An interesting dilemma for capital providers in energy transition these days is being able to underwrite the unique risk profile for infra development in the space. Traditional project development relies on visibility, predictability, and repeatability, all aspects that get blurred by the uncertainty, dynamism and constant “newness” that runs across energy transition. That’s why infra has traditionally focused on projects that have low to no technology risk, rich precedence, and contracted cash flows – things like roads, buildings, pipelines, etc.
Renewables has come a long way in its road to being the perfect project finance candidate. Technology development has progressed to the point where solar panels and wind turbines are proven at scale and, on the lower end, virtually commoditized. Backstopped by typically 15-20 year PPAs, renewable assets have become prime targets for energy transition infra deployment.
But there’s a whole host of other new energy infrastructure that relies and will rely predominantly on emerging energy technologies. That includes storage, CCUS, hydrogen, biofuels, water recycling and filtration, waste-to-energy, etc. For so many of the companies in these areas, the capital ramp is quick – going from Series A/B to the next phase of capital can mean a jump from $5-15mm to $50-500mm+. The step-change nature of the development cycle for hard tech means that the incremental de-risking that is achieved is often disproportionate to the incremental capital ask. Most of the time, the change in capital is much larger than the perceived change in risk.
NREL breaks down the different components of project motivation, which is what they define as what drives the project forward and gathers the necessary stakeholders. They break it down into BEPTC – Baseline, Economics, Policy, Technology, and Consensus. How this framework plays out in energy transition infra:
- Baseline – project should have an overarching reason why it’s needed. NREL calls it a “statement of purpose.”
- The biggest disconnect we get in energy transition infra here is that baselines are often “this will be the first…” or “this is proof that…” vs. establishing a true need from the market forces at work
- Economics – project should have favorable economics – ideally economics so favorable that there is margin for those economics to fall and still make money. NREL recommends a 20-30% rule of thumb margin
- This is a challenge for energy transition infra. The project may not be at true economics of scale because the vendor or offtake market is not mature or the technology still has to undergo some engineering work at scale. It may not be feasible to work at a 20-30% rule of thumb or it may be hard to pinpoint what the margin for error is exactly
- Policy – project should be aware of and have strategies around policy
- Most projects we come across have a good handle on existing policies. The problem with this component is that policy is not very well defined and rarely has precedents in this space. It sometimes takes coordination with the policy makers to have a view on future policy clarifications or decisions, access that some project developers may not have
- Technology – project should assess technologies available and choose ones that are “bankable” and NOT unrealistically early stage. NREL calls this the most straight forward component of project motivation, assuming there is plenty of commercial technologies to choose from that achieve the same end. But in the absence of choice around technology, we see this component as the most challenging to navigate
- Energy transition infra projects that are “first of its kind” need to have robust understanding and explanation of the technology. The earlier stage and unique it is, the more of a challenge this is. What has worked in the past is pointing to rough analogs of each technological component to build some element of precedence. For example, if the process is new but the reactor design, cooling towers, heating elements and all components in the process are old, that can be a form of precedence. Having a good initial list of expected engineering problems to be solved can also serve as a bridge to an investor getting comfortable with the technology
- Consensus – project should build consensus around stakeholders on motivation and development process. This component is the most difficult to gauge when bringing in a new investor or third party. In our minds, having initial consensus is great, but the perception of future consensus can be a real dealbreaker. In other words, the investor should feel like the project will have an easy path to getting anyone involved in the project now or in the future on the same page. A confusing story or eclectic market may feel daunting to buy into if the investor feels that they are alone in those efforts
- Energy transition infra ecosystem is constantly shifting, so predicting future consensus (what it will need and who it will come from) is a great challenge. Marketing the story and making sure there is broad public buy-in around the market need is a way to establish this (as is being done around batteries and EV infra) but takes time. The other way is to make sure that the stakeholders involved in the project are both committed long-term and have the necessary resources to commit long-term. Having contractual relationships with large creditworthy strategics can help establish this
How this relates to raising capital is that it’s these very core elements that come to form the “gut feel” of whether a project is worth pursuing. When presented with an opportunity, investors have to make quick decisions on whether to spend time on that opportunity – and what we’ve observed is that it’s this general framework that investors use to make those quick decisions.
Once a project gets the green light for deeper due diligence, the next steps are understanding the timing / stage of a project and refining an investor’s understanding around risk to see whether that matches up with an investor’s investment mandate. A good way to look at this phase is both quality of decision around and progress on decision around: site, resource, offtake, permits, technology, and team.