Investment Opportunities: Hope for a full pipeline
Will the COP21 global climate talks in Paris next month lead to a pipeline of renewable energy infrastructure investment opportunities? Carlo Svaluto Moreolo reports
There is palpable excitement, and some apprehension, in the investor community ahead of this month’s meeting of the UN Climate Change Convention, known as COP21. The event, successful or not, will go down in history.
Investors involved in the clean energy sector, and those yet to become so, will be assessing whether the outcome of the talks is likely to make investment in the sector more profitable.
“The expectations are clearly high for this conference. I think we can expect that the role of renewable energy in the energy mix is to increase on a global scale,” says Oldrik Verloop, co-head of hydro investments at renewable energy-focused asset manager Aquila Capital.
If countries pledge to reduce emissions further at the meeting, and words are followed by action at national level, the supply of clean energy infrastructure could be propped up by further domestic subsidies.
Thomas Deser, a senior portfolio manager at Frankfurt-based asset manager Union Investment, says the Paris summit could trigger further investment in clean energy, but only if it is accompanied by announcements on current or future subsidy schemes.
Deser is a buy-side analyst of utilities and renewable energy companies, and runs an equity fund focusing on pure-play companies whose businesses are related to climate change. “If the outcome of the summit concerns only commitments to more environmental protection, it will hardly trigger more investment in the energy sector,” he says.
“But if governments use that platform to announce an extension of running subsidy programmes, such as the production tax credit in the US, the outcome may be different.”
Deser sounds a note of caution, explaining that the capacity for national subsidies is and will be restricted by individual countries’ economic situations. Given worries about global growth, investors may have to adopt a wait-and-see attitude.
Yet the recent spate of investment activity in the clean energy sector suggests the market might already be ‘pricing in’ a positive outcome to the agreement.
On a global level, institutional investors, such as ESG-focused Nordic pension funds, are taking advantage of banks’ reduced appetite for project finance and becoming both lenders and equity providers to clean energy projects.
And rising activity suggests that a surge in the supply of projects, spurred by a positive outcome to the Paris talks, will be met by higher demand.
Clearly, many factors other than multilateral policy are at play in supply and demand for clean energy projects. First, technology plays an important role, in the sense that renewable energy competes against traditional forms of power generation that are more efficient – if one discounts the (future) cost of polluting the environment.
Although carbon is still priced in inconsistently worldwide, it is clear that the opportunity cost of developing clean energy capacity is decreasing as technology, from wind turbines to solar power, becomes more efficient.
But that cost is negatively affected by the recent collapse in the oil price. Mårten Lindeborg, recently appointed as CIO of Swedish buffer fund AP3, says: “The developments we have seen in the price of solar panels are encouraging, to the point that it makes economic sense to invest in solar energy. But that has to be compared to the fall in oil prices.”
Union’s Deser explains there are also some missing pieces to the technological puzzle, one of the largest being electricity storage. He says: “Electricity storage acts as an alternative to conventional backup power, for those days when the sun does not shine and wind is flat. This is a hot topic in the sector at the moment, but viable technology is years away from investors’ point of view.”
Regulation is another important factor influencing the supply of projects. Hard lessons are being learned about the impact of regulatory changes on revenues and cashflows, and investors will be looking for signs that countries’ commitments in Paris will bring stability to regulatory frameworks.
Gerry Jennings, global head of infrastructure at AllianceBernstein, says the presence of high regulatory risk leads investors to have a “polarised view” of clean energy, meaning they are either committed to it or uninterested.
“There is a level of nervousness by a large part of the institutional investment community,” Jennings says. “If you turn the clock back 10 years, one of the attractions was favourable regulation. It gave people comfort around the asset. Today regulation is top of the risk areas to understand, even in the developed economies. So there has been a perverse mechanism, whereby the element that tied people in is now the one that turns people off.”
Notable examples of changes in regulation come from Spain, which made a u-turn on solar power subsidies several years ago. Germany is also moving towards a more market-based method of pricing wind power subsidies. Other countries, such as Italy and US, are debating whether to reduce subsidies substantially.
To offset this, AllianceBernstein focuses on brownfield assets, where Jennings says it is easier to estimate regulatory risk and, in turn, project revenues. But he also says the firm sees “a steady, healthy flow” of projects, and investors’ interest is not an issue. “There is unquestionably a need and a desire to invest more in renewable energy,” he concludes.
A different issue, less often discussed, is even more political than subsidies, and has a potential to restrict the supply of clean energy projects, at least in Europe. To leverage on its commitments to increase renewable energy production, Europe needs to develop cross-border electricity transmission infrastructure.
Deser points out that further integration is paramount, because the revenues of energy producers are hit when supply exceeds demand in individual countries. In addition, the lack of cross-border transmission networks means excess supply of electricity cannot be channelled beyond national borders. This applies, for instance, to wind power in Germany.
Deser says: “Theoretically we should have an open European market for electricity. But the reality is governments do not want to give up control of their national markets. The political will to open these markets is lacking, because in many cases the revenues of quasi-state owned energy producers could be affected by competition from abroad.”
Aquila Capital’s Verloop does not see this as a hurdle, but rather as an element that should be part of the entire assessment of whether the demand of clean energy projects has a potential to increase.
“The more renewable infrastructure we build, the need to become interdependent increases,” says Verloop. “Therefore, we need to make sure that grids are connected with each other. We have to look at the entire value chain, and connection to grid is paramount for price assessments.”
It is clear that the outcome of the Paris summit will be important, but that the challenges will be at country level. As Verloop points out, the pace at which renewable energy production will increase depends on whether individual governments support the required regulatory frameworks.
But government may be swayed by the fact that a large part of the investor community is supportive of further investment in clean energy. Verloop concludes: “As seen in the speech by the Bank of England’s Mark Carney, the impact of climate change on investment portfolios is coming to the forefront. This is a further welcome step.”