Private Equity: The Energy Opportunity
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Table of Contents:
Summary
Energy brings both tangible financial benefits and measurable carbon reduction benefits, yet it is often overlooked in ESG considerations.
ESG gets the headlines, but is often abstract and judgemental rather than quantifiable. Mastering energy can unlock both robust green credentials and strong financial benefits.
This report provides essential intelligence for business leaders striving for cost efficiency and robust sustainability credentials. There is hidden value in energy. We can help you find it.
Energy is a key part of ESG, but is too often overlooked
ESG contains multitudes. Generally worthy aims promoted by a wide variety of stakeholders compete with or even contradict each other. Politics and controversy can intrude and financial imperatives can be forgotten. Standards can be unclear, leading to uncertainty and a default towards ticking boxes rather than taking action. Energy has none of these grey areas: it is cost and carbon.
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Energy used to be simple; it was a wire, a pipe, and an annual check-in with an energy broker. Climate change, massive price reductions in renewable technologies and an array of new regulations have made things complicated. For management teams under pressure, keeping up with these changes risks distraction. So opportunities can often be overlooked.
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Energy Architecture identifies strategies to:
• improve efficiency;
• reduce energy consumption;
• reduce energy and operational costs;
• minimise exposure to volatile prices and dependence on fossil fuels;
• reduce carbon emissions and minimise carbon tax risks.
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Investors understand that sustainability-focused changes bring real benefits in branding, employee motivation and social licence to operate. Rather than treating sustainability and decarbonisation targets as marketing or admin., they should be treated as a spur to innovation.
“Environmental soundness, and keeping
stakeholders and your supply chain
happy, means that you’ll be in business
for a long time”
New energy is cheaper, more secure, as well as greener
Cost saving opportunities in sustainability come predominantly from installing new energy technologies. But energy is rarely a top three priority. Time spent on ESG reporting often crowds out efforts to think more deeply about the potential for energy savings. When energy is considered, what looked simple at first can quickly become a rabbit hole.
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On-site power generation is often simpler than making major industrial process changes. It also acts as a clear statement of green intentions. In the UK, returns from self-generation are boosted by the nature of grid charges . With marginal electricity prices usually set by gas, on-site generation also significantly reduces exposure to wholesale price volatility.
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For most businesses, energy is far enough down the list that it doesn’t warrant regular attention. Specialist analysis and advice often identifies 10% - 20% savings available from relatively simple, low cost changes. With a little imagination and the right circumstances, much greater savings can be made from deeper changes to processes.
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Bank lending is becoming more environmentally and socially conscious. Sustainable borrowers can access lower rates from a broader pool of lenders. Governments are supporting this trend through loan guarantees for green assets and via a range of subsidies. The renewables infrastructure finance market has become increasingly sophisticated over the last ten years. Off-balance sheet finance for these assets, at zero capital cost for the energy user, is now a well-trodden path.
“I don’t personally care if you believe
in doing the right thing for the
climate or society, but you must
understand that these are value
levers that you can pull.”
Find hidden value (or risk): Energy should be prioritised when buying or selling
Expert energy due diligence can identify significant inefficiencies and opportunities to reduce operating expense. Post-acquisition change programmes can be drawn up. Material risks around the potential for equipment failure, price volatility exposure and carbon taxes can be assessed and factored in to price negotiations.
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EY found that 72% of private equity firms expected to capture an ESG premium on exit. However, the PE investors we spoke to were not convinced. Many saw no specific valuation premium. One noted they might pay extra 1.0 - 2.0x EBITDA for good management, with sustainability being part of that. Even those who saw strong potential for ESG to drive higher exit multiples would not explicitly forecast using those assumptions.
Of the many studies done in the broad area of ESG/sustainability and financial returns, the overall result is mildly positive. The Stern Business School’s meta-analysis shows a growing consensus “that good corporate management of ESG issues typically results in improved operational metrics”.
In short, there probably is a small premium for getting ESG right, but in practice it’s not bankable.
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If the premium is not bankable, exit preparation becomes about maximising exposure to the upside. Management teams that think rigorously about sustainability are generally well-perceived by private equity buyers. A sustainability angle can draw in cheaper funding, or bring new investors into an auction. Buyers that otherwise wouldn’t consider buying an asset may stretch their mandate as theyneed to deploy funds.
Getting the narrative right can animate an exit process, ultimately delivering better returns.
“Many PE firms won’t invest unless there’s a plan to get to net zero.”
Energy matters to your LPs
Limited Partners (LPs) are prioritising sustainability. A focus on renewable energy can provide real evidence of delivery.
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Even climate-sceptical investors with wide-open investment mandates recognise the future value of investments will be affected. For most of the professional investors we spoke to, LPs’ ESG requirements now play an important role in determining how they carry out business.
A subset of LPs are highly sophisticated in their approach. But in the candid view of the PE partners we spoke to, many LPs lack rigorous analysis and do not make data-driven decisions around ESG.
Instead, the motivation comes from:
reporting requirements, for both regulatory and marketing purposes;
the perceived wishes of their underlying beneficiaries;
a common assumption that a focus on sustainability indicates management strength;
a widespread, if imprecise, belief that those who lag behind will face higher energy, carbon-pricing, regulatory, funding and climate risks.
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The change in LPs’ attitudes is far beyond the point where it can be ignored. The challenge is therefore to deliver against LPs’ motivations without compromising operations or financial outcomes.
Energy can play a useful role. Cost savings are often carbon savings. Intelligent monitoring and control systems can automate reporting. Thoughtful analysis of energy brings both financial and soft benefits.
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What management teams need is a coherent, tailored plan that looks across all of their company’s needs, whether that’s lower costs, energy security, decarbonisation or valuation enhancement. This work maximises the benefits for the company, the GP and all of its LPs.
“As the PE house, you’re just the middleman. If the LPs don’t like what they see in your portfolio, they won’t invest.”