Q&A - Kerogen Capital: Spotlight on geothermal, biofuels and nuclear

Established in 2007, Kerogen Capital is an independent private equity fund manager focused on the international energy sector. Since its inception, Kerogen has raised over $2 billion (£1.5bn €1.8bn) in private equity and co-investment funds.

Having acquired GE Equity Asia Pacific (the in-house investment arm of General Electric), Kerogen Capital established CelerateX, a dedicated platform through which the firm's energy transition and decarbonisation investments are facilitated.

inspiratia speaks to Jason Cheng, chief executive officer at Kerogen Capital and CelerateX.

Can you provide an overview of Kerogen Capital's role within the renewable energy sector and specify the sectors within renewables the firm is particularly interested in?

We are energy specialists. In the renewables and wider sustainability sector, we focus on green baseload, renewable fuels, industrial decarbonisation, and enablers including, the energy transition supply chain. Particular sectors of focus currently include geothermal, biofuels, nuclear, energy storage and the wider supply chain.

The team has been involved in renewable energy for over three decades, and we have seen many trends within the energy value chain occurring during that time. The energy transition requires a lot of change and innovation, as well as deep sector knowledge of how things work today. In our role as specialists, we can get comfortable investing in areas where generalist capital struggles. A big part of our strategy is to focus on scaling de-risked technologies that can have a high impact on decarbonisation. De-risked technologies are solutions which have been commercially deployed already. So, we are not taking on binary technological risk in our investments.

Our role is to help scale these technologies and solutions and, in doing so, generate returns for our investors. We look at areas which have typically been overlooked due to a lack of expertise in the market. An example of this is green baseload power.

In your view, what distinguishes geothermal investments from solar and wind investments? Why the increasing focus on geothermal?

Firstly, I think, since the crisis in Ukraine, energy security is at the top of most government and corporate agendas, and the energy transition means decarbonising heat as well as electricity. Traditionally, natural gas has played the biggest role in heat generation in Europe.

A combination of energy security and energy transition efforts have created much more demand for geothermal today, especially in Europe.

Secondly, there is a lot of capital chasing projects in wind and solar. Hence, we feel returns have compressed, competition is high, and barriers to entry are low. In our view, geothermal does not have these issues.

In addition, compared to solar and wind, geothermal requires significantly less land use. In a population-dense region like Europe, land use has become increasingly important. As a form of green baseload it has an important role to play, particularly in Europe, to diversify and de-risk the energy mix.

Could you share your thoughts on both the prospects and challenges associated with such investments?

One of the prospects is the projected growth in the industry. Europe and the UK already possess abundant geothermal resources, fulfilling the key requirement with the availability of this natural resource.

The geothermal industry is currently at a growth inflexion point and is scaling rapidly. For example, the Netherlands geothermal master plan aims to grow the number of projects from about 30 today, to 175 by 2030, to 700 by 2050. We are seeing a very rapid rate of scaling, which is another attraction for us.

The other factor is that the decarbonisation of heat, as well as domestic energy security, is now firmly on the agenda for governments and corporates, particularly since the crisis in Ukraine. Geothermal can play a key role here. Again, in the Netherlands, they are targeting 25% of district heating to be geothermal.

There is another potential benefit – we are seeing high levels of lithium concentration in the geothermal brine in certain locations. Therefore, there is also the potential to create an independent battery supply chain within those countries, including the UK, France and Germany. This is a significant added potential benefit for investors within the opportunity set.

Challenges of geothermal energy include the requirement of geological technical expertise to develop new projects, which is lacking in the wider renewables industry, and the higher upfront capital costs.

With the increased interest post-CfD in the UK, can you provide insights into Kerogen Capital's geothermal investments? How do you identify suitable investments?

In the UK, we have provided financial support to Geothermal Engineering Limited for their first three geothermal projects in Cornwall. The projects will produce heat and power, and we are also trialling green lithium production. This is the first deep geothermal project in the UK. We were awarded three CfDs in the UK government's AR5 last year in 2023. We have provided capital to bring the first project, United Downs, into operation, and it is expected to be connected to the grid by the end of this year [2024].

In terms of our criteria, the first thing we look at is the regulatory framework. There should generally be a favourable or well-developed regulatory framework for geothermal to enable the rapid scaling of the industry.

Secondly, we focus on low technical risk. We do not take exploration risk, but development stage risk, so that there is not binary risk for the projects that we are investing in.

The third thing we look for is a high-quality team with strong operating expertise, technical and development skills.

Lastly, this is very much an area where there is potential for building scale through a mid-market aggregation of a range of distributed projects.

What are the regions you are currently looking at?

We have a global remit, not just for geothermal, but across all our verticals. We look at different parts of the value chain and different geographies. Within geothermal in particular, we are focused on Europe. We are currently active in the UK, Netherlands, Norway, Germany, Italy, Croatia, Turkey, and Iceland.

We are actively looking at North America – the US and Canada.

In these uncertain macroeconomic conditions, how has the investor base viewed the geothermal market? Have there been challenges raising funds?

Our investor base has been very positive around geothermal for several reasons. Firstly, because geothermal is differentiated from the "core" infrastructure exposures investors may typically have in their portfolio, which tends to be a lot of onshore solar and wind. Investors are looking for something additive to their portfolios.

Secondly, returns are less compressed than those sectors in core renewables. There has been a lot less capital in the space historically, with higher entry barriers.

