New Energy Economy and a 2008 Recession
By Michael Butler
Feb 19, 2008 - 5:00:00 AM
Like everyone else, we're running the numbers, searching for clues, and looking for empirical evidence in an effort to understand which way the economy is headed. We are optimistic for the emerging post-petroleum era, so we're especially focused on the impact a recession might have on the current revolution in sustainable industries.
But after conducting an analysis, we believe The New Energy Economy will hold up reasonably well -- even if the tide turns and a severe downturn washes over us. Of course, the effect of a downturn on sustainable industries will depend on the type of recession.
Five Reasons Not to Worry
1. Green Transformation - Large auto, utility and building construction companies have begun laying the groundwork for a sweeping eco- revolution; now that it's been started, it can't and won't be stopped. The participation of many public, large-cap and highly-valued companies in this revolution is a bellwether metric of success.
2. Investment Infrastructure - This fire wall is in place for clean technology and alternative energy, and it should provide a good measure of downside protection if a recession takes hold.
3. Energy Supply-Demand Imbalance - Investors will try to offset this increasing global disequilibrium, driven in large part by growing economies in
China and
India, by financing alternative and renewable energy plays.
4. Vociferous Voters - Americans are increasingly demanding change and accountability when it comes to
U.S. energy policy; they want our petroleum-based fuel dependency addressed.
5. Public Sector Engagement - A large amount of government money is being funneled into clean technology and renewable energy at the national, state and local levels.
Five Reasons to Be Concerned
1. Fear of a Bursting Bubble - Investors could worry about a repeat of Internet Era excess, even though The New Energy Economy is very different from the IT Economy of the late 1990s.
2. Lack of Track Record - There could be initial downward sentiment after a recession bites because the clean technology and renewable energy sectors don't have much of a track record yet. This negativity could prevent large scale capital formation in these new markets.
3. Failure of Nerve - In the face of economic adversity, New Energy Economy entrepreneurs and investors could shrink their appetite for risk.
4. The Public Sector Retreats - Economic pressures could force government to withdraw or scale back its financial backing for clean technology and alternative energy.
5. Consumers Lose Interest - The recession could damage pocketbooks to such an extent that citizens mute their demands for a new energy policy, despite the fact that "green" solutions are more economical in an environment with high energy prices.
What a recession would do to clean tech venture opportunities
A deep recession in the
United States that drags the rest of the world into the economic doldrums will clearly have consequences. Slower growth in
India,
China and - to a lesser extent - Asia and
Europe will meaningfully decrease the cost of oil. A significantly lower oil price will - at least emotionally and perhaps economically - reduce some of the urgency to find alternative sources of fuel.
Bio-diesel and ethanol projects will also have a hard time in a deep recession, largely because of uncertain end-user demand. Material science deals involving new technology that is years away from commercialization probably won't make the cut either. One last bit of caution: If there's a really deep recession, a number of renewable power subsidies and tax credits may be curtailed by a financially beleaguered public sector.
A deep recession in the
U.S. would also likely shut the IPO window. Exits for venture-capital-backed companies would also be fewer and at lower valuations. Historically, a slower exit environment has had a meaningful impact on the pace of venture-capital and private-equity investing. In addition, a deep recession would affect the credit markets and significantly impact the pace of new infrastructure projects because project finance debt would be very difficult to obtain.
Where to look if a recession happens
If there's a deep recession, investors will look for sustainable industry companies that are capital efficient and have a short timeline to positive cash flow status. Companies that focus on efficiencies and have software solutions that produce attractive ROIs for customers should also continue to attract investment capital. And efficiencies applied to the building sector (rehabbing existing HVAC, lighting and efficiency monitoring, for example) should remain as a sweet spot.
Waste to energy deals -- We believe that in this kind of tough environment, very few project finance deals will get done. One possible exception: waste-to-energy transactions where the input is trash, because long-term contracts for the input are in place, and the technology employed is already proven in the marketplace.
Auto sector clean tech -- Many clean technology deals involving the auto sector won't be affected simply due to the long product cycles employed by this industry. On the other hand, companies that compete with the auto industry - or those seeking to create a new auto infrastructure - may find the world less hospitable in a deep recession.
Contrarian analysis
A recession triggered, in part, by higher oil or fossil fuel prices will actually help sustainable industries for a variety of counter-cyclical reasons.
First -- higher energy prices will highlight the excessive cost of our fossil-fuel dependency; as a result, companies - big and small - will begin searching for ways to manage these costs and the accompanying volatility risks. This will mean hiring people for new positions in clean technology or even setting up new divisions focused on sustainable energy.
Secondly -- for their part, investors will finally - once and for all - come to terms with the fact that there is a fundamental long-term problem in the energy sector. We believe they will really dig in and truly step up by investing in new technologies, start-ups and early-stage companies that offer the potential to solve some of these problems. This will create more jobs in well-capitalized clean technology companies.
Thirdly -- a number of companies that were not economically viable at cheap oil or energy prices will quickly become economically viable. A wide variety of transportation innovations on the fuel side or the vehicle side, for example, will become cost competitive versus traditional products. This will lead to expanded sales and new hiring for those companies. The same pattern will take place in green building/energy efficiency. When energy costs increase, the benefits that accrue to real estate owners if they install energy-saving technologies become greater. Again, this leads to more work and more jobs.
Finally -- public discord will rise in a hurry if a recession is clearly prompted by high energy costs, so government will do what it can to retain renewable power incentives such as grants, loans and tax credits. As mentioned above, though, if a recession bites with severity, the economic pressure on the public sector may prevent this.
Recessions traditionally signal economic transition, and although they frequently cause financial dislocation, they also usually lead to a new clarity of thinking.
Long term good news
The good news is that even if there's a deep recession that slows sustainable industries, the setback will be temporary. We believe that there is a 20-30 year secular uptrend waiting for renewable energy enterprises on the other side of the downturn.
And if there's a mild recession, the effects will be short-lived on The New Energy Economy and not especially meaningful. Valuations will moderate, deals on the margin will not get done and current trends like the reluctance to finance bio-diesel and ethanol deals won't be altered. But progress won't be halted and the sustainable industry revolution will continue to move forward.
Email Michael Butler
Cascadia Capital web site
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