November 30, 2018 in
Q How have falling energy prices affected investment opportunities for infrastructure investors in North America?
HS: The shale gas revolution has created a great deal of disruption over the past 10 years. I remember the take-private transaction of TXU in 2007, the largest deal in the industry’s history. The sponsors were forecasting gas prices of between $6 and $8 for the foreseeable future. Now, the forward price is in the $2 to $3 range. That is a phenomenal shift and a reflection of all the technological evolutions in the oil and gas space, whether that’s fracking, or even newer technologies being implemented to increase the efficiency of existing wells.
With gas prices low, and expected to remain low, the profitability of power generation assets has changed. We have around 1,000GW of installed power generation in the US. A little over half of that is coal and nuclear. Before the shale gas revolution, these assets were highly profitable. But with the price of gas so low, there has been a shift on the marginal unit – effectively the last asset that has to run to meet the power demand at any point in the grid. That marginal unit has, generally speaking, become natural gas, so gas is now setting the price of power. In most markets in the US, that price of power is now in the $20 to $30 per megawatt-hour range.
At those prices, coal and nuclear plants are often no longer profitable and we are continuing to see economic retirement of nuclear and coal assets. This decarbonisation is not being driven by politics or regulatory issues. It is basic economics. The old technologies for generating power are no
longer the technologies of the future. Coal and nuclear plants are being retired and gas-fired plants and renewables are being built in their place.
Q But the energy sector is still facing decreased demand. What does that mean for the future?
HS: Over the past 10 years, there has been a big increase in the efficiency with which energy is used. That has led to flat or even decreased demand, despite population growth and despite strong economic growth. We are doing more with less energy.
Flat demand does create significant challenges challenges for some assets, but I think that the demand pattern is set to change. Look at all the data centres being built as tech companies like Facebook try to keep pace with demand. These data centres are massive users of energy. Also consider the amount of energy it would take to mine bitcoins, if projected growth ever becomes a reality. Electric vehicles are another piece of the puzzle. There are forecasts that envisage hundreds of billions of dollars of infrastructure being built to support electric vehicles
Q Given these macro trends, where is Starwood placing its bets?
HS: We focus on two key verticals: greenfield and brownfield. We look at building greenfield gas-fired power plants; renewable assets including wind, solar and biomass; transmission assets; midstream assets; battery generation and battery storage assets. We tend to get involved during the mid- to late-stages of development when it is not necessarily about deploying a lot of development capital but of adding value during critical phases of the development lifecycle. We have relationships with all the OEMs, with financing counterparties; we know how to negotiate a construction contract and how to find a long-term customer for the capacity and energy we are selling. Every asset we develop has pre-identified customers, whether it is a state, utility, city or a corporate that is willing to give us a long-term contract. It is a really important risk management tool for us.
So, essentially, we do a lot of cooking to produce high quality infrastructure assets and that cooking is how we create value for our investors. We have built six wind farms now, with combined capacity of more than 1.2GW. We have built large solar photovoltaic projects in Ontario and the largest biomass project in the country down in Florida. We have developed two large transmission projects, Neptune and Hudson, and are now developing our third, the Ten West Link, connecting Arizona and California. The other half of the business is buying existing assets with an eye towards adding value by making those assets run better, upgrading the capacity on the gas turbines or connecting the gas power plants to better pipelines. It is all about adding value. A lot of us are engineers by training and love getting involved with the assets.
Q You acquired a portfolio of coal assets from Ares last year. How does that brownfield deal fit in with the decarbonisation trends you were
HS: We don’t generally invest in coal, but this was a unique opportunity to buy a portfolio of four contracted assets – it was more about the contracts than about the coal. In time, these plants will be replaced with gasfired plants or with battery storage assets. Any time we are investing in an operating asset we are thinking about what we can do with it. We are selectively buying, selectively building and selectively switching between different technology types as windows of opportunity open and close. Q You are a mid-market player in an industry dominated by mega funds.
How does that affect the way you operate?
HS: There are firms out there raising $20 billion funds right now and we see a lot of competition for deals involving equity cheques of between $500 million and $1 billion. These mega funds are far less likely to pursue single asset opportunities – a wind farm in Ohio, for example, that is still three years from commercialisation. Mid-market deals, which I would describe as those involving equity cheques of between $50 million and perhaps $400 million at the top end, attract a lot less competition and can ultimately be more profitable.
Q How do you see the renewables industry evolving within the broader energy sector over the next decade?
HS: The renewables industry is here to stay. I read a report recently that said there is around 90GW of installed wind in the US, which is around 9 per cent of installed generation capacity. Most of that has been built over the past 10 years. I would expect that to grow by the same amount, if not more, over the next 10 years.
People ask whether renewables would have done so well without subsidies. Look at what is happening in Alberta, where they don’t have subsidies, or in Mexico. Wind is being priced in the high teens and low twenties. It is clear that wind can be competitive on an unsubsidised basis.
The other interesting point here is that demand for renewables is being driven by customers. Amazon, Google, Yahoo, Microsoft, Facebook – these tech companies are some of the largest buyers of renewable energy in recent history. They are not buying because they are obligated to. They are making an economic decision to buy this energy based on the ability to lock in favourable pricing and the ability to be sustainable. Facebook wants every new data centre it launches to be 100 per cent powered by renewables. That is what its users demand.
And it’s not just tech companies. Numerous non-tech names such as General Motors, Johnson & Johnson, Procter & Gamble – these businesses are looking, in many cases, to be 100 per cent green in their procurement. This huge buyer pressure means that renewable assets will continue to be built even if subsidies expire.
Q Nonetheless, regulatory and political risk is prevalent in the energy sector. How do you manage that risk?
HS: We do consider regulatory risk carefully. In many cases we will try and pass on some of that change of law risk to our customers, in our contracts, or manage it through insurance products. But the regulatory environment in the US is really, very stable. In other markets, such as Spain, where subsidies were given and then withdrawn, that hurt a lot of investors. We haven’t seen that in the US. That is why the US is one of the most constructive regulatory markets for operating assets in the world.