Renewables sector has transformed into a diverse and highly competitive asset class
Appetite for renewable energy infrastructure has been extremely strong, buoyed by ESG agendas as well as broader demand for infrastructure as an asset class.
The Covid-19 crisis threw a spotlight on renewables, with energy price volatility highlighting the sensitivity of renewable energy assets to merchant power prices while, at the same time, reduced energy consumption provided a glimpse into a future where renewables represent a greater proportion of global power generation.
Asset managers in renewable energy infrastructure – an increasingly numerous group with over 65 strategies now available – have not reduced return expectations amid today’s more competitive climate. Instead, the strategies available to investors have evolved substantially, with key trends including greater exposure to development risk, use of less conventional technologies, investing in new geographies and greater specialisation.
These are the key findings from bfinance’s new report, ‘Renewable Energy Infrastructure: Lessons from Manager Selection'.
According to the report, demand for renewable energy infrastructure has continued to rise with investors driven by ESG related priorities or drawn by the opportunity associated with the energy transition. A growing number of institutional asset owners are seeking ESG-related ‘thematic investments’ and/or ‘impact investments’ that explicitly aim to deliver positive non-financial outcomes. bfinance data shows that 34 per cent of investors in real assets (infrastructure and real estate) are involved in thematic investing, with a further 20 per cent considering doing so.
The report touches upon the trend among asset owners towards assessing portfolio carbon emissions and creating targets around reducing those emissions – a practice that can support demand for carbon-offsetting strategies such as renewable energy infrastructure. Recent data from bfinance shows that 46 per cent of asset owners globally are now assessing portfolio carbon emissions, versus just 13 per cent three years ago, and a further third are “actively considering” doing so.
bfinance's report highlights the considerable growth in the number of funds available to investors in renewable energy infrastructure, with more than 65 strategies fundraising as of early-2021 compared with approximately 50 in 2019. Strategies are classified in a variety of ways including by geography, where Europe remains the most popular region, and by sector focus where the report notes a rising number of strategies now focused on ´energy transition´. Offerings also be classified by overall risk profile – ‘Commoditised’ strategies with very well-established technologies and low development risk at one end of the spectrum; ‘Frontier’ strategies at the other.
The report highlights that due to a general reduction in the expected returns, particularly for conventional technologies in new markets, managers have been evolving their strategies to remain attractive. There is an increasing trend of managers prepared to enter projects during the development phase. Some managers are expanding the geographical remit, such as adding Central and Eastern Europe or developed Asia. Many are incorporating newer technologies, such as offshore wind, rather than focusing purely on the more conventional sectors of onshore wind, solar and hydro. bfinance´s report also notes a growing number of strategies targeting less-well established themes associated with the energy transition, such as smart meters, electric vehicle charging or grid stability projects. A notable emerging trend is the use of batteries paired with renewable energy generation projects.
According to the report, as greenfield investment becomes mainstream, it is important to distinguish between construction risk and development risk. Renewables differ significantly from other types of infrastructure investment in this regard: construction periods in mainstream infrastructure can often be longer than the development phase, whereas the construction lead-time for conventional renewable technologies is now relatively short. As such, construction premia have fallen considerably – particularly in Western Europe, where the difference between operational projects and those that are ‘shovel-ready’ translates to a premium of about 25-50 bps for solar and 50-150bps for onshore wind.
Although all risks should be handled with care, the report highlights that it is worth paying particular attention to the subject of how exposed investors are to merchant power price risk. With the decline of subsidy-led economics in renewable energy generation, managers now often point to corporate Power Purchase Agreements (PPAs) as the secure foundation for revenues but not all PPAs are created equal.
While ESG standards are generally improving in this asset class, the report does note differentiation between managers who rest on the argument that renewables represent a visible form of ESG in action versus those who are more committed to the broader ESG picture. The authors point towards asset managers that talk about their ESG capability but have no ESG sections in their Investment Committee papers, and even managers receiving ESG-related industry awards who have been found lacking when it comes to ESG integration in their investment process. Careful analysis is needed to distinguish between substance and style.
Anish Butani, Senior Director at Private Markets at bfinance, says: “Although renewables seem to be the way forward for global energy production, we are now entering a new phase for the emergent asset class of renewable energy infrastructure. The economics of this asset class are fundamentally changing with the overall withdrawal of subsidies and the development of the technologies. With more competition than ever, both from a fundraising perspective and an investment perspective, managers are having to be creative and adapt to the new climate.”