Trevor Castledine, chief operating officer of Future Capital Partners, the alternative investment boutique, sets out why investing in Renewable Transport Fuel (RTF)production may be the best way to benefit from the growth of the renewable energy market over the next few years.

Many investors like to include some “ethical” or “green” investments in their portfolio, but all investors like to see a tidy profit. So how can wealthy investors make socially desirable investments without damaging their investment returns?

The good news is that renewable energy is set to outperform the market generally as an investment class. Financial incentives designed to encourage a shift towards sustainable energy are becoming much more of a reality and much more powerful, generating artificial demand for green energy. Tax breaks for investors may also be available, making properly structured investments even more attractive.

Choosing the right investment

It’s still important to pick the right green investment however, by avoiding technology risk, identifying situations where legislative incentives (or penalties) will create the biggest economic discontinuities and finding opportunities with other attributes which underpin the investment returns available.

Investing in the next-generation of renewable energy technology is exciting but will be a hit and miss business - with some amazing success stories but also much money disappearing into developing technology that simply never becomes commercially successful.  Expert-led funds which diversify risk must be the way to access this type of investment, but diversification will also mean dilution of return expectation, and the timescales for bringing genuinely new technology successfully to market could be very long.

So where are the biggest incentives to be found without taking on technology risk?

If we take the view that in the medium term at least, profits from investment in the renewable sector will be driven by legislative incentives and penalties, then we need to look at where those incentives are likely to create the biggest impact. The fact is that the biggest benefits will accrue to currently available, proven technology which is capable of making a major and reliable impact quickly.

A stage already set

Which brings us to Renewable Transport Fuels (RTFs). Globally, transportation contributes one-quarter of all greenhouse gas emissions, with 80 per cent of that coming from road transport and half of that from cars. Liquid Renewable Transport Fuels (RTFs) in the form of ethanol and biodiesel are the only current low-carbon alternatives to fossil fuels and the liquid fuel infrastructure already exists, meaning that the transportation and distribution logistics are already in place.

First generation technology for producing RTFs is proven on a commercial scale (Brazil has been making bioethanol from sugar cane for nearly 40 years and a well established corn to ethanol industry sector exists in the US).  So legislators are quite logically targeting this enormous source of potential carbon savings. The EU Renewable Energy Directive (RED) has established a binding minimum target for renewable fuels to have a 10 per cent energy-share (13 per cent by volume) of the transport fuels market by 2020. This directive is embodied in UK and other European states’ legislation and severe penalties will be applied to fuel retailers for failing to meet these blending benchmarks.

Market potential

This will create a huge market for RTFs (6.5 billion litres in the UK, 49.5 billion litres in the EU by 2020), equating to a new market in Europe the size of the global market for RTFs in 2006. Given current blending at around 8-10 billion litres, this means a five to six-fold uplift in just 10 years (it took Brazil 30 years to develop a market for 20 billion litres).

We believe that other global producers will probably not have sufficient capacity to meet EU needs and are also unlikely to comply with the stringent sustainability criteria now introduced into the EU RED. The food for fuel argument is a non-starter, especially in relation to ethanol produced from European wheat, given the huge tracts of set-aside land that currently exist and the fact that bioethanol production uses wheat which is not of high enough quality to produce bread. One by-product of bioethanol production from wheat is a high protein animal feed which will displace imports of soy meal from areas where ecologically sensitive land may be used to produce it.

So investing in the development of the European RTF industry seems to offer a particular opportunity to capture the value of what are enormous legislative incentives, where the infrastructure is in place and proven, and large scale technology is available to meet the demand.

But getting access to such investments is not easy. Most publicly quoted companies with RTFs in their portfolios have many other products and business interests which could act as a drag to performance. Additionally, “green” funds may give exposure to RTFs, but once again diversification may mean that successes from RTFs are dampened.

If one believes in the investment story, therefore, seeking out opportunities which isolate the production of RTFs is the way forward. This might be through companies which exclusively own and operate RTF facilities or through an investment directly in the building and commissioning of an RTF facility such as Future Fuels, a recently announced opportunity to invest in a 200 million litre per annum facility to be built in Grimsby.

Other incentives

Three other factors bring added interest to such an opportunity. Firstly, current market conditions mean that the availability of project finance is limited and financing spreads are relatively high, especially during the construction phase. That means that equity investors should benefit from windfall gains on refinancing post-construction, or as and when liquidity returns to the financial markets.

Secondly, with oil majors having significantly under-invested in this technology over the past few years, vertical integration is likely in the future with a trade sale offering a likely exit strategy at a healthy profit for prospective investors.

Finally, structured appropriately, a compelling investment opportunity can also benefit from tax breaks associated with construction of major facilities, meaning that the risk/reward balance of the investment is improved even further. RTFs offer a government-incentivised market where existing, reliable technology can be put to use: now is the time to take advantage.

Trevor Castledine is chief operating officer of Future Capital Partners, the alternative investment boutique which specialises in investments such as renewable energy, international property, biotechnology and media and entertainment. The firm recently launched Future Fuels, an investment partnership established to build a renewable fuel plant in the North of England.