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Financing Energy Innovation in the Midwest

by Richard T. Stuebi

A few weeks ago, the Chicago Council on Global Affairs (CCGA) and NorTech collaborated to throw an event in Cleveland entitled “Financing the Midwest Energy Transition”.  I was asked to wrap up the session with some concluding remarks.  Normally, I don’t script out my talks, but for this occasion I did, and so I’m presenting my prepared comments on this topic as today’s blog post.

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I’ve been working in Ohio for almost five years to help accelerate our region’s transition to an advanced energy economy.  My work has been driven by four considerations:

One, diversification.  Our transportation system in the Midwest is virtually entirely dependent upon oil, and our electricity supply is nearly 90% reliant on coal.

Two, environmental.  Obviously, we burn a lot of fossil fuels, and would benefit from reducing that burn.

Three, economic.  The prices we pay for fossil fuel energy are likely to rise as the supply-demand balance tightens — there are only finite quantities of these fuels, while demand continues to grow — and as environmental regulations tighten.

Fourth, also economic:  We see tremendous opportunity to create new industries in support of the future energy sector, employing thousands of people, based on our region’s inherent skills and advantages. 

About two years ago, I was pleased to be invited by the Chicago Council on Global Affairs to represent Ohio interests on a regional task force chartered to outline the energy challenges and imperatives facing the Midwest.  I am glad they asked me to join their effort because I have long felt that we in the Midwest — from Cleveland to Chicago, and all parts in between and surrounding us — need to work together to pursue our common opportunities and overcome our collective challenges.  

We in the Midwest can’t succeed as independent islands.

When the task force completed its report in June 2009, the CCGA held a great event in Chicago to present the findings.  I thought we should do something similar here in Cleveland – hence our collaboration to convene this event today.  But rather than covering the whole waterfront of issues relating to advanced energy, I thought we should focus on just one.

To me, the biggest one:  Capital.

Energy is an incredibly capital intensive industry, perhaps like no other.  A couple of years ago, the International Energy Agency estimated that about $1 trillion per year of capital will be required globally over the next 20 years to replace and/or extend the current asset base to meet growing demands for energy. 

And, that’s just for a status quo energy sector.

If we want to transition to an advanced energy economy, a host new technologies will have to be commercialized – and this commercialization process takes additional capital for R&D.  Lots of it.

I heard a speech given last week by the head of ARPA-E — DOE’s center for innovative energy R&D — in which it was said that the U.S. annually spends less on energy R&D than on potato chips, and less on electricity R&D than on dog food.

Obviously, this will have to change if the U.S. is to avoid being reliant on other countries to provide a reliable energy supply in a world constrained by dwindling fossil fuel supplies and tightening environmental pressures.

Where will this capital come from to build the new energy sector?

And, what should we be doing in the Midwest to address this capital challenge – both for global energy opportunities, and for the need to transform our own regional energy sector?

Those questions are the crux of what brings us here today.  Based on what we heard and discussed today, I’d like to offer some closing thoughts on future directions for us in the U.S. Midwest.

We know we’re not Wall Street, and we’re not Silicon Valley, but we do have important financial institutions that we need to leverage.  For instance, we have two Federal Reserve Bank branches – in Cleveland and Chicago – and we need to figure out a way to get them into this conversation about the energy transition.  We also have large commercial banks such as Key Bank (NYSE: KEY), many of whom have dedicated energy-related practices, and we want to see them become major players in advanced energy financing.

The corporate titans of the Midwest – both industrial giants and large utilities – can benefit from the advanced energy transition if they take proactive actions to prepare and gain competitive advantage.  They can create wealth and increase profits via new business lines.  They can also lose if they stay mired in the status quo and fight change.  We need to help these companies see the first perspective, and move off the latter perspective, as these corporates have large capital resources to put behind the energy transition.

With our collective universities – not to mention other institutions such as NASA’s Glenn Research Center, Argonne National Labs, Battelle and so on – the Midwest may be unparalleled in its research capabilities.  We need to help these institutions gain more and better access to DOE and NSF funding on energy-related topics. In turn, this requires that these universities make energy-related research a higher priority – and pick focal areas for them to become distinctive winners. 

