Oil price decline may result in renewable energy collapse

An insightful op-ed published in Fortune states that oil price declined might mean the renewable energy market could collapse or be seriously damaged. Despite the renewables market taking off the first half of 2015, the essay’s author, Varun Sivaram, investors piled money into Yieldco companies that not only operated renewable energy projects but also helped hold down costs of projects. Now those companies are in jeopardy since oil and gas sources are becoming cheaper again, the Fed discussed raising interest rates and renewable energy firms wanted gigantic sums of money.

Now the stakes are high: if Yieldcos fail, renewable energy could lose access to public markets and the low cost of capital necessary to scale up wind and solar. To recover, Yieldcos may have to restructure, seek help from parent developer firms, and hope for constructive public policy to further de-risk renewable energy investments.

A Yieldco is an innovative financial vehicle that enables institutional and retail investors to buy shares of a portfolio of projects, unlocking public capital for renewable energy. In general, a Yieldco will team up with a parent renewable energy project developer to split the low and high-risk aspects of renewable energy deployment. The parent developer undertakes the risky activities of constructing the project and finding a long-term utility buyer for the power. The Yieldco simply purchases and operates a diversified portfolio of projects, offering public markets an attractive low-risk equity investment whose tax-sheltered dividend payout beats the return from other low-risk investments, like U.S. Treasuries.

Initially, Yieldcos performed spectacularly. In the two years leading up to this summer, 15 U.S. and European Yieldcos — most operating in the developed world but some branching out to emerging markets— entered the stock market at a collective $12 billion valuation. Buyers of Yieldco shares were predominantly investors in oil and gas assets through Master-Limited Partnerships (MLPs), which Yieldcos resemble. Having watched MLPs grow to over a half trillion dollars, these buyers forecasted jaw-dropping Yieldco growth and bid up market values to $24 billion.

Unfortunately, for the same reasons that Yieldco valuations spiraled upwards, they could also fall into a vicious downward cycle. Yieldcos are appealing when they can buy projects from a parent developer at a higher return than their cost of capital. When Yieldco share prices are high, the cost of equity, measured by the dividend yield, is low (because yield is the ratio of a fixed dividend to the share price). This means that every new project that a Yieldco acquires is “accretive”—that is, it increases the value of the company, boosting share prices, reducing yields, and enabling the Yieldco to raise even more cheap money on public markets to buy more projects. But this virtuous cycle quickly turns vicious when the share price starts to drop. This drives up yields and closes the gap between the cost of capital and the return on new projects, further depressing share prices.

This is exactly what happened when a freak confluence of events—the perfect storm—knocked sky-high Yieldco shares into a tailspin this summer. Oil prices tumbled 20% in July, deflating investor valuations of both fossil fuel MLPs as well as renewable energy Yieldcos, because the same financial models were doing double duty. Even though there is little fundamental linkage between oil prices and the competitiveness of solar or wind power across the developed world, newly risk-averse Yieldco investors raced to exit positions they suddenly considered overvalued.

Renewable energy sources are recipients of massive amounts of government money in the form of loans and loan guarantees. They were pitched as a way not only to reduce our reliance on fossil fuels but at the same time help address global warming. The results have been nothing more than a mitigated disaster since they cannot generate the power capacity needed to fulfill power needs since they are limited by the weather.

Even hydroelectric power projects are in trouble due to events like California’s drought and