipated, driving competition and disintermediation of the strangle hold of traditional energy suppliers. This is the key to unlocking consumer price reduction.

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If investors and renewable energy project developers close the gap in finance, knowledge and monitoring of these assets, we believe the industry can overcome these challenges and allow investors to diversify their portfolios to generate long-term returns and create a broader impact to achieve their environmental and social goals.

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Authors:

Nicole Anderson, Managing Partner Redsand Ventures

Sandeep Dama, Partner Redsand Ventures

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Redsand Ventures is committed to breaking barriers between funders and industry to fuel further innovation at scale. We do this through our unique experience in asset funding and industry specialism in energy, data infrastructure and fintech sectors.

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