These institutions, and other Midwestern parties that can’t pick up and move also need to start allocating some of their investment portfolios to local opportunities.  In particular, we need more Midwestern venture capital funding regional entrepreneurs and innovation. 

This is a particular passion of mine.  Early-stage venture capital is a local phenomenon, requiring a lot of interaction between investor and management.  But, as Frank Samuel has pointed out with his recent research at Brookings, we have a huge deficit in Midwestern venture capital — which translates to a huge deficit in Midwestern entrepreneurship.  While we might want to attract venture capital to the Midwest from outside the region, that capital is not likely to come from without if it’s not first coming from within. 

To start this process, states and municipalities with pension funds and other asset pools can and should require a percentage of their dollars to be deployed locally.  If they’re not willing to do this, then they’re not investing in their own futures.  In which case, I would say:  Shame on them.

And, though I’m a devout capitalist, yes, there is also a crucial role for government.  We need policies – at the local, state, and Federal level – that push us here in the Midwest towards the new energy future.  Both positive pressures (incentives/subsidies) and negative pressures (penalties and requirements) imposed by the government would shift capital towards the opportunities and the needs for new energy in the Midwest.

You’ll notice that, in all of the thoughts I’ve just expressed, I use the word “we”.

Well, who exactly is “we”? 

I think it’s us, here in this room, to start.  And, clearly, we need to expand the circle.

So, as you go home tonight, and to work tomorrow, be thinking about new actions you can take to expand the pool of energy capital flowing to our region.  Ask yourself the following two questions:

What did I learn today that might be able to make me or my organization a good return on investment?

And, who else do I know that should have been here today, but wasn’t?

Really think about answers to those questions, and then go forth and act upon them.  In so doing, let’s reclaim for the Midwest the leadership that made this region great in the mid 20th Century:  serious industriousness, innovation and wealth-creation to invent the economic system that enables the next phase of global prosperity and peace.

Richard T. Stuebi is a founding Principal at NorTech Energy Enterprise, where he is on loan as the Fellow for Energy and Environmental Advancement at the Cleveland Foundation.  He is also a Managing Director at the Cleveland-based venture capital firm Early Stage Partners, where he leads the firm’s cleantech investment activities.

Thoughts on a Clean Energy Development Authority

by Richard T. Stuebi

As a class, new energy technologies have proven to be quite difficult to successfully commercialize. Often, they must surmount substantial technical, scientific and engineering risks to get from concept to the market. And, to prove at scale and expand to broad application, very large sums of capital are typically required.

Accordingly, many private sector capital sources — venture capitalists, private equity firms, corporations, and banks — are wary of funding new energy technologies on their own. Put another way, for the clean energy economy to emerge in a major way in the coming decades, the public sector will have to participate in new and significant ways in financing the development and deployment of new energy technologies. Innovative public-private partnerships in the capital arena will be essential. And, given the massive amount of dollars required, these programs will have to be Federal to score any major successes.

For the most part, Federal engagement in the financing of new energy has been historically limited to various subsidies embedded in the tax code, such as the production tax credit for large-scale renewable energy projects or investment tax credits for customer-sited renewable energy or energy efficiency investments.

More recently, stemming from the Energy Policy Act of 2005, the Department of Energy has been authorized to provide loan guarantees underlying private sector loans for projects employing new energy technologies.

Although somewhat effective, clearly the Federal programs to complement the private sector in financing new energy technology development and deployment have not had impact anywhere near the magnitude that pretty much everyone but guardians of the status quo desires.

To that end, both the Markey-Waxman bill that passed the House last year and the Bingaman bill being floated in the Senate include the creation of a Clean Energy Development Administration (CEDA), whose purpose would be to provide debt capacity that is otherwise inaccessible to innovative energy technologies.

Ordinarily, I’m not a big fan of new government bureaucracies. Indeed, a CEDA might not be necessary if the pricing signals for clean energy were set in a manner that induced the appropriate level of investment in RD&D. However, without political will to take on energy pricing — i.e., taxes and carbon policies — it’s clear that finance capacity for clean energy is currently inadequate, and that only a player of the heft of the Federal government can make any meaningful dent in improving the situation.

