New energy technologies, those typically used in distributed generation (DG), are attracting the interest of the venture capital market, especially boutique firms that are investing in firms developing hot new solar and wind technologies.

These companies are looking for innovative technologies that may provide solutions to the challenges the energy industry is facing today—witness the major August 14, 2003, outage in the Northeast and power-quality issues in today's digital economy. Investments in energy technology firms have grown steadily over the past five years.

A second financial category is emerging. The traditional funders of projects using equipment that made up a typical DG package—e.g., internal-combustion engines and supporting equipment—have gone away. Instead, either equipment vendors are picking up the ball, or small financing companies are adding energy technology experts to their staffs and jumping in.

The overall change is that non-recourse financing is no longer available for individual projects. Instead, venture capital is flowing into companies that design their projects to be self-supporting, often with the help of utility rebates. Another trend is that small financial institutions are arranging financing for groups of projects.

Investment Dollars Growing

Investments in DG and storage were almost half of total worldwide energy technology investments in 2002 and 2003, according to Nth Power, a San Francisco—based energy venture capital firm. The company tracked activity, dollars, and the number of deals going back as far as 1990, when energy technology was not a separate venture capital segment. It estimated that, worldwide, venture capitalists invested $583.6 million in 2002, and $526.2 million in 2003 in energy technologies.

In the United States, venture capital investment in energy technologies totaled $435 million in 2002 and $428 million in 2003, down from $1.27 billion in 2000 and $858 million in 2001. Rodrigo Prudencio, a principal with Nth Power, says figures for investment in distributed generation in the United States alone were not available, but, worldwide, venture capitalists pumped $329 million in 2002 and $224.7 million in 2003 into DG.

Prudencio explains that companies raise capital for 18- to 24-month periods so the numbers will always look lumpy, up one year and then down for several years. More importantly, while investments in energy technologies appear to be dropping, their percentage share of the total venture capital pie increased from less than 1% in 1999 to 2.2% in 2003, according to Nth Power.

(Nth Power compiled its data in collaboration with Clean Edge Inc., the Cleantech Venture Network, and the PricewaterhouseCoopers TVE/NVCA MoneyTree Survey. A summary of the study can be found on its Web site, www.nthpower.com, under press releases.)

Resource Dynamics Corporation (RDC) in Vienna, VA, has recently released a report arguing that the market potential for DG applications is likely to grow significantly. It emphasizes that new DG technologies and recent changes in fuel prices will have a profound effect on the marketplace.

RDC estimates that the market potential for increased sales—given today's DG technology price and performance, current natural gas prices, and the most likely escalation of rates in gas prices—is $13.1 million, representing 49,500 new units, with a potential megawatt capacity of 28,300. The existing installed base is 29,000 non-emergency DG units. Three-quarters of the potential capacity might be sold for cogeneration applications, RDC reports.

However, if natural gas prices rise as much as 22%, some 32% of the DG market potential is at risk of being lost, the report says. If natural gas prices were to fall to historic 1990s levels, RDC predicts potential market growth could increase 92%. Furthermore, DG will have the most growth potential in areas such as California, New York, and Michigan, where the economics are most favorable. Spark spreads—the difference between electricity and natural gas prices—are highest in those areas, according to E.J. Honton, the report's author at RDC.

RDC also reports that the potential capital market for DG could be $13 billion, plus almost as much in heat recovery and emissions-control equipment, engineering, permitting, and siting costs. A copy of RDC's report, The Potential U.S. Market for Distributed Generation: 2004 Edition, is available on its Web site, www.rdcnet.com.

Project Financing Evolving

Traditional sources of funding are going away, but new companies are cropping up to take their places. According to Dan Potash, a financial consultant in the San Francisco Bay area, players such as ABB Capital, Heller, CIT, and Pitney Bowes Credit are getting out of the financing business. For example, an ABB senior vice president says the company is no longer underwriting projects, but is advising customers, and structuring and arranging the financing in support of ABB's providing subsystems for small and medium projects ranging from a few hundred thousand dollars to several million dollars.

NexGen Power LLC, headquartered in Chicago, is one of a new breed of companies. "We're a vehicle for vendors to sell their projects and we finance developers," explains Jerry Davia, senior vice president in NexGen's San Francisco office. "A lot of the energy business is done by smaller developers," he says, so NexGen becomes a partner, taking a participation fee and a percentage of the profits.

To interest financial partners, Davia and his company are consolidating projects. He is currently working with a large food company, putting together a package of projects at 30 locations where ice cream and milk are processed.

