A recent Business Insider headline read, “By 2030, cleantech market could surpass the value of oil market.” Though significant, the possibility should come as little surprise as governments around the world look to accelerate the energy transition and as the cost of fossil fuels rise amid the war in Ukraine and ongoing supply chain disruptions.
Private equity funds, in particular, are taking notice: Collectively, U.S. funds invested more than $27 billion in cleantech in 2021; in the first half of 2022, funds investing in natural resources raised $110.7 billion, a 73% increase from the same period last year.
As momentum builds, investors hoping to ride the wave should understand that the cleantech market in 2023 isn’t the same as it was even just a few years ago. There’s a budding and nuanced ecosystem that goes far beyond the traditional renewable plays—as well as new regulations, technologies, and business models.
To make the most out of their capital, it’s critical that private equity investors grasp the interplay of cleantech operations, value creation opportunities and challenges, and new technologies. Here’s how to get started.
When most people think clean energy, their minds go straight to utility scale renewables. But there’s an increasingly dynamic ecosystem of enabling technologies and infrastructure underlying those assets that investors need to understand.
Consider the following breakdown:
Traditional utility infrastructure. Cleantech and renewables are useless without the backbone of a functioning power grid, including transmission lines and effective power distribution. For instance, as electric vehicles (EVs) begin to proliferate, there must be a monumental increase (and investment) in the underlying utility and charging infrastructure to make widespread adoption a reality—as well as grid-size storage capabilities from which utilities and market operators can access additional clean energy when it is needed most.
Proven renewable energy assets, like wind, solar, and battery energy storage. These technologies and associated supply chains are changing rapidly, creating fluctuating availability and cost effectiveness. Investors must be knowledgeable enough to assess whether an existing asset or portfolio will be financially attractive and produce sustained returns with adequate useful life—or if a new greenfield development has strong enough economics and clear path to commercialization and interconnection to weather the project development and finance lifecycle. AS emerging AI technologies are increasing the accuracy in predicting the output of intermittent renewable sources, this forecast data will drive greater reliability for development studies and assessments.
Technology orchestration layer. As renewables and DERs take hold, a significant number of disparate assets will have a direct or indirect impact on the grid—all of which need to be organized and orchestrated to provide value to customers, the broader energy market, and new markets (the carbon capture and accounting). Software platforms are needed to register, assess, dispatch, and measure those assets and ESG reporting, enabling them to participate in traditional energy markets.
Emerging technologies. EVs, energy-as-a-service providers, distributed energy resources (DERs), and advanced building electrification—such as clean backup generation, battery energy storage, and modular microgrids—are beginning to become more economically viable. These technologies are often being implemented to stretch the edge of the grid and provide resiliency. But while there’s a massive growth opportunity, the nascence of these technologies sometimes requires additional due diligence to adequately assess associated risks. The convergence of operation technologies (OT) that run the energy grid and enterprise applications (Information Technology) that support business functions are central a new wave of opportunities to improve grid operation efficiency and meet the ever-increasing energy demands.
The alignment and interplay of OT and IT is developing widely. New Distributed Energy Resource Management Systems (DERMs) are fast becoming a vital technology in the smart energy grid. DERMs improve the control and management of complex energy grid by integrating multiple sources of energy that are generated and disbursed in different locations. As smart cities advance and evolve, a DERM system can monitor energy consumption for all connected meter assets in real-time—including EV chargers and other DERs—allowing the system to balance the energy load and redirect energy where necessary to improve efficiency and reduce the waste of energy consumption.
A resilient and efficient energy grid is underpinned by a secure and stable communication infrastructure and a common data source of truth. The success of implementing and converging OT and IT builds upon the Industrial Internet of Things (IIoT). It’s the glue that binds and automates processes to work in unison, further embodying a holistic energy ecosystem that nourishes greater opportunity.
This year, PE firms with dry powder on their balance sheets are well positioned to make fruitful investments in cleantech platforms, infrastructure, physical technology to support transmission and distribution, and more.
Here are some key tailwinds driving these opportunities:
Government incentives. Together, the Inflation Reduction Act (IRA) and Infrastructure Investment and Jobs Act (IIJA) will provide nearly two trillion dollars in federal funding towards modernizing grid infrastructure, reducing greenhouse gas emissions, and accelerating the deployment and accessibility of clean energy. A 10-year horizon for tax credits for wind and solar – and the availability of investment tax credits for standalone energy storage and wind plus storage projects – will provide the assurance that investors and developers need to develop long-term clean energy initiatives.
Regulatory changes. The Federal Energy Regulatory Commission (FERC) has initiated significant policy changes to address challenges in bringing renewables and DERs into traditional markets. Order 2222 removes the barriers preventing DERs from competing on a level playing field in the organized capacity, energy, and ancillary services markets run by regional grid operators. This past June, the regulator announced plans to address “significant current backlogs” in grid interconnection queues for DERs and renewables—queues that have an average timeline of three years to get connected to the grid. These fixes will help smooth out clean energy project finance, increase the number of deals, and allow cleantech infrastructure to come online in a much more rapid manner.
New business models. Energy-as-a-service models, where customers receive a packaged (typically clean) energy solution in exchange for a recurring fee, have become increasingly popular in the past few years—particularly with commercial real estate and small to mid-size retail business, universities, schools, and hospitals. These models promote price certainty and help consumers capture the value associated with energy efficiency improvements without having to directly purchase capital improvements—nor directly manage a complex array of connected devices. Opening doors for additional net-metering and demand response opportunities, or improved reliability and resiliency.
Meanwhile, power purchase agreements (PPAs)—contracts which facilitate the purchase of, for example, the electricity powered by a wind farm for a long-term period at a fixed price—provide opportunities for regulated utilities and large corporations to hit decarbonization efforts and stability for sellers exposed to the fluctuations of wholesale power markets and uncertain weather patterns. The use of PPAs continue to rise as demand for renewable energy booms, particularly from the increasing number of corporations making climate commitments.
Market consolidation. PE firms should be on the lookout for market consolidation opportunities in cleantech—for instance, around firms that design, implement, and support cleantech solutions; solar products; and portfolios of DER assets and/or renewables.
Though the cost of renewable energy has decreased substantially over the past decade—namely through sustained government investment and maturing technologies—prices have begun to rise due to soaring cost of materials, shipping and labor, and the supply chain chaos brought on by the pandemic.
That goes for PPAs, too, which spiked by nearly 10% in Q3 2022, as demand for renewable energy runs up against supply chain and transmission constraints and a limited number of projects.
Some of those constraints, like the interconnection queues FERC hopes to address, could impact the efficacy of projects catalyzed by the IRA. Another headwind involves the variability of state-by-state regulations, the outlook of which can be difficult to predict.
The success or failure of the Inflation Reduction Act rests at public service commissions because if the utilities are not making good decisions and the commissions are not regulating appropriately, then those states are going to be left behind,
As such, investors must do their due diligence to understand the regulatory climates of the state and local governments in which they hope to participate.
As the energy transition continues to pick up steam, the cleantech market is poised for more rapid growth in the year to come. Investors—both in private equity and elsewhere—are rightly taking notice and investing in the space.
The opportunities, spurred by government incentives, regulatory changes, maturing technologies, and new service models, are vast. So, too, are the challenges: differing state regulations, price volatility, or the increasing complexity of the cleantech ecosystem. More than ever, success depends on a thorough understanding of the technologies, operations, and market forces at play.
Done correctly, and with the right support, cleantech will continue to be a prosperous area of investment in the future.