Perhaps Wall Street agrees as well. Two finance industry leaders — Eric Fornell, the Vice Chairman of Investment Banking for J.P. Morgan Chase (NYSE: JPM), and Mark Heesen, the President of the National Venture Capital Association — recently wrote a thoughtful article providing both support and words of wisdom in establishing a CEDA.

Richard T. Stuebi is a founding principal of NorTech Energy Enterprise, the advanced energy initiative at NorTech, where he is on loan from The Cleveland Foundation as its Fellow of Energy and Environmental Advancement. He is also a Managing Director in charge of cleantech investment activities at Early Stage Partners, a Cleveland-based venture capital firm.

Financing the Fifth Fuel

by Richard T. Stuebi

Jim Rogers, the CEO of Duke Energy (NYSE: DUK), has been widely touting the phrase “the fifth fuel” as a synonym for energy efficiency.

As many analyses have shown again and again, such as the very prominent 2008 work of the McKinsey Global Institute, the most cost-effective approach for reducing emissions is afforded by increased emphasis on energy efficiency. Indeed, the impressive legacy of the Rocky Mountain Institute is based largely on the now 30-year-old observation by its founder Amory Lovins that energy efficiency is often less costly than supplying an additional increment of energy — irrespective of any mandate to reduce emissions.

So, if energy efficiency is so great, why isn’t it more widely pursued? This is the central question posed by the January 12 issue of Time, with a lengthy cover story exploring why energy efficiency is so underexploited.

Certainly, one of the key reasons is that energy efficiency seems so, well, boring. Compared to the sizzle of solar panels or wind turbines, or even the old-school industrial aesthetic of oil rigs and coal mines, efficiency is invisible: you can’t see what you don’t consume. It’s hard for most of us to get passionate about the lack of something. Weak public enthusiasm for energy efficiency is no doubt a major factor in coining the phrase “fifth fuel”, to put it on par with energy forms that people can relate to.

Beyond psychology and semantics, though, the bigger impediment to energy efficiency has often been finance. Economically-prudent energy efficiency options often don’t get implemented either because the benefits (in the form of cash savings on energy bills) don’t accrue to those who pay the costs for building upgrades, or because the savings take a few years to pay off — and clients either won’t or can’t afford to make such an investment.

Creative financing mechanisms are necessary to close these gaps. Thankfully, new financing approaches are increasingly emerging that aim to bridge the market failures that have heretofore thwarted full capture of the potential offered by energy efficiency.

For instance, the City of Berkeley has implemented its FIRST (Financing Initiative for Renewable and Solar Technology) program, which enables property owners to finance energy efficiency (and solar) installations via a 20-year surcharge on the building’s property tax bills. In Milwaukee, the Center on Wisconsin Strategy is similarly organizing a 2009 pilot launch of the ME2 (Milwaukee Energy Efficiency) Initiative, which involves charging for energy efficiency retrofits on energy bills via a rider that is linked to the building’s utility service meter.

In both cases, energy efficiency adoption should become much more compelling to many more clients, because the cost associated with the energy efficiency investment is amortized over 20 years at lower interest rates than most customers would be able to obtain on their own. This will create only a very small periodic payment, while leading to immediate and substantial monthly savings on energy expenditures.

I would expect that these models, and others, for financing the fifth fuel will become more commonplace in the coming years, as the imperative for more aggressive pursuit of energy efficiency becomes stronger with each passing day.

We should begin anticipating that eventually the biggest problem with these approaches will be answering the “too good to be true” perception. After all, who in their right mind would turn down the opportunity to save money instantly, without any cash outlay?

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc. Later in 2009, he will also become a Managing Director at Early Stage Partners.

As Financial Markets Circle the Drain, What Happens to Clean Energy?

by Richard T. Stuebi

as seen at Huffington Post

An investment banker was quoted in Sunday’s Financial Times as stating that the global financial market “changed more in the past 10 days than it had in the previous 70 years.”