Each site will have a small generator set sized between 1.5 megawatts and 5 megawatts. Electricity will be used onsite, along with the excess steam. Each host will agree to a minimum monthly payment that is less than the current utility bill. Savings will pay for the $3 million to $4 million installation cost at each site in four to seven years, Davia says.

Projects have to meet certain criteria, Davia says: There has to be a good off-take agreement or power sales agreement, and the host must have good credit. There has to be strong operations and maintenance in place or under contract, and the construction contractor must be bonded.

Another company, Resource Management Associates in Portland, OR, has formed a partnership with Cogentech, an engineering firm, and Republic Financial of Aurora, CO. Resource Management develops renewable energy projects and arranges the financing through Republic, while Cogentech engineers them. Lane Kadel explains how the three power projects he is developing for the partnership become ripe for financing.

Two of the projects are anaerobic digester plants to be installed at dairies in Oregon, where "nutrient control management" is the byword for disposing of cow manure. Digesters will soon be required by the state to prevent manure from leaching into the water table. A 1-megawatt plant will be built in Rickreall, and a 350-kilowatt unit will go in at Turner. Both will sell electricity to utilities. More importantly, the projects will make their real money selling compost to a thriving market that includes golf courses, greenhouses, nurseries, vineyards, and wholesalers, Kadel says.

The 6-megawatt biomass plant, which will burn agricultural waste, is being developed for a city in northern California. A power purchase agreement is being negotiated with the city's municipal utility.

Kadel says that one funding source for the anaerobic digester plants is the State of Oregon's small-scale energy loan program, which obtains its funding though bond sales. Resource Management must come up with 18% to 20% bridge funding as a condition of the loan. The state wants to see equity participation as well. "Today you need collateral assets," he says.

Equity Now A Must

Project financing has changed completely in the past five years, Kadel argues. If a project had secured a power purchase agreement and a fuel source, the developer was able to obtain 98% to 100% non-recourse debt financing. After Enron, those days are gone. Now, it's zero financing, Kadel says, even with power purchase agreements. Things are improving, he says, now that smaller financial houses have added energy technology experts to their staffs.

Kadel also runs the Utility Warehouse, an online brokerage service, www.utilitywarehouse.com, where he matches up buyers and sellers and brokers the deals. He has sold $90 million in power plant assets over the past five years, he says.

Kadel gets one or two calls a week from hedge funders looking for renewable projects—hydro, biomass, wind. Large pension funds such as the California Public Employees Retirement System are also interested in investing in renewables. He is now working with a pension fund to buy a biomass plant on the East Coast, he says.

Capital Source, a commercial finance company based in Chevy Chase, MD, has financed a number of inside-the-fence cogeneration projects, 1 megawatt or less, with independent companies. These projects are installed in commercial and industrial buildings and hospitals, typically for $2 million or less, according to Michael Hammond, a principal with the company. But these small projects, he says, are tough to get financial people to spend time on, and often end up being financed by equipment vendors. He is now seeing some consolidation of these small projects, similar to what Resource Management is doing.

The larger, 10-megawatt to 40-megawatt fossil-fueled projects for industrial and commercial customers costing $10 million and up, while still considered small by financial banks, are easier to finance, Hammond says, especially if the owner invests some capital in the project.

This spring, Capital Source provided funding to Real Energy under a $15 million line of credit secured by GFI Energy Ventures and Global Innovation Partners for Real Energy. Real Energy develops, owns, and operates permanent onsite power generation systems in commercial and industrial properties. While the host company continues to pay a monthly fee equal to the local utility retail rate for electricity and steam, Real Energy pays rent to the property owner for the space where the power plant is located.

Venture capital firms perk up when they can identify a startup company with a technology that has won federal and state funding. This is especially true for such new and emerging technologies as advanced solar products and fuel cells. According to Atakan Ozbek, director of energy research at ABI Research, federal and state incentive funding reduces risk and justifies the technology. In effect, it legitimizes the company's business plan.

Hammond embraced the idea that federal and state grants or loans enhance the reliability of new renewable technologies. Because the technology is not commercially proven, a financing company is not set up to evaluate the technical risk. But a technology that has been reviewed by an agency qualified to do so, and awarded an incentive such as a grant or loan, lessens the risk for the financial company.

For example, Hammond pointed to the federal investment tax credit for wind, which in recent years has been converted to a production tax credit. In the first instance, he says, the credit was obtained by getting the project built, but the production tax credit is more meaningful, at least to banks, because it could be used only after the project begins producing power and, thus, becomes an incentive to prove the technology.

