By Keith Button
Renewable energy and low-carbon-emission industries have become popular private equity investing targets as PE firms adopt ESG – environmental, social and governance – investment principles. But some PE firms are also finding ESG investment opportunities in manufacturing and industrial companies with high carbon emissions and other environmental issues that can be cleaned up.
Private equity fund investors are pushing PE firms to focus on environmental issues and they’re demanding more than lip service. “In ESG, you can say what you care about to investors. But really the mantra has switched from ‘Say it’ to ‘Prove it,’” says Mike Bridge, director of operations and ESG leader for Middleground Capital, a lower-mid-market PE firm based in Lexington, Kentucky. “Prove you’re reducing energy use; prove you’re improving working conditions. That definitely resonates with the investor base: they want to they want to see it rather than read it on paper.”
ROI plus environmental impact
There are many opportunities for cleaning up environmental problems at companies while meeting return-on-investment thresholds, but “sometimes you have to go looking for those types of solutions, and you won’t find them unless you are really focused on it,” says Heather Faust, managing partner and co-founder of Argand Partners, a mid-market PE firm in New York.
“Prove you’re reducing energy use; prove you’re improving working conditions. That definitely resonates with the investor base” Mike Bridge, Middleground Capital
Often with mid-market acquisitions, environmental problems are uncovered during the due diligence process – problems that the family or entrepreneur selling the company isn’t aware of, Bridge says. “We’re not afraid to make investments in companies that have issues that need to be addressed,” he says. “We think we’re in a perfect position to make a real impact on the world through our ownership of these private companies. We can be good stewards of the environment and make a profit for the investors, and frankly, that’s what everyone wants.”
Even for companies that have been granted grandfather exemptions to new environmental regulations, as is the case with some steel foundries, the bottom line of a struggling business can benefit from environmental updates, Bridge says. “There’s actually not an incentive to upgrade now, with some older steel mills, to the newer, less energy-intensive production techniques,” he says. “But we think we should go in and make those investments to, for example, reduce their energy use.”
Modernizing a steel plant produces other benefits, even beyond the environmental upside, such as improving worker safety and the attractiveness of the workplace, which in turns helps attract and keep workers, Bridge says.
“If you walk into a plant, it might have a dirt floor; it might not even be concrete,” he says. “You get hot, molten steel flying around; it looks like a dirty environment. But that doesn’t mean I don’t know what to do with that – we’ve got the experience to come in and modernize the operation, to make investments in modern equipment, to make it safer for team members.”
For some industries, a high level of carbon emissions is an inherent part of the business – with cement or precast concrete businesses, for example, or steelmaking, Bridge says. But with the right operations approach, PE firms can reduce the carbon footprint of their portfolio companies and make other improvements toward environmental goals.
With all of its portfolio companies, Bridge says, his firm measures progress on achieving environmental goals through metrics on energy and water use, for example, and it works toward achieving ISO 14001 certification of its companies’ environmental management practices.
Relatively better carbon footprints
Private equity firms are also targeting “green-it-up” opportunities in retrofitting carbon-emitting companies with carbon-capture technology, which isn’t yet well-proven, or changing over combustion-powered plants to electric power, says Rahul Advani, managing partner of SER Capital Partners, a mid-market private equity in Belmont, California.
Advancements in battery technology combined with steep electric power rates are sparking a PE environmental investment opportunity on the sites of fossil fuel-burning power plants: installing racks of lithium-ion batteries for power storage.
In the hierarchal ladder of power generation, renewable energy sources such as hydro, solar and wind, along with nuclear plants, occupy the most favored rungs, while the oldest, most-expensive, and/or most polluting coal, oil or natural gas power plants are fired up to generate power only during periods of peak demand. “You have a whole set of plants that are out there that are sitting dormant for the hot days when everybody’s cranking their AC and it reaches that peak point,” Advani says. Peak-power plants can be designed to only run 5 percent of the time, and they can earn most of their revenue in just a few hours in a year.
Now, there are PE investment opportunities in replacing some or all of the generating capacity in the peak power plants with lithium-ion batteries, Advani says. The partially decommissioned, natural gas-fired Moss Landing Power Plant in California is one such example. The idea is for the peak power plants to supply some or all of their power to the grid from their battery storage, which draws power off the grid generated by other sources during non-peak periods.
That concept that wasn’t viable before the cost of lithium-ion batteries dropped dramatically, which was spurred by manufacturers globally scaling up their battery production and wringing out significant economies of scale for the anticipated onslaught of electric vehicles.
“We’re using the same lithium-ion batteries that you’re using in truck batteries,” Advani says. “If you look at this demand, battery storage for the grid – even if it proliferates – is just a small, small part of what’s coming for EVs. It’s really benefiting from this scale-up in manufacturing.”
Cheap battery storage of electrical power, high rates for grid power and frequent power outages for the grid, such as the outages experienced by Californians in recent years, also presents a private equity opportunity for building “micro-grids” for certain manufacturers.
In some cases, a manufacturer can buy power from an onsite steam cogeneration plant, supplemented by solar power and battery storage, that is cheaper and more reliable than power supplied by a utility’s electrical grid, Advani says. PE firms can help build the self-contained micro-grid and then sell the power to the manufacturer through a long-term contract. Besides lower and more reliable energy costs, and a more reliable energy source, the arrangement results in a reduced carbon footprint.
Warming temperatures and other effects of climate change are bound to drive more such PE investment opportunities, Advani says. “Those kinds of equations that we’re seeing, it’s not uniform across the market, but they are sprouting out and that is an economic decision. The sustainability is the byproduct.”