Private renewables have entered the same economic war zone as all other investments. They may be receiving superficial exaltation — the equivalent of green ribbon bow decals affixed to the windshields of hybrid cars, but the new American casbah of clean is rapidly turning into an orange zone of lurking uncertainty.

Energy project finance and energy technology finance have each regularly been victims of cyclical contractions tied to the strength of capital markets’ support. Renewables projects, like cogeneration, IPPs and energy tech before them, are vulnerable not only to the way in which market trends affect them but to the availability of leverage to keep their projected IRRs competitive with non-renewable energy alternatives. Recently, we have already heard, as the debt markets tighten, worn but telling words like “stricter project quality requirements” are dusted off. Players like hedge funds and some private equity investment funds are (as it is euphemistically put) “returning to basics”. A great deal of equity designated for renewables or cleantech has already been raised which remains to be put to work. However, investors taste for the renewable flavor of the month is more finicky than ever. The capital markets relatively recent turn against biofuels, while certainly related to commodity economics and some adverse regulatory developments, certainly illustrates this trend.

There are, however, some things proponents of renewable finance can do besides rail against the venality and short-sighted lack of vision of those who nurture its health. They fall in three basic categories:

(1) Preserve and foster the regulatory architecture on which renewables investment rests and whose improvement would enhance the perceived future quality of renewables investments;

(2) Examine and extend the ways in which public capital and public supported initiatives can be more effective in assisting private energy project development;

(3) Analyze the sectors of private capital support which will be sustaining and encourage public programs for their enlargement.

Here are some specifics on each:

(1) Regulatory Architecture. Renewables today still are still almost without exception dependent on tax incentives for financeability. Somehow, despite $100/barrel oil, Congress has allowed political machinations to jeopardize these incentives and the investment community’s expectation of their continuation. There have been repeated examples in the past of how, in the best of times, the clogging of the tax incentive spigot leaves renewable projects whirling down the drain. At a bare minimum, some continuation of tax incentives is required for vigorous industry development. Particularly in the short run it projected competitive technological edge is no adequate substitute.

Admittedly, a significant segment of renewable energy production is not directly about oil displacement: it is an alternative to domestic environmentally or domestic supply challenged fuels. To date, it has been about creating distributed electric generation substitute for capital intensive central production. The Congress and the regulators fought themselves to a fatigued standstill on power deregulation and have made only faint jabs at large scale infusion of renewables to meet clearly foreseen forthcoming load requirements. The battle over climate change regulation and its impact on these issues will not relieve and perhaps may even increase pressure on this situation.

Renewables need a core of supportive energy regulatory policies which assure not only their ready integration into the grid, but their facilitated development. The specific traditional areas where this is true, notably transmission and local level reward for utilities for cooperating with distributed generation remain unresolved. In addition, utilities and renewables developers also need some assurance that the Resource Performance Standards’ success and future proliferation will not be cut down by the way in which carbon reduction regulations are implemented.

(2) Coordination of State and Local Support. In the face of the wintry blasts from the economy and deficiencies in Federal incentive and regulatory programs, it is more than ever up to the States to act on recognition of the reality that renewables development can represent a long term, expanding job source. At present, 28 states have one or more of the following: Clean Energy Funds, RPS, Fuel Cells and Hydrogen Funds and carbon trading arrangements. Several other states have governors who are independently pursuing far ranging fuel independent, environmentally substainable programs. Some State funds are direct in their application, i.e., project development and investment; others are more geared to energy as another form of traditional industry development. Some support R&D programs. In addition, the interest in climate change has led several State Treasurers and pension funds to focus on renewables - over $1.7 Billion to date (a total which does not include various non-profit initiatives). This diversity of programs, without coordination, does not serve the renewable industry well today. In the current changed environment, the challenge for the industry is to seek support as a united force – not a series of independent sponsor benefit takers – and to encourage such coordination among states and between state programs with different policy objectives.

In particular, efforts to coordinate approaches for renewables stimulation and climate change response are particularly necessary. At a time when the Federal government is inclined to quick fix “stimulus” packages where advances of public funds are intended to be rapidly recycled back into the economy it is important that some long-term perspectives be taken as well. Overall Private Renewables need to better highlight to states the linkage of the near term job creation value which they have to their longer term energy/environment benefits.

(3) Facilitation of Private Credit Support. Whatever the public policy environment, there needs to be updated recognition on the part of industry players as to which financial sectors are more likely sources for them to turn for funding, and what public policies should focus on to keep those particular windows open for renewables. Consider two polar points on the renewables capital source spectrum, which only collaterally compete in the same market: credit companies on the one hand and privately placed securitization pools on the other.

Credit companies are free to invest in various forms of debt or equity, multiple alternative tiers of the capital structure. They are oriented toward larger leveraged projects, entered into with strategic partners to avoid debt consolidation. Their preference is to be lessors rather than owner/operators. For many, but not all, their tax appetites are substantial. For many, equity investment presents a less attractive option than debt investment, because their income return pattern does not fit their preferences.

By contrast, there exist a smaller member of investment funds which are prepared to aggregate and securitize the cash flow from multiple smaller projects. While tax benefits are not without value to such funds, reliable credit support (public or private) to support cash flow returns is the preeminent concern. Risk is reduced in these projects by creating separately financed packages from multiple vendors and projects.

Certainly in any market situation, but particularly in the current tightening capital markets, it is critical that project sponsors focus on the fit between the investment preferences of potential capital sources on the one hand, e.g., related to threshold return risk, investment remarketability and their own investment profile characteristics, e.g. control; tax appetite; strategic contribution to business plan execution.

But regardless of whether the financing is large or small, it is important to focus on the extent to which public programs can serve to fill in the gaps between active financier preferences and sponsor offerings. That conclusion leads to a different perspective in recommendations for the appropriate role for government (Federal or state) programs. In particular, both for large project financings and small project securitizations, it shifts the focus to risk management, i.e., governmental temporary or contingent support for project debt or preferred debt in securitizations. It leads to a policy focus not on raising the IRR for sponsors but enhancing the probability of financing (and collaterally therefore lowering the cost for debt). Energy and environmental security is a function of preserving functioning capital markets available to renewables: not on governmental technology selection, but on governmental facilitation of sound capital structuring.

Support by industry members for a consistent program which addresses all three of the factors described above could serve as a flare which would enable Private Renewables to get through the fog of carbon smoke and toxic economic news which otherwise threatens to reduce their mission to the role of careful, lucky – and unfortunately much more occasional – marksmanship.

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ROGER FELDMAN, Co-Chair of Andrews Kurth LLP Climate Change and Carbon Markets Group has practiced law related to the finance of environmental and energy projects and companies for 40 years.  In particular, he has analyzed and executed a wide variety and substantial value of project financings.  He chairs the American Bar Association’s Committee on Carbon Trading and Finance, serves on the Board of the American Council for Renewable Energy, and has been a senior official in the Federal Energy Administration.  He is a graduate of Brown University, Yale Law School and Harvard Business School.