Increasing Early-Stage Project Success in a Highly Competitive Renewable Energy M&A Landscape

Renewable energy project developers and offtakers face a rapidly changing landscape when it comes to mergers and acquisitions (M&A). Across all Independent System Operators (ISOs), more projects are in the interconnection queue than can plausibly be built, putting downward pressure on M&A prices for early-stage projects. Dr. Brent Nelson, Managing Director of Markets and Strategy at Ascend Analytics, recently hosted a webinar that identified multiple strategies for differentiating early-stage projects, thus increasing the probability of M&A success.

Key Takeaways

• ISOs across the country face an oversupply of renewable energy projects, putting downard pressure on M&A pricing for early-stage projects.
• To succeed, project developers must articulate critical differentiators including siting strategy, Investment Tax Credit (ITC) bonuses, land acquisition strategy, interconnection, engineering, procurement, and construction (EPC)/hardware supply viability, established financing, or strong tax equity relationships.
• The value difference between early-stage and late-stage projects can be illustrated by indicative development fees across multiple ISOs, in which early-stage solar+storage projects see $0.02-0.05 per watt, while late-stage projects see $0.07-$0.20 per watt.
• When valuing potential projects, forecasts should be consistent with the most probable future and should adhere to long-run equilibrium, as Ascend Market Intelligence forecasts do.

Interconnection Queues in Excess of Demand

Every ISO across the country faces an oversupply of renewable energy projects, as demonstrated by the size of interconnection queues relative to peak demand, which varies from 1.8 times to 3.6 times peak capacity depending on the ISO, as seen in Figure 1. Because supply exceed demand, undifferentiated projects in terms of risk, location, maturity will be cut.  

"When we're talking about multiples of peak demand, the markets just can't absorb it all," Dr. Nelson stated. Not every project can be above average, so how do you make your project have a higher likelihood of success than all the others?"

Reducing Risk: Finding the Sweet Spot in the Project Lifecycle

One significant factor for assessing potential project success involves having a clear understanding of where value lies within project lifecycles. Projects can be developed through operation or sold prior to their Commercial Operations Date (COD), in which case the developer fee represents the difference between the sale price and the investment costs. While developer fees vary by project, they increase as projects become de-risked. As projects advance through the interconnection queue, the probability of construction rises significantly with a corresponding decrease in project risk. Once a project reaches notice to proceed (NTP), capital outlays increase steeply, and risk diminishes.

The value of a project, then, moves inversely to the risk of that project being built. Accordingly, the highest difference between project value and capital outlay occurs from the interconnection agreement to the NTP, as shown in Figure 2.  

"We're really interested in the ratio between the value of a project and the capital outlay, as the biggest value-add happens in the late development phase," noted Dr. Nelson. "That's where the developer fees come in at the highest value. So, the key question as we are trying to navigate this space is how do we drive down that risk? Because as we drop the risk down on a project, that's how we increase the value."

Market Tailwinds: What Pulls Projects Forward?

Even with excess interconnection queues, demand for clean energy remains robust, and load growth will allow grids in multiple ISOs to continue to absorb clean energy capacity. Multiple factors drive this dynamic. First and foremost, price remains the defining factor. Elevated gas forwards, which maintained a structural increase after Russia's 2022 invasion of Ukraine, make clean energy the clear least-cost source for new energy resources. Corporate demand for clean energy and ESG targets continues to grow, and nearly all utilities – even traditionally conservative ones – have decarbonization goals that are not driven by state mandates. Thermal retirements continue, and the potential for stranded asset risk leaves most developers reluctant to build new thermal capacity.

Other economic factors help to pull renewable projects through the development lifecycle. Large institutional capital looking for late-stage renewables has outpaced the supply of available projects, leading to high competition. As a result, much of this capital now looks to fund or own development arms, thus driving demand for 'platform' acquisitions. At the same time, major oil companies are increasing spending related to renewable energy, as shown in Figure 3. These companies have made very significant commitments to the energy transition, indicating that approximately 30% of their capital expenditures, representing more than $20 billion per year, will be directed to renewables by 2030.

