Renewable Asset Valuation and M&A Activity: Keys for Navigating a Rapidly Shifting Market Landscape

As the renewable and storage industry matures, asset valuations continue to shift in response to major changes in policy and macroeconomic outlook. Valuation proves especially challenging, given the market uncertainty caused by supply chain woes driving up capital costs, rate hikes leaving lending rates at their highest in the last 20 years, and global conflicts causing upheaval and high prices across commodity markets. These events, along with the passage of the Inflation Reduction Act (IRA), have led to fluctuating asset values. This dynamic further highlights the sensitivity and importance of timing and due diligence. At the Ascend Summit 2023, Dr. Michael Fisher, Senior Manager of Portfolio Analytics at Ascend Analytics, led a panel discussion that centered around development strategies related to greenfield activity, as well as M&A opportunities. Panelists included Michael Rucker, Founder and CEO of Scout Clean Energy; Hagen Lee, CEO of Peregrine Energy Solutions; and Andrew Waranch, CEO of Spearmint Energy.

Key Takeaways

• For developers, nodal choice is a critical ingredient for project success, especially as lenders increase scrutiny with regard to price volatility.
• Success in asset M&A and divestiture requires a strong development thesis, authentic company strategy, and flexibility in responding to market conditions.
• Diverse asset portfolios and sophisticated approaches to structuring and hedging allow developers to access a deeper pool of capital.
• The increasing cost of debt and uncertainty around capital expenditure has put downward pressure on development fees.

The Importance of Premier Nodal Locations

Panelists noted that, while strategies vary from developer to developer, several common core themes exist. Nodal choice, a crucial ingredient for project success, tops the list. Recent trends suggest increased lender scrutiny of projects with average or even slightly above average price volatility. Where greenfield investment allows developers to select premium nodal locations and control the entire project lifecycle, M&A activity also requires due diligence of project features like site control, congestion analysis, and injection withdrawal capacity at specific nodal locations. All three panelists emphasized the need for a rigorous, multi-factor, data-driven screening process to ensure that project returns are sustainable. Premium nodal locations remain crucial, both for pre-selection by developers and investors, as well as for targeted acquisition opportunities.

When to Sell Development Stage Projects?

Project value can increase dramatically as development risk is mitigated, but a developer’s need to recycle capital can lead to tough decisions on when to divest projects. Early-stage assets typically have the lowest multiple on invested capital (MOIC), due to the significant risk that the project doesn’t make it through the interconnection queue, while late-stage assets retain the highest value per unit of invested capital. This dynamic leads to tough decisions on whether to lock up capital to de-risk projects in exchange for higher returns, or to divest early to keep capital flowing.

Today’s market conditions also require developers to ask important questions about offtake arrangements. Risk-seeking capital may accept a riskier return profile in hopes of high returns from merchant exposure, while infrastructure funds may only have interest in structuring and contracting to lock in contracted revenues, albeit at lower returns. These and many other questions necessitate a strong development thesis, authentic company strategy, and flexibility in responding to market conditions related to asset M&A and divestiture.

Merchant vs. Contracting and Optimizing Risk-adjusted Returns

Historically, project financing processes have been largely binary. While more risky private equity buyers demonstrated willingness to finance and chase the upsides of a merchant storage asset, the low-risk, low-reward nature of tolling agreements provides the security and guarantee that entices a different class of developer. Mr. Lee spotlighted the opportunities in the middle ground of these two historical extremes for proprietary structuring of projects. Having an active portfolio with a blend of contracted and merchant assets mixed in with asset divestiture and acquisition allows developers to optimize risk-adjusted returns in this gray area. Many sources of capital, like insurers and corporate entities, have been excluded from the storage financing and offtake market due to this dislocation in risk-adjusted returns. Sophistication with structuring and hedging also allows developers to access a much deeper pool of capital.

Tax Equity’s Growing Role in Storage Financing

The passage of the IRA supercharged storage and renewable development. However, many developers awaited further guidance from the IRS to clarify the new transferability and direct pay provisions. Mr. Waranch commented on the importance of tax equity for financing renewable projects, which helps keep the long-term value of storage high as increasing renewable penetration induces price volatility. He anticipates strong demand for tax equity (historically $20 billion annually, expected to be $60 billion in 2024 and increasing). The added tax provisions of the IRA will cause new players to appear, including those willing to finance projects across the risk spectrum from fully contracted to merchant.

Closing the gap between the full value of tax credits and their market value under the transferability provision of the IRA emerged as another major theme. Currently, panelists saw the tax credits valued at between 92-93 cents on the dollar; however, as financing becomes more efficient and markets get more liquid, this gap should close.

Where Are Asset Prices Headed?

As panelists discussed where they expected asset prices to go in the next two years, concerns emerged about lending rates. The increasing cost of debt and uncertainty around capital expenditure has pressured project returns, which has forced some developers to accept lower development fees and to re-negotiate PPA prices. Consistent with the theme of targeting strong nodal locations, panelists agreed that developers would pay top dollar for late-stage development assets in premier locations while the price for the average early-stage project would drop. On the M&A side, given the difficulty of building storage projects and the unpredictability of the interconnection queue, panelists expected completed asset prices to rise. Despite the tumultuous nature of the industry, the panel remained steadfast about the key role that storage will play in the energy landscape of tomorrow. Mr. Lee said, “Energy storage gets no respect – I truly believe that’s about to change".