Vertically Integrated Business Models in Renewable Energy
In today's renewable energy market, characterized by “yield compression,” control has become more valuable for many developers and investors in managing risk and profitability. The quest for control created vertically integrated business and partnership models, making financial asset management more valuable. Higher interest rates can boost stronger asset valuation, encouraging asset ownership business models.
Assets with merchant risk exposures remain too risky for most banks as stand-alone project financing. Renewable energy players position themselves strategically and create new business models (e.g., low PPA floor with upside sharing), which can attract sophisticated project equity owners searching for attractive risk-adjusted returns.
These forces contribute to the growth of vertically integrated business models that allocate risks better across the value chain. Each business model has pros and cons, and the decision often comes down to many internal and external factors, including organizational structure and capabilities, core competency, project risk and return profiles, capital availability, market conditions, cost of capital, and business strategies. In this blog post, we listed the main pros and cons of some of the most common business models in renewable energy.
The Conventional Flip Model
The most conventional approach, the flip model, involves a developer building a project and selling it for a lump sum to an asset owner. The developer assumes all the development risk but retains no ownership after the sale.
Developers have timing options for when to flip their projects and typically sell at the Notice to Proceed (NTP) stage or after construction (sometimes referred to as the commercial operating date or COD).
Selling at NTP
Many developers select a site, secure funding, obtain permits, cover interconnection costs, and then flip the project. Because the project is ready to build, it is very attractive to asset managers.
Advantages
- High margin: The developer can see a very high return on a very low investment. They have only completed the preliminary steps required to complete the project and covered the costs of connecting it to the grid.
- Low capital requirements: If targeting an NTP flip, the developer only needs a little capital to bring a project to sale.
Disadvantages
- Lower value capture: Because the developer exits the project early, they don’t unlock any long-term operational revenue the system could generate.
- High risk: The project developer assumes all the development risks, which can be binary (0/1). There’s no guarantee of success.
- Cyclical cash flows: The unpredictable nature of project success and external conditions, such as interconnection delays, can impact financial stability and add significant business risks.
Selling at Construction
Other developers continue past NTP and only flip to an asset manager after the system is fully operational. They break ground, build the infrastructure, install the system, and connect it to the grid.
Advantages
- Additional premium captured: The project is close to (or already) generating revenue at sale, generating additional returns for the developer.
- Demonstrated Capability: There is a shortage of and a premium fee for EPC firms that are capable of delivering projects on time and on budget. Successfully completing a project enhances the developer’s reputation and track record, potentially leading to more lucrative opportunities in the future.
Disadvantages
- Lower margins: Completing a project takes lots of capital, leading to decreased margins on the flip.
- Increased risk and complexity: Managing a construction project to finish introduces added variables that can delay projects or inflate budgets. If the project goes off course, the developer eats the cost.
Partnership Model
In this model, partners share responsibilities and capital across project development, construction, and financing of the assets without co-owning the assets themselves.
Advantages
- Maintaining Core Competencies: Developers and investors focus on their strengths without expanding beyond traditional project phases.
- Shared Risk and Resources: Partnerships allow for shared financial and operational risks and pooled resources, leading to more efficient project execution.
Disadvantages:
- Restrictive Nature: Partnership models can be limiting, as developers do not take ownership or control of the assets once they are operational.
- Complex Coordination: Managing partnerships requires precise coordination and alignment of goals, which can be challenging.
- Partnership models offer a balanced approach to project development by leveraging shared responsibilities and resources while maintaining core competencies.
Emerging Vertical Business Models
The renewables industry is booming rapidly thanks to private investment and government funding. Global investment in the energy transition hit $1.8 trillion in 2023, up 17% from the previous year and a new record. Sustained access to institutional capital for renewable energy is now a common feature of power markets. Accelerating capital flows into clean energy powered by maturing technology, competitive power purchase agreements, and sharp equipment price reductions have resulted in more intense competition amongst investors, driving down their expected returns, also known as yield compression.
Increased competition for operational assets and other factors, such as development delays and shortages in EPC companies, have forced companies across the renewables sector to evolve their business models.
