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Investing in capital intensive industries

09 August 2010 #Environment

The last UK government often stated that to enable the transition to a low-carbon economy, the UK needed a trinity of solutions. The trinity consisted of renewables (mostly wind power), nuclear and carbon capture and storage (CCS). There has been a huge amount of money invested into renewables. Although there are significant costs, the returns on investment are commercially attractive. However, nuclear energy and CCS have seen less venture money invested and will likely be the domain of large infrastructure investments. This is down to the huge capital costs involved, upwards of £1 billion per power plant, and the vast amounts of money already and still to be spent on R&D.

However, it is still possible to make smaller investments into these capital intensive industries and expect commercial returns. A common strategy and a growing trend among investors is to invest in enabling technologies and component suppliers, rather than final product manufacturers.

These companies have the advantage of supplying to a range of clients and industries and are not as dependent on government subsidies since components are generally easier to ship globally. Factors like these help to de-risk investment proposals from policy risk (reliance on subsidies) and market risk (very few customers). There has recently been interest in the wind supply chain from investors due to the UK Round 3 licensing; businesses from lubricant manufacturers to mining companies could see huge increases in demand for their products during the offshore wind construction phase. Similar trends are seen in automotive; why compete with Ford and Toyota, when you can partner and supply them?

One method of separating CO2 from the flue gases in CCS utilises a chemical to capture CO2 under certain conditions (pressure temperature etc.) and then releases it again once those conditions are changed. Manufacturers and suppliers of this chemical could potentially be venture investment targets. However, these companies would have to contend with the large, established chemical companies who can afford to spend millions on R&D. These chemicals also corrosive, so a company that provides coatings for metals that resist this corrosion would be vital, and another potential venture investment target.

Alternatively, some investors will take on the huge capital costs through game-changing innovations rather than look at the existing supply chains. For example, Bill Gates has recently invested some of his personal fortune, along with Khosla Ventures, into a nuclear company called TerraPower. TerraPower claim to have designed a nuclear reactor that uses very little uranium and can also run on depleted uranium - essentially refuelling itself as it goes.

The economics of these industries, without subsidy, depend on carbon prices rising to such a level as to make fossil fuel power too expensive. This would require carbon prices in excess of €30 per tonne by most estimates, with some estimates even higher. Even with favourable economics though, this does not make the investment decision straight forward. With most funds expecting a successful exit within 5 years, these technologies are perhaps too immature at the moment to deliver. Longer term outlooks from investors may help to enable innovation and growth in the industries, with large adoption of nuclear and CCS not expected before the tail-end of the decade. Investors who can take on lengthier risk horizons, such as utilities, can and are making investments in order to prepare for future regulation and heightened costs.

Written by The EIC Environmental Investment Network.


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