Special Report ESG: Carbon Risk, Borderless potential

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Spurred on by the recent political turmoil in Ukraine, the European Commission has made energy security one of its key policies for the coming years. At the heart of this action is increasing the interconnectivity of national power networks across the continent, and tackling the issue of stranded energy – a surplus of power production in one member state that could be put to use in another.

The ability to increase interconnectivity 15% by 2030, one of the Commission’s aims, will hinge entirely on the availability of finance, an area where pension investors could prove useful. While there has been much talk of spurring on greater investment in infrastructure, tangible projects have yet to materialise, but given the right regulatory framework, a long-term asset part of a regulated utility should be appealing.

“The UK and Germany have very ambitious plans for investment in offshore windfarms and energy-grid structures over the next decade, and both countries have an urgent need for private capital,” notes Torben Möger Pedersen, chief executive of PensionDanmark.

He says better connectivity is “pivotal”, as it will allow the renewable energy produced in countries at the vanguard of the market – northern Europe, largely – to travel to central and southern European countries struggling with the low-carbon energy transition.

The labour-market fund is one of the few to be active in the burgeoning market, boasting that its 10%, DKK17bn (€2.2bn) allocation to green energy infrastructure, including power grids, would produce renewable energy equivalent to that consumed by its 640,000 pension scheme members. Others to invest in grids include Finland’s LocalTapiola and Keva and a number of the large Canadian pension schemes.

Möger Pedersen says his fund likes renewables because of the regulatory environment, such as power purchase agreements, feed-in tariffs and other agreements providing stable cashflows, a good replacement of income at a time when fixed-income markets offer ever-lower yields.

 “Geographically, our focus is the northwestern Europe and North America, where we feel the regulatory systems and the political culture are pro-investor,” he says.

He adds that for all its plans to succeed, the EU will need to ensure the regulatory environment remains stable, avoiding situations such as occurred in 2008 in Spain, where the government changed the rules surrounding feed-in tariffs for solar panels to the detriment of investors.

Interest will be driven further by energy networks sitting among the projects the Commission’s European Fund for Strategic Investments will help finance. The €315bn initiative is aided by guarantees to reduce the risk and assisted by a hub offering advice to smaller investors.

The Institutional Investors Group on Climate Change (IIGCC), which counts PensionDanmark, many of the largest Dutch schemes and the largest UK fund among its members, wholeheartedly endorses the Commission’s push to grow investment, especially in energy. 

“Scaling-up of investment through appropriate long-term policies will be key to making substantive progress towards an Energy Union,” it said in a policy paper released in December 2014.

According to a recent report complementing Commission president Jean-Claude Juncker’s cornerstone venture, nearly 250 grid investments are in need of €119bn in financing by 2020.

The report says that cross-border interconnections have been hampered by “relatively weak incentives” to deal with the complications involved in transnational coordination, planning and implementation of projects, but only proposes that existing remedies, including 2013’s trans-European energy networks (TEN-E) plan be emphasised once more.  

Donald MacDonald, chairman of the IIGCC and a trustee of the UK’s BT Pension Scheme, previously said that the “heavyweight” capital needed in the market was being deterred by the lack of framework, and it remains to be seen if the initiatives taken by the Commission will be sufficient to attract investment.

Other, smaller and localised initiatives may also have an impact, such as attempts by the Research Institute of the Finnish Economy (ETLA) to kick-start growth among smart-grid companies through the launch of a fund that would offer the investments packaged in a manner attractive to the country’s pensions mutuals.

Hanna Hiidenpalo, CIO at Finland’s €20bn Elo Mutual Pension Insurance, says the interest in energy efficiency is one worth pursuing for both investors and society as a whole. 

“Investments into networks are necessary to support de-centralised energy production such as small-scale rooftop solar,” she stresses.

Hiidenpalo has past experience as CIO of LocalTapiola, one of the investors that was part of a consortium that bought power distribution networks from Fortum for €2.5bn. The investment is now part of Elo’s portfolio, the mutual formed in 2014 after a merger between Tapiola and Pension Fennia.

Asked if investing in better connectivity is the best, or merely a pragmatic way to tackle carbon emissions, Hiidenpalo simply says that climate change is one of the “most important underlying trends” facing the mutual, and that the risk is addressed across the entire portfolio due to companies owned by Elo tackling emissions in their own way.

Möger Pedersen is blunter in his endorsement: “Without even taking the climate impact into account, we think that pension funds should be exploring these opportunities because the traditional sources of financing have dried-up significantly,” he argues. “Government budgets are stressed all over the world; utilities are trying to reduce their balance sheets in order to support their credit ratings; and banks are no longer making the same amount of project-financing available.”

The Energy Union investment story is one of the sudden confluence of many streams: heightened energy security concerns, the need to squeeze more efficiency from Europe’s sluggish economy, the drying-up of bank financing under new regulation and the thirst for yield from institutional investors. Its impact on the carbon footprints of the European economy and European investment portfolios would seem to be an added bonus. What must follow are the mechanisms to make this opportunity a practical reality for providers of capital.

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