Chapter 1
Incentivizing private investors to do more in renewable energy
New investment models could help direct a greater share of capital into the sector.
There is growing interest in renewables investment from the private sector, particularly in the COVID-19 pandemic era. Large private investors, such as pension funds and insurers, are increasingly expected — by shareholders, governments and financial regulators — to operate with an eye on environmental, social and corporate governance (ESG) credentials.
Although many institutional investors have pledged to invest along low-carbon or environmental lines, research shows they could do more. According to the IRENA research, approximately 20% have invested indirectly through funds in renewables over the past two decades, while only 1% have invested directly in projects.
These direct and indirect investments totaled US$6b each in 2018, out of a possible US$87t managed by the group of investors IRENA analyzed. It pointed out that: “Such renewable investments represent a miniscule share of the capital held by the world’s institutional investors.”
A growing number of investors are now integrating ESG considerations into every investment case. This typically involves scoring a potential investment, using a best-in-class approach and based on ESG considerations relative to other companies in the same sector.
A perhaps more direct approach involves using positive screening solutions to actively invest in projects with a specific ESG objective, such as a renewable energy project. While such strategies are growing, allocations are not always as significant for the sector at present. For example, Amundi, Europe’s largest listed asset manager, has expanded its assets under management for environmental solutions from €10b ($US12b) in 2018 to €22b (US$26.4b) using this kind of approach, but had allocated €356b (US$428b) at the end of December 2020 under the first type of strategy.
For many institutional investors, engagement is preferable to divestment for all but the most polluting industries, such as thermal coal. It enables large investors to retain some power of influence, guiding capital to encourage a low-carbon transformation of the organizations in which they invest.
Another way in which capital is increasingly flowing from institutional investors to renewables is via engagement with energy companies that are pivoting from fossil fuels to lower-carbon strategies ahead of the energy transition. Growing numbers of financial firms are divesting from heavy-hitting emissions sectors, such as tar sands and thermal coal, but there is also a growing movement to engage with organizations to encourage the phase-out of fossil fuels in line with net-zero emissions targets.
In 2014, Norway’s US$1t Government Pension Fund Global decided to engage, rather than divest, to combat climate change. The largest pension fund in the world — Japan’s US$1.36t Government Pension Investment Fund — has also emphasized strongly to its asset managers the benefits of stewardship when discussing climate risk issues in recent years. This movement has reverberated throughout the market, with similar action from major asset managers, including BlackRock and L&G Investment Management.
For many institutional investors, engagement is preferable to divestment for all but the most polluting industries, such as thermal coal. It enables large investors to retain some power of influence, guiding capital to encourage a low-carbon transformation of the organizations in which they invest.
Chapter 2
Taking the strain out of finding and accessing projects
More information on pipelines of relevant investments would make planning easier for investors.
Even as capital allocations from institutional investors to the sustainability sector grow, challenges remain for this type of investor to participate in renewables financing in particular.
“There is a surplus of demand to invest versus opportunities,” says Gareth Mee, Partner, Sustainable Finance Consulting, at Ernst & Young LLP. European investors often encounter difficulties relating to long-term planning, he adds, because there is insufficient information available about pipelines of relevant investments that are likely to be supported by governments.
“For example, if you look at the UK infrastructure development plan for all of the projects the UK Government is planning to finance over the next 10 years, there is often insufficient information about start dates, debt versus equity structures, likely terms and so on. So it’s very hard for an insurer to plan to invest in a specific project at a future date,” Mee explains.
Similarly, when considering individual investment targets, current reporting and disclosure requirements and capabilities leave a lot to be desired, creating a level of regulatory overhead for those involved in these markets. “In Europe, for example, insurance companies can benefit significantly from demonstrating that their investments meet certain regulatory criteria,” Mee says. “But the level of disclosures required to help insurers understand whether they meet those regulations are quite onerous. It’s become standard for the funds that raise money to understand those conditions so they can help the borrowers — that is, the projects — to provide that information.”
For a developer attempting to enter into a bilateral agreement with an insurance company, however, it could be quite a formidable undertaking to provide this information at the outset of a deal.
Amundi’s Chief Responsible Investment Officer Elodie Laugel highlights the same challenges around evaluating a renewable energy company or project for investors who want to invest directly: “The financial markets offer a lot of listed companies and issuances, but — in the renewables segment — part of the job for us is also developing the ability to source projects; we raise a lot of environmental finance, but the market is not equipped to channel this into projects.”