Given such a profound shattering of the status quo, I am skeptical that anyone can yet provide clear perspective or accurate clairvoyance stemming from the unprecedented meltdown still underway. Far be it from me to assume that I’m especially well-positioned to develop a superior synthesis – especially since so many of the pieces are still moving.

Even so, it is my professional responsibility – both to myself and to those I serve – to begin speculating how the current crisis may affect the realm of clean energy. I cannot claim much insight yet, but the following represents a few disparate thoughts that I offer to my colleagues across the physical and virtual worlds to advance the discourse.

Lower growth in demand. For virtually all goods and services for customers in the developed world, it is hard to escape the conclusion that demand will abate. (Whether the economy falls into a severe recession, or deepens into a full depression, is anyone’s guess.) In turn, this means that energy demand will also see a softening. In the past year, demand has already declined measurably for gasoline, as customers have responded to higher prices by driving fewer miles and beginning to buy more efficient vehicles. Demand destruction will now be amplified by the effect of decreasing corporate and personal incomes.

Weaker dollar. In the wake of the calamities of the past few weeks, it is also hard to envision that the dollar can do anything but fall. If true, imported goods into the U.S. will become dearer (thereby further discouraging demands), though it will create new opportunities for exporters, such as those developing and manufacturing clean energy products and services in the U.S. In addition, foreign direct investment in the U.S. will become more attractive.

Less debt, costlier debt. With even lending between banks at a standstill, it seems pretty clear that credit markets will be much tighter and debt will be much more expensive for a long time to come. Marginal credit risks – such as ventures in high-growth mode, or projects entailing new technologies – are much less likely to be approved for loans. Even if approved, debt coverage ratios will increase. This means….

More need for equity. With less debt to fund expansion, companies and projects alike will require more equity in their balance sheets to achieve growth. Assuming an unchanged supply of equity (perhaps an optimistic assumption), higher demand will drive up the cost of equity alongside the rising cost of debt. A higher cost of capital (both debt and equity) in turn means….

Declining company/project valuations and increased investment hurdles. Higher discount rates (corresponding to an increased cost of capital) means relatively more value associated with current results and less value ascribed to future possibilities. Certainty and stability become more prized, and potentialities with limited near-term returns are punished. Fewer transactions/projects occur – and those that do occur will happen at lower valuations.

Glut of financial professionals, illiquidity in carbon markets. As the financial institutions get swallowed up, shut down or shrink, lots of bankers and traders will be looking for work. Many of these people were likely to have worked in companies that were the leading players in the still-nascent carbon markets, so it is quite possible that those markets (and monetization of carbon reductions) will dry up.

Increased oil price volatility. With weakening economic conditions, there will be declining demand for oil from the developed economies, from which one might expect prices to generally decline. However, it is eminently possible that demand growth from the developing economies (especially the still-booming China and India) will more than take up the slack. Furthermore, the declining dollar will also put upward pressure on world oil markets, which are supplied mainly from overseas and increasingly denominated in Euros. Lastly, investment in new oil infrastructure or projects may be depressed by the adverse climate. All told, it’s hard to have much conviction about the future direction of oil prices – other than they will continue to fluctuate, perhaps even more severely than of late.

Risks to climate legislation. Though both the McCain and Obama candidacies have stated support to enact cap-and-trade legislation that would drive reductions in U.S. carbon emissions, the dramatically worsened economic conditions might cause either President-elect – and even more importantly, the new Congress – to be more wary of imposing a new set of environmental requirements that would entail a net cost to the economy. On the other hand….

Reduced appetite for laissez-faire capitalism. A wide variety of observers are clamoring that the current financial crisis is rooted in many years of lax regulatory oversight and excesses of unbridled capitalism. Whatever the merits of this logic, to the extent that such thinking takes hold of the public and political imagination, it could imply a general trend towards more interventionist policies and regulations in the energy sphere (and in other aspects of society). In the extreme….

