PRIVATE EQUITY: Sunny days ahead for energy investors

Solar-powerPrivate equity is playing an ever more significant role in the Mena economies. Nick Fitzpatrick finds out why renewable energy is a target for investors, and looks at the development of the asset class.

Picture this: violent social unrest, bloody uprisings, brutal state suppression; but regime change prevails and a fragile seedbed of democracy is sown. This may sound like areas of the Mena region in 2011, but actually it is Latin America in the 1980s.

Where the Middle East political climate is now, Latin America’s was 20 years ago. Back then, investors would not touch that continent in any meaningful way. Now their money seeks the safety of Brazilian local currency government bonds as Europe’s debt crisis
plays out and the dollar sinks, and according to a recent Bank of America Merrill Lynch fund managers survey, Brazil is also the favoured destination for emerging market equity investors.

Chile, Colombia and Mexico also attract investors looking for growth opportunities beyond the Brics [Brazil, Russia, India and China]. And the money rolling into Latin America’s capital markets is likely to be a lot stickier today, too, because longer term institutional interest is replacing the “hot money” that dipped in and out two decades ago.

If Latin America’s experience offers any clues as to what Mena capital markets may become one day, then in all likelihood private equity will play a tremendous role in getting the region there, particularly where seed or early-stage capital in young companies is involved. Private equity fund raising has grown dramatically in Mena in recent years. Meanwhile, demographic trends point to a growing need for job creation – not retirement planning as they do in Europe. Small and medium-size enterprises (SMEs) are the chief employers in the region, and governments are seeking to diversify their economies. They are spending, too – not least on the energy market.

Beaming down fuel
The rationale for doing this is not as obvious as you may think. There is the need for economic diversity, which is clear. But the idea that these oil-rich countries need to seek other sources of export income to replace oil when it runs out could be a flawed notion. It may be the case that demand for oil will run out before the fuel itself does. Higher prices could see demand fall and stimulate alternative energy forms before the oil beds are dry, so many Mena countries see the value in creating a renewable energy industry regardless of the longevity of supplies.

Much attention is given to solar energy production and export in the Mena region. This is hardly surprising. Approximately 800 terawatts (800 trillion watts) of solar energy shines on Earth every year. Given an annual worldwide energy demand of 15 terawatts, the sun meets the world’s energy needs 53 times every year. And where better to harvest this energy source than deserts such as those of North Africa and Arabia.

“We think Mena will be one of the leading hubs for solar photovoltaic and thermal electric energy,” says Nizar El Hachem, a partner at I2BF Global Ventures, a private equity firm founded in Silicon Valley, in southern San Franciso in the United States, and head of its recently opened Dubai office.

He says that in the “cleantech” sector, government support is a key incentive for investments. “Mena countries and, more specifically, Gulf States such as the Emirates, Qatar and Saudi Arabia are keen to join this global policy environment, pursuing cleantech initiatives and making a huge push to become the Silicon Valleys for these technologies.”

In 2008, Abu Dhabi pledged $15 billion (€10.8 billion) to support a sustainable energy and clean technology industry as part of its aspiration to be a world leader in the sector. In April this year, Saudi Arabia – which has one of the lowest electricity tariffs in the world but has been letting prices rise in part to promote conservation – issued a royal decree ordering the construction of a renewable energy “city” in Riyadh, the capital. Qatar has staked a claim to become a leader too, and in 2010 joined the International Renewable Energy Agency.

I2BF, which has more than $155 million in assets under management across three investment vehicles, invests in renewable energy and other cleantech companies across the US and Europe. It aims to bring suitable technology of its portfolio companies to the Mena region.

The Gulf has some of the world’s best solar resources. Photovoltaic is the method of producing solar energy using solar panels. El Hachem says that according to several studies, investment in photovoltaic projects could generate around 9.5% if oil reaches
$160 a barrel and at a capital cost of $3.14 per watt.

If oil goes to $80 to $90 a barrel, these projects costing $3.14 per watt would offer a yield of circa 5%.

“If we compare these figures to 2019 Abu Dhabi government bonds with a yield of 6.75%, these investments are viable in the region,” says El Hachem. “These project returns, along with the desire to diversify from traditional energy sources, could create a thriving market for solar technologies in the region.”

The firm officially opened its Dubai office in March and the I2BF Venture Fund II started investing in April. The fund is focused on global venture capital opportunities, including in the Mena region, particularly early-stage companies developing cutting-edge technologies in renewable energy in fields, including solar. The fund is expected to operate over a seven-year period.

Sources of capital
A driving force for private equity investing in the Mena region is the relative scarcity of other sources of capital. Sovereign wealth funds may have vast holdings, but according to a report by Abraaj Capital, a major private equity house in Mena, more than 92% of sovereign funds in the Gulf Co-operation Council region are invested internationally.

There has also been a slowdown in credit, which has led to a constrained financing environment, according to the Abraaj report, entitled Middle East & North Africa: Opportunities Notwithstanding Challenges, published in June.

The private equity industry in Mena has seen tremendous growth over the past ten years. Following the September 11, 2001, attacks on the US, large amounts of local capital were deployed back to the Middle East. Some of this capital, coupled with vast amounts of income created by the strength of the oil price, found its way into private equity hands. The skills of private equity had been built up in the region thus far by overseas allocations. But by now the time had arrived for the local industry to come to fruition.

The momentum grew and grew. Even the financial crisis could not halt it. As an indication, venture capital deals that closed in the Mena region in 2009 and 2010 were almost triple the amount of deals closed in the two years prior to that. On the fund-raising side, venture capital funds raised in 2010 alone were almost equal to the total number of funds raised in the four years before that, according to the Mena Private Equity Association.

©2011 funds global

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