“The electricity industry’s shift towards renewable energy is now unstoppable”

Future global development depends to a large extent on which technologies humanity chooses to meet its future energy needs. By taking a close look at global interrelationships and technological developments in many sectors, including renewable energy, the “Responsible Investing” strategy can identify attractive investment opportunities for Kaiser Ritter Partner’s clients. This interview with Dr. Dominique Candrian, Managing Director of partner company EIC Partners AG, explores the subject further.

The European Union has set itself ambitious climate targets. Surely this automatically means that investors can find good opportunities in clean energy?
The simple answer is yes, they can. The European Union has set two important objectives. By 2020, it wants to meet 20 percent of its energy requirements with renewable energy. And it wants to reduce its CO2 emissions to 20 percent below the 1990 figure. These are binding targets.

And as a non-binding target, the EU wants to reduce CO2 emissions by 80 percent by the year 2050. Extrapolating from this, we find that electricity production will not be allowed to produce any CO2 at all. All of which means conditions are fertile for investing in clean energy.

And what’s happening outside the European Union?

The European Union is leading the way, but there are three reasons to believe others will definitely follow. Firstly, the EU has shown the political will to continue with the expansion of renewable energy despite the economic crisis; this should have an encouraging effect on other countries and regions.

Another good reason to expect new players to join in – and I think this is very important – is that most regions of the European Union, and especially Germany, are not exactly tailor-made for the exploitation of renewable energy. A wind power plant in Germany produces electricity less than 20 percent of the time. And Germany is not the sunniest place in the world either. Other regions offer much better wind and solar conditions. Entry into the renewables industry will be easier for other countries whose natural environments are simply more conducive.

The third reason to expect other countries to copy Europe is that the expansion of renewable energies in Europe has led to economies of scale. Renewable energy technologies have become significantly cheaper, especially in the solar energy sector. Other regions are now profiting from this decline in costs.

Can your EIC Renewable Energy Fund benefit from these developments? How would you rate its performance over the last few years?

The fund was established in December 2006. Our first year, 2007, was certainly a good one, but 2008 was made very difficult for renewable energies by the financial crisis. But we escaped with a severe bruising and didn’t do as badly as other participants in the market. 2009 saw a recovery of sorts; but not enough, of course, to make up for 2008.

So as with other investments, the fund experienced large fluctuations?

2008 has unfortunately cast a shadow over the fund’s recent history. Renewable energy is undoubtedly a volatile investment sector. It’s a young industry that is exposed to certain political risks. In other words, we have to deal with circumstances that potentially lead to higher volatility. The fact that we have indeed seen such volatility has not come as a surprise to us.

So if you knew all this, why did you set up the fund in the first place?

We want to give dynamic investors a chance to gain diversified exposure to a growth area. Following the corrections of 2008, we now believe there are good opportunities to buy into the sector. We believe our valuations are reasonable – certainly not excessive.

There are many facets to renewable energy. How difficult is it to get to grips with this type of investment?

You can define the renewable energy sector very broadly, but we want to give investors an opportunity to get involved in the most focused way possible. That is why we have defined the theme so narrowly. If a company is to be accepted into our fund it must generate at least 50 percent of its revenue from renewable energy activities – solar power, wind power, geothermal energy, water power or wave power; i.e. very concrete renewable energy technologies. This is a stricter requirement than other funds apply.

How do you pinpoint a concrete investment?

We approach each theme using three criteria. The first is energy policy. The whole energy industry is very political. The second is the price of raw materials – also very important in our sector. The third is technological progress. We look at these three drivers every quarter during a three-day meeting. We try to identify the megatrends and then weight the different investment themes in our fund to match the conclusions reached at this meeting.

Do you still find small firms run out of people’s garages, or does the technology require large industrial structures these days?

Renewable energy is no longer in its infancy. Industrialization has begun. You just have to look at the major projects, like offshore wind farms, which present a huge technological challenge. Too big for people working out of their garages. Only heavily capitalized companies have any chance of supplying an offshore wind farm.

Something similar has happened in the solar energy sector. Costs have fallen a long way and you simply have to be big enough to manufacture a mass product like solar panels in very large volumes. The barriers to entry have become higher. It’s a general trend.