Possibility of nationalization of energy activities in the U.S. I never thought I would write this, but the recent actions to essentially nationalize large parts of a financial industry formerly in private ownership provides a precedent for a not-too-distant U.S. government to take control of a similarly fundamental and strategically-critical industry being besieged by crisis. Given the daunting challenges likely to be faced by the energy industry in decades to come, it’s not out of the question to see the same game played out in the energy sector.

Buying opportunities? Short of the U.S. stepping in, many companies and assets will be available to purchase. Savvy players with strong positions will be able to make some really good buys on the cheap. Potential case in point: the Mid-American Energy arm of Berkshire Hathaway (NYSE: BRK.A, BRK.B) announced that is snapping up Constellation Energy Group (NYSE: CEG) whose trading desk was essentially pushed to the brink by the lack of liquidity in the credit markets. By adding Constellation, the Warren Buffett investment vehicle is slowly but surely becoming an energy behemoth.

End of American financial hegemony. With the recent convulsions, I think it’s becoming clear that the era of undisputed U.S. pre-eminence is coming to a close, if not already having closed. The 21st Century will belong not to the U.S. but to other powers – primarily China, but also India and (unless we move off of oil sometime soon) the OPEC economies. This means that U.S. interests cannot afford to think and behave as parochially as we have through most of our history. As I argued in a recent editorial in The Plain-Dealer, and in a recent post in CleanTechBlog.com, many of the best opportunities for many U.S. players will lie in China. The U.S. will simply be unable to afford to consider itself the only, or even the most, important market on the planet.

In the coming weeks, as the outline of our society’s next-generation financial system becomes clearer, perhaps I will become more confident to offer more definitive speculations about the future of the clean energy world. Maybe some stronger causes for optimism will emerge. Until then, like everyone else, I too must resort to buckling up and watching events unfold further. Meanwhile, the storm rages on, and I expect more dominoes may fall.

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc.

Wake Up Call

by Richard T. Stuebi

Last week, three financial titans — Citigroup (NYSE: C), J.P. Morgan Chase (NYSE: JPM), and Morgan Stanley (NYSE: MS) — announced “The Carbon Principles” to provide guidance to energy companies in managing carbon risks. The upshot of The Carbon Principles is that these big banks are stating explicitly that, going forward, they will only provide debt financing to new power projects if proponents can prove that the proposed plants will remain economically viable under future climate change policies. (Read Citigroup release on The Carbon Principles.)

Put another way, Wall Street sees federal carbon legislation as imminent, and doesn’t want power sector executives to try to “sneak in” any last coal plants before the legislation whose economics might be threatened in a carbon-constrained world. The banks’ interest is not necessarily environmentally-motivated — they simply don’t want to see any more loans go bad — but the effect of this announcement is likely to be positive.

The energy sector can’t claim they weren’t at the table. The Principles were developed by the banks in consultation with a who’s-who of power industry giants: American Electric Power (NYSE: AEP), CMS Energy (NYSE: CMS), DTE Energy (NYSE: DTE), NRG Energy (NYSE: NRG), PSEG (NYSE: PEG), Sempra Energy (NYSE: SRE), and Southern Company (NYSE: SO).

But, apparently, the willingness of these utilities to participate in the process of developing The Carbon Principles doesn’t mean that everyone in the energy sector is reading yet the writing on the wall regarding climate change. In the February 4 Wall Street Journal, reporter Jeffrey Ball quoted Jeffrey Holzschuh, Vice Chairman of institutional securities at Morgan Stanley, as saying “We have to wake up some people who are asleep.”

If a remarkable July 2006 letter from Stanley Lewandowski, the General Manager of Intermountain Rural Electric Association in Colorado is any indication, it would seem that there’s still a number of Rip Van Winkels out there in the electric utility world.

Rise and shine! Climate change is a real phenomenon, and carbon legislation is coming — let’s begin to deal with it!

Given how Wall Street didn’t seemingly exercise any leadership whatsoever on the subprime mortgage debacles, it’s refreshing to see that they’re actually out in front (at least a little bit) on the climate change issue.

Richard T. Stuebi is the BP Fellow for Energy and Environmental Advancement at The Cleveland Foundation, and is also the Founder and President of NextWave Energy, Inc.