When talking about risk, what comes to mind? Monster catfish noodling? A WWE championship bout? ISLE of Man Tour Trophy (TT) race? All fair answers as all these events come with extreme risk. But you do not have to be battling a catfish or a pro wrestler to deal with risk because every decision is risky. A decision implies more than one option, which implies uncertainty. And one of the lessons I have learned this summer is that risk (and uncertainty) might not be a bad thing.
Like any investment, renewable energy investments are exposed to various external risks: ever-changing policy, energy regulations and customer credit risk to name a few. Below are some notable takeaways from my internship this summer at Madison Energy Investments:
- Managing the exposure sensitivity, to increase beta over tailwinds and decrease beta over headwinds
- Increasing alpha, the unique competing capability
- Optimizing portfolio diversity
Manage the exposure sensitivity: this involves understanding, experience, and insight about the target market, local investment environment, and industry knowledge:
- On a broader level, it is critical to have a deep understanding of the market’s history: if international it is important to understand whether the countries have been colonized? What’s the sovereign state’s institution? What’s the legal system: civil law or common law? Chaebol, state-owned, or open to foreign investors? Currency stability? Local content restriction?
- Government relationship and policy: The number of related departments and their cooperation mechanism (generally including energy department, development commission, national grid, the national planning committee,). The tension between U.S. FERC and the state government entities is a glowing, recent example. The policy continuity: long term trend versus U.S. election year ripple.
- Energy market knowledge: how is the national energy security? What’s the energy shortage? Is there a future curtailment risk? Electricity price mechanism? U.S. RPS policy? Innovation revenue streams in U.S., including reactive power, storage, capacity savings, transmission savings, and SMART adders in Massachusetts.
Increase alpha: how to differentiate oneself, build a unique capability, and dig a deeper moat. In energy investing this includes:
- Credibility and trust: secure the exclusive right to purchase development assets
- Team speed and flexibility: lean team, standardized project delivery, streamlined acquisition process, low-cost partnership strategy that allows the company to pivot nimbly across state markets as windows of opportunity open and close quickly
- Low financing cost: multiple draw loan facilities that are tailored to different layers of risk
- Open ecosystem: strong connections with bilateral institutions, EPC, advisors, sponsors, financing institutions, regulators, and technology providers.
Optimize the portfolio diversity: in different dimensions from off-taker credit, installation method (rooftop, carport to on ground), scale, revenue stream, to project phase and state, regional and national markets.
Risk is not all bad. Managing risks is a pre-requisite for investing and when managed correctly through appropriate expertise, experience and networks it can be a competitive advantage. By taking risks we build partnerships with emerging startups to put autonomous drones into asset management use. By taking risks, we bring light to remote villages in need of infrastructure investment. By taking risks, we provide clean energy to low-income households who are deprived of clean energy access.
By utilizing the proper risk pricing strategy, we can help boost market efficiency, invite more players into the game, enrich the ecosystem, and encourage new technology applications. The former UN Secretary-General Ban Ki-moon has emphasized that ‘energy is the golden thread that connects economic growth, increased social equity, and an environment that allows the world to thrive’. By taking risks, we not only help to combat climate change, improve energy security, but also boost energy equality.
- Hedan Liu