On one side, investors get involved early in the development cycle to identify better project opportunities where they can add value and maximize returns as part of their portfolios later. This gives them longer-term certainty and more knowledge and control over the fine details of running renewable energy power plants as efficiently as possible.
On the other side, many developers act like independent power producers (IPPs) to take advantage of yield compression by holding on to their projects longer as they become operational and generate stable revenue streams.
At their core, the conquest is to control renewable energy assets. The optionality gives the owner the flexibility to use the asset as leverage, a source of income, and more.
These business models necessitate financial infrastructures, capabilities, and tools to help untangle them. They’re not without their advantages and disadvantages, and knowing the difference could have far-reaching impacts much further down the road.
Integrated JV Model
A more holistic approach, the integrated JV Model, is when asset managers partner with a developer or create their own in-house team so they can control the entire project lifecycle. They’ll handle the project from financing and development to long-term management.
The JV model arose from the competition driven by supply chain issues and a lack of EPC suppliers. As the demand for quality projects grew and developers increased prices, it became more cost-effective for asset managers to finance and build projects themselves.
When a JV partnership, a fully integrated model allows both the asset manager and developer to share risk and reward. They’ll both maintain control but are both responsible for financing and management.
Advantages
- Control over the pipeline: Managers and developers have full pipeline visibility and can better forecast and deploy capital.
- Control over the price: By financing and constructing a project according to their standards, they can avoid paying a premium for a quality project from another developer.
- Increased revenue opportunities: Both parties can share in the operational (recurring) revenue from the project.
Disadvantages
- Increased risk: By taking the project from start to finish, a fully integrated partnership shoulders a lot of complexity. From resource allocation to coordination of operations, they’ll face varying execution and management challenges over the life of the project.
- Split operations: A partnership or in-house team is effectively two companies in one. This can lead to slower decision-making or power dynamics that hamper business.
Minority-Interest Model
An optimized middle-ground agreement, this hybrid model allows developers to sell a completed project yet retain a minority stake. This keeps them involved long-term and provides additional revenue from the operational cash flow.
This model originated because of the cash flow challenges faced by many developers. The construction component of their business is very high risk and high reward, leading to a need to diversify their holdings by adding income streams.
With a minority-interest model, they can effectively de-risk their cash flow, balancing their development liabilities with steady revenue from operations. They can even leverage that steady cash flow to lower the cost of capital for future project development.
Advantages
Aligns interests: Because both parties have a stake in the success of the project, there’s a much better relationship between the developer and asset manager. There’s also greater interest in managing project performance, as both benefit from production.
Creates business stability: The passive (recurring) revenue stream gives developers a more steady cash flow that they can leverage for less-expensive project financing. It also allows them to employ a workforce during typical downturns and project development cycles.
Disadvantages
Limited control: As a minority partner, the developer has less control of key decisions on the project. They’ll be more dependent on the majority partner and impacted by their actions.
Reduced short-term profits: In exchange for a minority stake, the developer leaves some of the immediate revenue from sale on the table.
Increased complexity: Developers in a minority-interest model will add new complicated operational layers to their existing business. They’ll need to balance their project development while also managing a steady cash-flow operation.
New Business Models, New Infrastructure Needs
Building a new business model depends on many factors, such as the cost of capital, the core competency of the business, the structure, the culture and risk tolerance of the team, and the types of opportunities they find and lose. As discussed, vertical integrations present many advantages for renewable energy developers who are strong in specific geographical markets and asset types. By expanding to asset ownership and management, they achieve more control across the value chain and create more stable and predictable revenue streams. This means asset management will inevitably be a part of the developer’s strategy throughout development, construction, and operations. Market factors like competition and capital availability will make some form of integration beneficial for both sides.
Due to these emerging models, financial complexity will increase, and developers will need the right tools and expertise to manage their processes. How should developers price the risks and decide when to flip vs. when to hold? To oversee assets and deploy capital at scale, they’ll need a united platform for managing and analyzing their projects from pipeline to operations with precision and speed.
Perl Street’s platform connects these dots for developers and asset managers, offering solutions and guidance to help them strategize and scale their renewable portfolios. By providing easy-access asset analytics across a portfolio, streamlining processes, and unifying financial data, they'll give both sides all the control they need to grow.
Manage and scale with the right financial infrastructure