Thirdly, geothermal plays to our track record and skill base and, therefore, is consistent with what our investors expect us to do.

And finally, geothermal has a lot of characteristics that are attractive to investors, such as long-term (typically between 10-15 years) contracted revenue, and such as CfDs with inflation linkage.

How does Kerogen Capital approach risk management in the context of renewable energy investments?

Through multiple cycles, we have developed a comprehensive risk management approach. We aim to construct a portfolio where there is a low correlation between the different types of risks that we are taking based on different themes, different geographies and different risk types.

As a private equity investor, we are active stewards of our investments. Our role is to identify and manage specific risks or arbitrage risks where we see the perceived risk is higher than it may be in reality.

For example, in geothermal, we have done a lot of work in the subsurface within traditional energy, and our Investment Committee has regularly opined on decisions related to subsurface risk. With our expertise and track record, we are better able to understand and manage that risk compared to, say, a manager who has not had that experience and, therefore, usually perceives the risk to be much higher.

The approach we take is a very active appreciation of the risks, knowing the risks that we want to take, and then being able to leverage our expertise around those particular risks.

The risks include regulatory risks associated with planning and permitting, as well as in the incentives and revenue support on offer. There are also risks relating to subsurface, drilling and project execution, the offtake/customer base, and grid connections.

To deal with the risks, the asset quality, the management team and the right capital structure are critically important to support that business going forward.

Could you offer insights into CelerateX, the platform through which Kerogen Capital facilitates its investments in the renewables sector?

We launched the platform CerelateX in 2021 after we committed to net-zero in 2020. The platform was created having acquired GE Equity Asia Pacific (the in-house investment arm of General Electric).

We believe that to reach net-zero, you cannot simply add more renewables – although that is critically important. To achieve net-zero, we need economy-wide decarbonisation across a range of industries, including many new solutions, new technologies and new business models. With this in mind, we decided to create a dedicated platform, CerelateX.

We decided to incorporate additional skill sets to be able to cover a wider range of decarbonisation opportunities. We acquired the former General Electric private equity business, which added deep sector expertise in areas like manufacturing and supply chain, nuclear, aviation and renewable energy as well as an operational value-add tool kit that had proven experience in building world-class businesses.

Our mandate is to look for industries or companies with de-risked technologies and business models that can scale. Through scaling these businesses, we can generate returns. To scale businesses, they generally need partnerships with both sources of capital and operational expertise in areas such as: growing revenues, financing projects, expanding through acquisition, and entering new international markets. That is the strategy behind the platform.

Given GE's experience, you also look to invest in the nuclear sector. How is the European market looking?

We are very excited about nuclear. There have been very few new builds over the past decade, so it is an area that investors have had less familiarity with more recently. It requires a lot of technical and industry expertise to invest. But that also means, for us, that there is less competition. Nuclear has been around for about 70 years, and it provides around 10% of the global electricity mix, so it is quite large and established. Nuclear will be a key technology to achieve net-zero, as it provides green baseload power. We saw 22 countries commit to triple nuclear power at COP28 at the end of last year.

Small modular reactors (SMR) are a disruptive solution, which may overcome many of the concerns around traditional nuclear. I think many governments have grasped this opportunity very quickly, and we foresee that SMRs are likely to drive a lot of the growth in nuclear going forward.

With regards to how SMRs differ in contrast to the traditional nuclear sector, modularity and simplification are the breakthroughs. They have the potential to address some of those issues around cost overruns, the time it takes to build nuclear developments, and further increase safety. SMRs open up quite a wide range of new use cases, not only in replacing existing reactors and coal, but also applications like industrial parks, hydrogen, desalination, distributed energy or off-grid solutions.

The challenges, I think, are likely around rebuilding the supply chain, including fuels, given that nuclear has not had a lot of growth in the past decade. As the sector now turns to growth, we need to see the supply chain ramp up, and there is a lot of anticipation around that.

And how about biofuels? How is the European market looking in that sector?

Sustainable aviation fuel (SAF) is the only viable solution in the short to medium term to decarbonise aviation. It is a direct drop-in solution using existing aircraft and infrastructure. I think any innovation such as electric or hydrogen will take some time, given the length of time for regulatory approvals and the required changes to infrastructure.

At the moment, SAF is experiencing very rapid demand growth due to government mandates, particularly in the EU. The world is currently producing around 0.2% of SAF to fossil fuels. The aim is to get to 6% blending by 2030, and up to 70% by 2050. So there is explosive growth in demand, and there is very little supply at the moment. This generally makes for an attractive opportunity. Europe has the most advanced and comprehensive regulatory framework for this – and that is notwithstanding that airlines globally are making even more aggressive commitments than governments, often targeting 10% SAF by 2030. It is a very exciting sector to be in at the moment.

The challenge in the short term is that there is not enough production. So, scaling the production and supply will be critical to meet that demand. Over the longer term, the feedstock availability for the dominant current technology, the Hydrotreated Esters and Fatty Acids (HEFA) technology, is ultimately limited. The EU is very clear about what is permissible as a waste feedstock. The quantity of HEFA feedstock is not going to be sufficient for the entire aviation fuel market to be decarbonised. Therefore, we will need alternative technologies and pathways. In the longer term, the challenge is to develop these new technologies and pathways to fill the demand gap.