At the same time, of course, we are seeing innovation in a lot of areas, and innovations often happen in smaller companies. Just look at what’s happening with batteries or wave power. We’re investing, for example, in a company that can convert wave energy into electrical power. And you could still probably call the business a “garage” company. But when this technology makes a breakthrough in the way that wind and solar energy have, industrialization is bound to follow sooner or later. Mass production helps to reduce costs to the point where the technologies can establish themselves in the market.

Solar power has been a very fashionable area, partly because of the massive state support received by certain players. Some critical observers call it a bubble …

The valuations and p/e ratios are somewhere between 10 and 14 based on expected 2011 earnings. We are optimistic that these earnings will in fact be realized and that the companies concerned have growth potential. We don’t think these valuations are excessive. But they were at one point, that’s certainly true.

There’s no doubt that state support brings the risk of rapid initial growth that simply can’t be sustained. Sectors can receive a quick boost and build up excessive capacities on the back of this.

We expect the solar industry to have a very good 2011. It will be better than a lot of people are predicting. In 2012 demand, 50% of which currently emanates from Germany, will drop significantly. This raises the question: who is going to step into Germany’s shoes? We are confident that China and the USA will, and that the industry will continue to grow.

Do we need another growth engine for solar power – as Germany has been till now – or will there just be a general growth and spread of demand, perhaps because of the economies of scale you describe?

Absolutely. If you were a rational house owner in Tuscany, for example, you would put solar panels on your roof. In a sunny region like that you can generate your own electricity more cheaply than your local supplier’s household rate. We’re seeing this in China too. The latest take-up rates reported from certain regions there suggest you don’t need much government encouragement if any.

You mentioned wave power. This is still not as fashionable as solar power.

Within the next ten years, Ireland wants to build an offshore wave power plant to generate 1500 megawatts – that’s one and a half times the output of Switzerland’s biggest nuclear power station. The UK has also launched a major program to encourage wave energy. There are particularly high hopes for this technology in developing countries, where the populous regions that need electricity tend to be near the sea. I’m convinced that wave power will be of great interest in the future.

Since you mention developing countries: to what extent do renewable energy technologies also have a social element?

Let me take the example of a project that I’m personally involved in at the moment through the company Globeleq. Just a few weeks ago we took the decision to build the largest wind farm in Central America. There were several years of project development in the run-up to this decision, during which we had to grapple at first hand with all the many dimensions of sustainability. The project will obviously make a positive contribution to clean electricity generation, but the construction, operation and maintenance of the plant will also create a lot of jobs. Thanks to the project and the land survey work that had to be done for it, we were able to help small farmers gain official title over the land they cultivate. We held countless events where we gave the local population open and honest information about the project, including details of its emissions. Because the people affected participated in the process, the region looks on the project with great pride. In our dealings with the authorities at all levels we have followed impeccable, transparent processes. So the project unifies all three “ESG” dimensions of sustainability.

Which issues will drive the energy industry in the years to come?

The first question is whether the transmission network can be expanded to match the expansion of renewable energy. The second is which regulatory regime can best direct the electricity market in a way that continues to encourage renewables, but in sensible coexistence with conventional energy. The key issues here are prioritizing renewable energy feeds into the grid, and the need to develop balancing energy markets. A third question will be how the increasing relocation of the manufacture of wind and solar energy systems to China will affect the political debate in the west.

How much of a role does the financial crisis play? Cuts to renewable energy budgets are being discussed in some countries, even in Europe.

Renewable energies will continue to expand, and massively so. The volume of solar panels was twice as high in 2010 as in 2009. In California recently, we saw an interesting signal relating to the apparent conflict between environmental and economic concerns: voters were asked whether subsidies for renewables should be suspended until the unemployment rate falls to 5.5 percent. The initiative was thrown out by a clear majority, with 57 percent voting against.

In my opinion, the biggest threat to renewable energy is, ironically, unrestrained promotion. To put this in concrete terms: Germany cannot deal with an annual expansion of 6000 to 7000 megawatts of solar energy per year. It would make no sense in terms of energy economics. A sustainable program for renewable energy would have to cap the growth in volume per year by some means or other.

I hope you sense the underlying tone in my answers: I’m very optimistic. Basically, I’m more convinced than ever that the electricity industry’s shift towards renewable energy is now unstoppable.

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