Similarly, infrastructure funds continue to invest in clean energy, closing a record amount of $162 billion in funds raised during 2022, with renewables representing the largest constituent among sector-specific funds at $21 billion. Increasing ESG-concerned capital is also reshaping the landscape. Investment assets incorporating ESG in the US have grown to more than $8 trillion, more than 40% of which is overseen by managers listing climate change as their top ESG priority. In Europe, trillions more are being added to the pool of capital required to be put into ESG-conscious investments. A muddier picture emerges in the tax equity market: It requires a massive expansion, but the tax credit transfer market enabled by the IRA remains in its nascent stages.

According to Dr. Nelson, these tailwinds represent a double-edged sword for renewable energy projects. Many developers have a business model that requires selling early-stage projects to recycle capital, but because only a fraction of the projects currently in the interconnection queue can plausibly be built this will lead to a supply glut of early-stage projects. The same factors that reduce success probability for early-stage projects will actually increase the value for projects that achieve late-stage development.  

"Late-stage projects are going to carry a lot more value because there are going to be fewer that make it through to that stage," Dr. Nelson stated. "So those projects that have their financing lined up, have the offtake deal lined up, have the hardware lined up, make it through the interconnection agreement, and have the labor to get it built, are going to see a lot of value."

Thus, enhancing success probability will be critical for early-stage projects, and will require differentiation to distinguish real, potentially high-value projects from speculative ones. Important differentiators include:

• Strategic siting, with particular attention to high value nodes/barriers to entry, bonus ITC, low interconnection costs, and differentiated land acquisition strategies.
• Offtake deals and hedges.
• Engineering, procurement, construction (EPC) and hardware supply commitments, especially valuable because of the current strong demand for and low supply of EPC.
• Having a deep balance sheet or strong financial/tax equity relationships.  

M&A Forecasting: Choosing the Right Approach

To demonstrate the value difference between early-stage and late-stage projects, Dr. Nelson discussed indicative development fees across multiple ISOs. He noted, for example, that solar+storage projects are seeing $.02-.05 per watt, while late-stage projects see $.07-$20 per watt. A similar spread exists for storage-only projects.  

Dr. Nelson discussed two general project valuation approaches, top-down and bottom-up. Top-down valuations use M&A comparisons for similar projects, which often look at location, configuration, development stage, contracting, and other variables. Top-down comparisons should carefully examine distinguishing characteristics. In particular, Dr. Nelson warned that not all locations are created equally. Interconnection costs matter, as do nodal price dynamics – and the relative durability of those dynamics. Other considerations include assessing whether contracts provide sufficient internal rates of return considering both project revenues and capital expenditures. Having a realistic sense of interest rates, and how much they might move between project start and potential completion, also remains a critical factor.  

For bottom-up valuation, value in the merchant tail poses a major concern, especially if using a forecast that provides unrealistic scenarios in which merchant revenues are discontinuously higher than the tolled period. A forecast should be consistent with the most probable future and should adhere to long-run equilibrium, as Ascend Market Intelligence forecasts do. For renewables, this means that a high renewable future should have relatively low prices when renewable generation is high.  

Ultimately, success depends on project lifecycle and a commitment to differentiation. Dr. Nelson noted that the M&A market has continued to soften during the past year due to rising interest rates, clogged interconnection queues, initial uncertainty related to IRA guidance, a cresting of market exuberance, and large platform acquisition taking demand off the table.  

"Late-stage projects are expected to maintain most of their value," Dr. Nelson stated. "For early-stage projects, we expect to see some significant decreases, but with a lot of spread. Whether you sit at the top of the spread versus the bottom of the spread, it's really going to come down to those differentiating factors."  

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