As government subsidies for renewable energy have fallen and the sector has evolved from being a niche to more mainstream, the PPA route is becoming more significant. This news service speaks to an investment firm operating in the space.

There appears to be a relatively new way of investing in electricity generation and in a risk-controlled way: power purchase agreements (PPAs). 

A PPA involves a contract to buy power – such as energy from a hydro-electric plant, a wind farm or a solar farm – for a set price and a set period – such as five years.

This means that instead of buying a solar or wind farm, and all the costs and hassle that involves, an investment firm obtains the power generated from them instead.

According to the European Investment Bank, in 2021, for example, more than 137 companies in 32 countries announced that they had signed power purchase agreements. The EIB noted that in general, PPAs are more common in the US, but said this type of financing is gaining ground in the European Union. "Despite this recent growth, a number of challenges remain, though most regulatory barriers to such agreements are addressed by the European Union’s Clean energy for all Europeans package, which was adopted in 2019. Some EU Member States, however, have yet to transpose the European legislative framework into their national laws," the EIU said in a commentary in July 2022.

This is the approach favoured by Augusta Investment Management, a UK organisation launched in 2018. Augusta & Co, its parent and specialist in M&A and corporate advisory in the sector, was launched in 2002. (A few months ago, Augusta advised BlackRock’s Climate Infrastructure Group on the sale of its 354-megawatt onshore wind portfolio in Norway for €537.5 million ($581.6 million).

As government subsidies for renewable energy have fallen and the sector has evolved from being a niche to more mainstream, the PPA route is becoming more significant. AIM is determined to a major player, and it argues that the PPA model is one that family offices and wealthy individuals, for example, should consider. AIM is targeting levered returns of 12 to 15 per cent. The minimum investment entry level is €10 million.

WealthBriefing recently spoke to Mortimer Menzel, managing partner at AIM, about the business. He’s been managing partner at the firm since 2002. Prior to this, he worked at Goldman Sachs, which gave him a taste of the corporate finance and investment world.

Mortimer Menzel

Augusta & Co’s work in the corporate finance and M&A world gives has access to deal-flow that “other investors can only dream of,” Menzel said. There is also tight alignment – Augusta & Co is owned by its staff.

Change
“We realised that the renewable industry has changed," Menzel said. "For the first decade, it was the question of `Does the technology work?’ In the second decade it was about power pricing predictions and what price curve you should assume today to finance a project that will last 30 to 40 years. The third decade, which admittedly has just begun, may well be about making renewables into baseload by removing the volatility of its production, using storage and efficiency, grid technology etc. But it is of course a little early to tell.”

“We realised that the PPA was the most important part of the new market,” Menzel continued. 

While the market for renewable energy sources has not all been easy in recent years, as seen by gyrations to energy prices after Russia’s invasion of Ukraine, the sector is also maturing. Some statistics catch the eye: According to the International Hydropower Association, around 60 per cent of all renewable electricity is generated by hydropower. The sector produces about 16 per cent of total electricity generation from all sources.

In AIM’s case, it focuses on buying power from Nordic region reservoirs because they have storage and a relatively stable supply of water and crucially are part of the baseload provision of electricity in those markets. Unlike solar and wind, such hydropower does not vary when the weather changes. AIM concentrates exclusively on large, reservoir hydro, not “run of the river” hydro plants. Countries that have a large amount of such hydro will include the Scandinavian nations, the US, Austria, Switzerland and to a certain extent the UK (Scotland).

AIM completed its last deal in 2023 which covered reservoir hydro power from 15 assets in Sweden.

Timeframes
AIM said its investment lasts for 15 years with a possible earlier exit. 

“This exposes investors to much less operational, counter-party, power market and climate change risk than buying the asset itself. When buying a standard solar or wind project these days, you need to calculate in your model for an ownership period of 30 to 40 years. That exposes you to all sorts of risks that are hardly calculable today, but the problem is you must pay today, to acquire the asset,” Menzel said.

PPAs were designed to circumvent the impossibility of buying reservoir hydro assets from their owners

“They simply don’t sell those assets, and in many jurisdictions baseload reservoir hydro is considered `strategically important’ infrastructure, which cannot be sold at scale to external (non-state owned) investors. For many of our institutional investors, this product is the only way into an investment in Nordic reservoir hydropower,” he continued. 

Menzel said returns are higher than buying a traditional e.g. wind project, in the same region due to the way the transaction is structured. 

The macroeconomic background – it increasingly appears that central banks have finished rate rises – is positive. 

Investors are “re-allocating assets generally to infrastructure to get protection from the one thing they still see as a problem, which is inflation. The best way to manage inflation is to buy real assets whose value increases with inflation. Power prices rise with inflation, protecting the investor,” Menzel said.  

“Private equity” approach
Since the AIM product invests in the electricity and not in the asset itself, it can be more flexible in its construction, the firm argues. AIM can structure a more typical “private equity” exit after five years (perhaps with two extension years) and generate what is currently a 15 per cent levered return on the base case assumptions, or if the market conditions at that time are not favourable, AIM can stay invested until market conditions for an early exit improve. If they do not, the base case assumption is that a 12 per cent levered return will be generated at the end of 15 years when the PPA simply runs out. 

“This level of flexibility is not usually available when the underlying asset is an investment in bricks and mortar and people and teams,” Menzel said.

“Importantly, the PPA structure allows AIM to do something that is not usually available to the owners of renewable energy assets. We can mitigate the market risk volatility of the electricity that we buy by forward selling chunks of it at fixed prices,” Menzel said. “We therefore create a floor under which the price of that electricity cannot fall. There is a big and liquid market, for example, in Nordic electricity futures, and it is possible to hedge out the power price risk for a considerable period of time and for a considerable volume of the electricity that we buy. This means we have downside protection against a drop in power prices to maintain our minimum target return. This type of risk reduction is simply not available to the same extent if you buy the asset.”

No nukes
WealthBriefing asked Menzel what AIM’s approach is to nuclear power. After all, the European Commission in 2022 included nuclear energy in its “green” taxonomy, provoking controversy. 

AIM does not invest in nuclear energy for various reasons.

“We try and be very green and nuclear is a little controversial in terms of how green it is (concrete use, net CO2 use etc.). In addition, there is a huge amount of government and regulatory control on nuclear and one cannot just buy power from nuclear production without jumping through all sorts of hoops which are cumbersome,” he said. “The final, uncomfortable, fact is that nuclear power and nuclear weapons are fairly closely related and it’s just not something we felt our ESG approach allows us to do.”

As far as target investors go, Menzel said that AIM is looking at larger investors who can do significant stakes of upwards of €20 million. It can also pool investors of, say €10 million and above into a commingled diversified fund.

“This investment sits very well with an investor who wants to make green investments but does not want to go down the traditional wind and solar route either because the economics do not look attractive or because they specifically want access to reservoir hydro which are assets you can’t usually buy into,” he said. “The returns are higher than on those more traditional investments, and the risks are lower, and the period of investment is much shorter. We think owning the power as opposed to the asset itself makes a huge amount of sense. It is just not such a widespread and established asset class yet.”

To join the party, Menzel added that the minimum “ticket” is around €10 million. “We can’t buy anything under around €75 million of equity per transaction so we do need a few of those pooled to be able to have enough to do a transaction.”