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In part one of this post we looked at the prevailing winds propelling the renewables trend – and how that’s creating a demand for infrastructure to support a greener future. But what does that mean specifically for investment approaches?
- There’s more diversity in renewables technology, prompting funds to look overseas to locations with increased space, as well as tight regulation
- Fossil-fuel businesses looking for carbon-neutral activities are driving competition for sought-after assets with predictable returns
- Fluctuating power prices and the likelihood of varying government support mean smart investors still need to watch how things evolve
1. Diversified portfolios
Wind turbines are one of the great ‘infranewables’ success stories. But don’t forget solar power. Even in overcast Britain, capacity increased from 5,488 megawatts (MW) in 2014 to 13,259MW in June 2019. In 2020, the first full calendar year without UK subsidies, analysis from Solar Media showed that 545MW of new solar PV capacity was added to the fleet (60% of it large-scale ground-based installations).
“We’re seeing other diversity in the technologies being rolled out, too,” says Angela Marchant, senior director in funds banking at RBS International. “Big subsidies helped get wind and solar off the ground; now they’re established, the subsidy profile has changed. So new tech might well be supported in time. Hydrogen, for example, is less mature, so you need to build up your investment case much more carefully. Waste-to-energy is breaking through in a big way and still attracts subsidies – but the asset profile of an anaerobic digester is still very different to a solar farm.”
In addition to funds that set themselves an ESG (environmental, social and governance) remit that includes renewable power infrastructure, but doesn’t prevent asset diversification, many funds are also looking to diversify internationally. That approach – while maintaining the same rigorous investment standards – can help them handle regional fluctuations in power prices, localised risks and availability of projects.
“Not every location has the regulatory conditions right for major infrastructure, especially in Europe,” confirms Roeland Borsboom, EPC director of offshore wind specialist Ventolines. “And, globally, space is often less of an issue than in the crowded North Sea.”
One commonly cited example is the Saudi Arabia National Renewable Energy Program, in which empty desert is being used for giant solar farms. (The scale is so vast that power from some of these projects will be incredibly low cost – one other factor private investment funds must consider.) Another example is Taiwan, which has relatively empty upland regions, and may see its cumulative installed solar grow from approximately 4.3 gigawatts (GW) at the end of 2019 to 20 GW at the end of 2025, according to market research firm GlobalData.
2. Competition for assets
New infrastructure projects create capital deployment opportunities, then, but there is also a lot of money looking to get into long-term assets with predictable returns. Borsboom is now at Ventolines – but until March he was CEO of Blauwwind, an offshore wind joint venture now supplying 731MW of power, backed by his former employer Shell.
“When I joined [in 2018], financing of the Blauwwind project was already under way,” he recalls. “We were looking for €1bn in loans and it surprised me that it was a borrower’s market. We had 30 banks bidding for the business. We’d issued a prospectus with an indication of target rates, and found that some of the banks were coming in below that benchmark to win the business.”
“The global objective to cut carbon emissions and the disruptions of lockdown also show why renewables infrastructure can be attractive – they’re less vulnerable to disruption”
Angela Marchant, Senior Director, Institutional Banking, RBS International
Fossil-fuel businesses eager to shift into carbon-neutral activities also intensifies the competition for assets. These strategic buyers of infrastructure pile on the pricing pressure – and given recent regulatory and even legal pressure for the oil majors to drive towards carbon neutrality (which many are publicly leaning into), competition for assets will increase.
This is likely to be more keenly felt as the Covid pandemic recedes. Jonathan Dames, who is a partner at law firm CMS, specialising in infrastructure deals, says even with all the activity during the past 18 months or so, things slowed a little: “Terms have tightened, and there’s more appetite for larger club deals – which means you’re moving at the speed of the slowest bank. There’s also been a big demand for additional liquidity through the pandemic, not least because some funds have been delaying exits, nudging up demand for fresh capital.
“But a return to a more normal economic outlook should see more funds returning,” he continues. “We might expect more private equity fund growth, too, which could trigger more leveraged loans, given low-interest rates.” That means investment discipline will be essential, especially if new project green lights are slow to flash thanks to planning hurdles or resource and skills constraints.
Funds able to move fast, therefore, could gain a competitive advantage in winning sought-after assets. “We support renewables funds, both listed and private, with RCF finance to ensure they can make quick investments ahead of drawing down LP funds or issuing new equity,” says RBS International’s Marchant. “Essentially, short-term financing means they don’t need to raise equity until it’s needed.”
3. Returns profiles will evolve
Investors also need to watch the changing economics of renewables infrastructure. The evolution of wind and solar subsidies illustrates the point. The UK government said in 2015 most of them would be phased out, only to announce new subsidies in contracts for onshore wind being assigned at the end of 2021.
The subsidies are also designed to account for the fact power prices fluctuate. We know demand will grow for electricity as electric vehicles (EVs), for example, become the norm; but price-per-kilowatt is still subject to the laws of supply and demand – which has been hard to forecast during the pandemic. And the huge renewables capacity coming online is also tending to push down the contracted price – in some cases dramatically.
That’s often a bigger factor for fossil-fuel generators on the grid, with their higher operating costs. And it means investors in renewables still have a big advantage over fossil fuel infrastructure when it comes to the predictability of returns.
“You’re talking about a commercial rationale for energy projects based on an economic life of 25 years,” says Ventolines’ Borsboom. “Then you can look at the engineering challenges and see whether you can extend its life meaningfully. The big difference between hydrocarbon projects and wind energy, of course, is that an oil deposit will eventually run out regardless of how well you maintain the platform over it. The wind won’t!”
For many big investors, particularly pension funds, the ideal is a low-risk, steady yield with a predictable returns profile – matched well to their liabilities. While other forms of infrastructure – for instance demand based assets – offer limited or unpredictable income streams, renewable power generation will always find a commercial market and cash flow.
But those fluctuating power prices and the likelihood of varying government support mean smart investors still need to watch how things evolve. “Infrastructure is rarely going to deliver the highest returns, but the stability of earnings is a huge factor for many investors,” says Marchant. “The global objective to cut carbon emissions and the disruptions of lockdown also show why renewables infrastructure can be attractive – they’re less vulnerable to disruption.”
4. Play the long game
Infrastructure is by definition made up of long-term assets. And renewables have a shelf life much longer than most energy assets – not for nothing are they called ‘sustainable’. So rapid portfolio turnover starts to look less attractive. Sticking with investments can even help with deal origination.
We spoke to one fund manager who pointed out that infrastructure is a different play to big-ticket private equity (with its five-year churn) or sector- or asset class-focused cyclical investment patterns in the public markets.
A project that makes sense in year two more than likely makes sense in year 20 – and when experienced infrastructure builders and operators look for fresh investment, they’ll often gravitate towards the steadfast funds they know will help them minimise fuss and reduce lifetime cost of capital.
Infrastructure investing, in general, benefits from changes to society – the need for new public transport, upgraded cell towers, bigger datacentres and charging infrastructure for soon-to-be-dominant EVs. Renewables, in particular, are a crucial plank in the very survival of the human ecosystem. “We’re certainly expecting to see an expansion of investment in renewables infrastructure,” concludes Marchant. “NatWest Group itself has made some big commitments here – and this is just the start.”