Season Investments


Two Types of Green

Posted on December 29, 2015

“The world is going to be using 50 percent more energy by mid-century than it does today.” – Bill Gates

2015-12-29_Two_Types_of_Green.jpgDecember has been a big month for green energy. At the very end of last month, a group of two dozen billionaires including the likes of Bill Gates, Mark Zuckerberg, Jeff Bezos, Meg Whitman, and Ray Dalio announced the formation of the Breakthrough Energy Coalition with plans to invest large sums of money into the clean energy and energy efficiency space. The goal of the coalition is to fund research and development and higher risk projects that have the potential to produce technological breakthroughs in energy production. The timing of this announcement was no fluke as it was strategically made a week before the United Nations Climate Change Conference in Paris. The conference, held earlier this month, produced another major clean energy milestone as all 193 nations in attendance approved an accord to cut greenhouse gas emissions. Then in the middle of December, the US Congress approved a bill to extend solar and wind tax credits through 2022.

Whether or not you are supporter of green energy, it is safe to say that this industry has some major tailwinds at its back. For this reason, UBS estimates that global solar capacity will triple in the next 10 years and then triple again between 2025–2050. In reference to the accord which came out of the UN Climate Change Conference, one writer for the NY Times stated:

[T]he deal could be viewed as a signal to global financial and energy markets, triggering a fundamental shift away from investment in coal, oil and gas as primary energy sources toward zero-carbon energy sources like wind, solar and nuclear power.

This sentiment has been widely adopted for some time now as capital continues to flow into clean energy investments for capitalistic and altruistic reasons. One could say that investors in this space are capturing two types of green. Look no further than the great Warren Buffett who last year announced that Berkshire Hathaway would be doubling its investment in renewable energy assets.

So why are infamous investors like Buffett investing in solar and wind power, and should other investors be following suit? The answer to the first part of the question is simply because there is money to be made in a fairly low risk investment. As a former employee of a major utility company, I can tell you that the push for wind and solar power is not going away anytime soon. The majority of the states in the US have either a renewable energy mandate or a goal to increase the use of renewable energy to power the grid. As an example, California just recently passed a mandate requiring 50% of the state’s energy consumption be powered by renewable sources by 2030.

With those types of mandates utility companies are gobbling up all the renewable power generation they can get their hands on at “well-above market prices” to quote Buffet who was referencing the 20 year power purchase agreement (“PPA”) Berkshire signed with Edison International for their Antelope Valley solar project. In other words, companies like Berkshire Hathaway which own renewable energy assets are selling their production into a market with built in demand from utility companies who are required to purchase their product (megawatts from renewable power sources) in order to meet their mandates. Add in the fact that the cost to produce solar panels has dropped precipitously over the past decade due to advances in technology and low cost manufactures entering the space, and you have the perfect storm for a Buffett type investment (falling costs and rising prices). Warren Buffett has been a long-time fan of toll bridge type investments where the consumer has very little choice but to use a company's product or service. The current landscape in renewable energy seems to fit that bill fairly well.

2015-12-29_Price_history_of_PV_cell.pngSo the next logical question is should other investors be following suit by investing in renewable energy? The first thing to point out is that not all renewable energy investments are made equal. The highly speculative type of investments that Bill Gates and Mark Zuckerberg will be making through the Breakthrough Energy Coalition have a lot more risk and, if things go well, a lot more upside than the sleepy toll bridge like investments being pursued by Warren Buffett. We understand the merits for both ends of the spectrum, but think the more prudent path to follow for most investors is that of the low risk, existing technology producing renewable energy which can be sold to off-takers (primarily utility companies) at well above market prices.

As such, we have actually spent the last couple months vetting a unique opportunity in this space. The investment is in a private Yieldco called Greenbacker which is distributed by a company called SC Distributors out of Newport Beach, CA. Much like a REIT, a Yieldco is designed to pool money from investors in order to purchase assets with a current yield. In the case of Greenbacker, that means buying up small solar and wind projects that are already producing energy and have long-term PPAs in place with credit worthy off-takers.

As of a couple months ago, the average yield on the assets in the Greenbacker portfolio was 11.5% on a portfolio of renewable assets with long-term (average remaining contract term of 16.6 years) PPAs in place with high quality off-takers (83% investment grade). Since utilities are the primary off-taker of the electricity being produced by the renewable energy assets, investors in Greenbacker are essentially taking on the same amount of risk as a municipal bond holder with a much higher yield and total return potential. Based on a number of factors including the current yield on the portfolio and the current valuations on publically traded Yieldcos, we think the annual return potential for an investment in Greenbacker could push into the upper teens with a projected 2-3 year hold time. That being said, we do have some reservations with Greenbacker, most of which stem from its relatively expensive fee structure (even on the RIA share class with no commission). All else equal, we prefer investments with lower fees to those with higher ones, but in this case all else isn’t equal as there is no publicly traded or low fee alternative to invest in this space.

As Bill Gates indicated in the opening quote, demand for energy to meet the needs of our technologically advanced society will continue to grow. Fossil fuels are a limited resource whereas renewable sources such as wind and solar are unlimited in their supply. As such, accords and mandates are being passed by politicians to encourage the further development of this once niche industry. Companies like Greenbacker stand to benefit from the current landscape where they can capitalize on assets producing above market yields from contracts with credit worthy utilities. We will be following up with our clients in the next couple of weeks with more information on Greenbacker, and encourage those that aren’t yet clients but are interested in this opportunity to reach out to us for more information on how they might be able to capture two types of green.

elliott_headshot_bw.jpgAuthor Elliott Orsillo, CFA is a founding member of Season Investments and serves on the investment committee overseeing the management of client assets. He spent nearly ten years as a financial analyst and portfolio manager working primarily with institutional clients prior to co-founding Season Investments. Elliott earned a bachelor's degree in Engineering from Oral Roberts University and a master's degree from Stanford University in Management Science & Engineering with an emphasis in Finance. Elliott and his wife Gigi have three children and like to spend their time outdoors enjoying everything the great state of Colorado has to offer.

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