07 Jul 2022
The march towards energy independence
The UK is aligning its zero carbon targets with a goal of weaning the nation off traditional oil and gas and diversifying its energy sources.
The government has set out its plans to strengthen the nation’s energy independence in the British Energy Security Strategy, which was published in April this year. The strategy included a series of targets that combine deployment of renewable energy sources with support for shorter-term oil and gas projects in the North Sea, which could see 95% of electricity being low carbon by 2030.
If this target seems ambitious, consider the huge recent changes in the composition of power generated in Britain. About 10 years ago, 40% of the nation’s power came from coal and barely 10% from renewables. Today, well over 40% comes from renewables.
The combination of newer technologies can solve the “energy trilemma” of security, affordability and sustainability, says Julian Critchlow, Advisory Partner at Bain & Company’s Energy & Carbon Transition Centre. “The UK has oscillated in the triangle between security of supply, sustainability, and affordability for the past four or five decades. Now the iteration around that triangle is starting to narrow down into a set of technologies that potentially offer the silver bullet of achieving all three at the same time.”
The government’s strategy is for offshore wind generation to deliver 50GW by 2030, and a potential five-fold increase in the current 14GW solar capacity by 2035. It also wants to see nuclear account for up to a quarter of projected electricity demand, hoping that small modular reactors can deliver faster and cheaper power than current large projects.
However, nuclear faces serious cost competition, given the rapid fall in the price of renewables over the past decade, says Simon Virley, UK Head of Energy and Natural Resources at KPMG. “The cost of offshore wind, for example, has fallen from about £130 per MWh 10 years ago to below £40 today,” he points out.
Generating electricity locally is the starting point to increasing Britain’s energy security, even though electricity accounts for about 20% of Britain’s total energy use, according to government figures.
Perhaps the biggest challenge is the heating sector: the Committee on Climate Change says that 85% of Britain’s homes currently run off gas boilers. “Getting them on to a low-carbon alternative, whether that’s a heat pump, district heating scheme, or potentially hydrogen in the longer term, is a huge challenge,” says Virley. “Hydrogen can be more suitable for industrial sites, but areas that aren’t on gas already are much more likely to go electric.”
Once the electricity system is decarbonised, much of the rest of the nation’s energy demand can be moved on to it, says Critchlow. “The biggest issue beyond power generation is transport – electrification of vehicles is an opportunity to transition that energy demand to zero emissions.”
This is why a core government strategy is decarbonising the grid as fast as possible. “About 40% of our energy use is in gaseous form, the majority of homes are on the gas system, and gas is used a lot in energy and power generation,” says Critchlow. “Electrifying with heat pumps would reduce dependence on gas. You could use batteries for short-term storage, but medium-term hydrogen could be an option, although again storage would need to be addressed.”
“One of the best ways of demonstrating environmentally friendly credentials is by investing in intrinsically green assets to show seriousness about the environmental impact of the company’s activities, while supporting the transition to greener and cleaner sources of energy”
Bryan Fashola, Director of Institutional Banking at RBS International
Assets that can improve Britain’s energy security should ideally form a part of all Fund Managers’ portfolios. All sectors and asset classes are affected by the rising cost of energy and its consequential impact on yield therefore, increased investment into supporting energy transition can help mitigate some of that impact while accelerating the journey towards energy independence. This could either take the form of direct asset investments or supporting portfolio companies to increase investment into energy-efficient technologies.
Vast amounts are at stake. Globally, an estimated $4 trillion annual investment in clean energy is needed by 2030 in order to reach net zero by 2050, according to the International Energy Agency. “That working capital will provide many opportunities for investment and returns over the next 30 years,” says Critchlow.
And then there is investor demand for a cleaner economy. “One of the best ways of demonstrating environmentally friendly credentials is by investing in intrinsically green assets to show seriousness about the environmental impact of the company’s activities, while supporting the transition to greener and cleaner sources of energy,” says Bryan Fashola, Director of Institutional Banking at RBS International.
One of the issues fund managers will consider with intermittent technologies such as wind and solar is storage, says Virley, who thinks green hydrogen will have a significant role to play here. “The excess renewable power that is generated at times when it’s windy or sunny can be converted using electrolysis into hydrogen and then stored for later use in transport, or in industrial or heating applications.”
Batteries are becoming increasingly important to the storage solution, says Fashola. “Battery storage helps bridge the sporadic nature of renewable power generation and mitigate some of the impact of that volatility. Batteries can be used for peaking; they can be used to shift energy so you charge low then discharge to meet demand. And they have a vital role to play in all levels of power use, from households to commercial and industrial sites, as well as grid and utility-scale energy storage.”
The multiple use cases for battery storage technology is certainly contributing to the increase in deal activity we are seeing in this space, with energy storage solutions growing considerably in recent years. “This is evidenced by the significant increase in battery storage projects in the UK alone, from about 16GW in 2021 to more than 32GW in 2022 – of which about 1.6GW consists of fully operational projects,” says Fashola.
This growth will continue to create opportunities in the medium term, with the evolving energy mix leading to a big shift in investment patterns in the industry.
Funds, particularly those in the infrastructure and renewables sector, have begun to expand their investment strategies to include battery storage assets, which is certainly a welcome development. By investing in storage assets, fund managers can benefit from the attractive returns associated with a sector in growth mode, while also demonstrating their green credentials to provide a positive double bottom line.
The transition is a global one, so funds have plenty of experience to draw on when assessing potential investments. Chile is one of the countries that is leading the way with its new solar and wind projects while Norway’s large hydropower reserves (accessible to Britain through the North Sea Link) mean the nation’s electricity supply is almost completely clean.
There are other challenges to consider. For example, in Britain, offshore wind generation is in the north but most of the power will be used in the central and southern areas, meaning successful investment depends on upgrading the grid. “Funds wanting to drive improved yield need to understand the risks involved and how they will impact costs and the bottom line,” says Fashola.
Funds have a crucial role to play in increasing energy security as significant custodians of capital, adds Fashola, and channeling that capital towards energy transition assets means they can support the march towards increased energy security. “By looking at peers who have been first movers, they can see the positive returns that diversification within their underlying asset base can provide, thus generating decent returns for investors while increasing the nation’s energy security and having a positive impact on the environment.”
Voluntary carbon offsets allow funds to offset unavoidable emissions by purchasing carbon credits delivered through projects that avoid greenhouse gases.
As alternative funds gain popularity, the sector is seeing the rapid rise and fall of funds, and higher levels of consolidation.
Welcome to Depositary Insights Summer 2022 edition which offers the latest thinking on regulatory and industry developments from NatWest TDS.