But Nth Power's Prudencio cautions that while federal or state funding can be an important bridge for technology development, a company that lives off government funding without moving quickly into manufacturing is a high risk for a venture capitalist.

Venture Capitalists Love Renewables

Two companies that have created new technologies to manufacture solar cells made announcements within two weeks of each other in August. Nanosolar Inc. of Palo Alto, CA, won a $10.3 million research and development contract from the Defense Advanced Research Projects Agency (DARPA) and has already received funding from such investors as U.S. Venture Partners and Benchmark Capital.

Nanosolar started up in 2002 and created a new process using nanotechnology materials to manufacture flexible roll-printed solar electricity cells. The company says this new process will produce solar cells that match and exceed the efficiency and lifetime of conventional solar cells but are far less expensive, lighter, and sturdier.

The company first received funding from the Public Interest Energy Research (PIER) program of the California Energy Commission (CEC). At a CEC meeting in early September 2004, the commission announced that with Nanosolar's DARPA contract the level of follow-on funding companies have received subsequent to their PIER grants had increased up to 12 times the amount of funding the CEC had awarded. The PIER program annually awards up to $62 million to conduct the most promising energy research.

(It should be noted that many states have grant programs for energy research. For example, the New Jersey Board of Public Works Clean Energy Program awards grants for renewable, solar, small wind, fuel cells, and sustainable biomass equipment installations. However, it has just $300,000 to award annually for 2004 and 2005.)

The second company to make a financing announcement in August, Evergreen Solar Inc. of Marlboro, MA, secured a $5 million line of credit from Silicon Valley Bank, the primary banking subsidiary of Silicon Valley Bancshares. The credit will be available to the company for 12 months and will be used to further support its ongoing expansion plans.

Founded in 1994, Evergreen Solar is a public company that trades its stock on NASDAQ. Its revenue increased from $2.2 million in 2000 to $9.3 million in 2003. It had already secured $29.5 million in private-equity financing in May 2003 through a syndicate of 14 institutional investors.

Evergreen Solar developed a proprietary manufacturing process it calls String Ribbon, which produces a flat sheet—or ribbon—of silicon, the substrate for making solar cells. The process uses about half the silicon and avoids the costly sawing of solid silicon blocks used in other manufacturing processes. Its solar products are used in rural electrification, water pumping, telecommunications, lighting, and, of course, residential, commercial, and industrial solar-power applications. The company is targeting grid-connected markets in Europe and the United States.

Nth Power believes that energy is one of the four biggest and most critical industries in the world, and is focusing its investments on new technologies and innovation in that field. In addition to Evergreen Solar, it has chosen distributed energy companies such as Capstone; H2Gen, a manufacturer of low-cost, small-scale hydrogen generators for industrial applications; Proton Energy Systems, which develops hydrogen-generation products utilizing proton exchange membrane technology; Clean Air Power; and STM Power.

Pushing Innovation in Engines

STM Power has developed a 55-kilowatt Stirling engine that uses landfill and digester gas, petroleum flare gas, and other low-grade waste fuels and hydrogen to generate electricity in landfill and waste-recovery operations. It is now taking orders for its units, which will be in full commercial production in the third quarter of this year. The company raised over $20 million in financing earlier this year.

San Diego–based Clean Air Power, a company that is filling the niche for low-cost power availability, announced in July 2004 it had raised $6.4 million in venture capital funding to finance product and market expansion for its dual-fuel and after-treatment technologies for transportation and power-generation applications. Clean Air Power has developed a natural gas/diesel hybrid generator that produces low emissions, which is especially attractive to urban markets. It has attracted venture capital funding not only from Nth Power, but EnerTech Capital, CIBC Capital Partners, RBC Capital Partners, Angeleno Investors, and Endeavor Capital Management as well.

Nth Power is backed by a group of limited partners who promote and employ the products and services offered by its portfolio companies. Those partners include such utilities as Alliant Energy, PacifiCorp, Cinergy, and First Energy, as well as such financial institutions as BancofAmerica Securities, CDP Capital, and CIBC.

Citing the major blackouts of August 2003, Maurice Gunderson, co-founder and managing director of Nth Power, said in a recent statement, "As the industry and its customers find themselves going from crisis to crisis, there is a growing realization that patchwork solutions are not going to solve the challenges facing energy producers and users. Sustained investments in new technologies are required to fix problems creatively and effectively. Such investments are absolutely vital because of today's digital economy."

DG technologies have found their place in the global energy marketplace, and their financing is evolving as innovators create the products that excite the financial institutions that share their vision and sense of risk.

California-based Lyn Corum is a technical writer specializing in energy topics.

DE - November/December 2004