To address this issue, Amundi has established partnerships with organizations including the World Bank’s International Finance Corporation, the European Investment Bank, and the Asian Infrastructure Investment Bank — public entities that help to source projects. This has been particularly useful for less developed or more illiquid renewables markets in which finding the necessary information about projects to establish robust financial contracts can be even more difficult. “They can source the project and ignite the offer, so that we can bring the capital of our investors,” Laugel explains.
Chapter 3
Nuanced solutions for greater private sector involvement
As the energy market transitions, new tools are needed to support institutional investors.
Institutional investor needs tend to tally with the benefits of renewable energy infrastructure investments, including asset diversification, and strong and stable long-term cash flows. However, they also require risk mitigation tools and structured finance mechanisms that are tailored specifically to the renewables sector. Flexible options that work across many different types of market and market maturity will give larger investors access to bigger, or more aggregated, investment opportunities.
New tools are certainly needed to support more investment by institutional investors in the global renewable energy sector as the market looks toward the energy transition. These approaches must be increasingly nuanced, however, to provide the returns needed to satisfy growing institutional investor interest in renewables.
Vimal Vallabh, Global Head of Energy at infrastructure investment management firm Morrison & Co, says that, although institutional investors are increasingly interested in renewables, the sector has struggled to meet their return expectations.
“There seemed to be more capital than there were high-quality projects in supply in recent years, and that, effectively, is what made us go into development,” Vallabh says of Morrison & Co, which operates several international renewable energy development platforms. “The institutions wanted to invest in renewable generation given the energy transition, but they did not feel the returns were good, relative to the rest of the infrastructure spectrum.”
When they could not get the required returns from contracted renewables, many institutional investors wanted to move up the risk curve into development, Vallabh explains. To aid this trend, Morrison & Co developed a bottom-up approach to comparative risk analysis, to better assess renewables investments relative to other assets.
“Investors talk about renewables on a relative basis across asset classes, but it’s difficult to compare returns when the risks can be inherently different,” Vallabh continues. “For example, how can you compare volume risk on a renewables offtake contract with that of a data center? There are key stages to the development cycle of a renewables project and, if you put them side by side with a data center, they are not comparable.”
Investors talk about renewables on a relative basis across asset classes, but it’s difficult to compare returns when the risks can be inherently different.
Morrison & Co’s approach is focused, instead, on assessing risk versus return within the same asset class but across geographies, rather than comparing investments across asset classes. “So, I understand the risks of an Australasian wind farm development and operations, but how does that compare with a different market with the same asset — Texas versus New South Wales or Andalusia, for example?” Vallabh explains. “It’s a bottom-up, purist approach to comparative risk analysis.”
Starting in 2016, Morrison & Co applied this model to the North American market through a platform called Longroad Energy, and has since established similar platforms in the European and Australasian renewables markets, with entry into Asia on the horizon.
Others in the market have also identified the need to tailor renewable energy investment offerings to suit specific institutional needs, particularly as renewables markets around the world mature.
Previous conduits, such as yieldcos and infrastructure funds, have provided a point of access for investors without necessarily requiring an in-depth understanding of the specifics of the sector. With the energy sector at a tipping point in relation to the swing toward low-carbon production, investors now require “deeper domain expertise” than before, according to Bob Psaradellis, Chief Executive Officer of Renewable Power Capital (RPC), a UK-based platform launched in December 2020 to invest in the European solar, wind and battery storage markets. It is majority owned by the Canada Pension Plan Investment Board (CPP Investments).
“Previously, the barriers to entry were very low for investors … but everyone in our industry now has one thing in common: the need to sell electrons,” Psaradellis says. “And we haven’t had to think very hard about how we sell those electrons until now.”
As the main shareholder in RPC, CPP Investments expects to deploy a “meaningful” amount of capital at good, risk-adjusted returns through the platform, according to Psaradellis. RPC sits within the newly established Sustainable Energy Group at CPP Investments, which combines the organization’s expertise in renewables, conventional energy, and new technology and service solutions, and has approximately CA$18b (US$14b) in assets. In January 2021, it committed up to €245m (US$290m) to RPC in support of the latter's first European renewables investment – a 171MW capacity portfolio of wind projects in Finland.
RPC plans to invest right across the value chain for wind and solar, from development to construction and operations. It will handle power purchase agreements (PPAs) and project financing rather than relying on developers.
“We have built an analytical framework to help guide our decisions about when we contract, for how much, and for how long — and we can look at the whole range of options, from short-term hedges to long-term corporate PPAs, to being fully merchant," Psaradellis explains. "We will make those decisions based on signals we receive at the time.”
It is increasingly difficult to satisfy stakeholders’ appetite for risk-adjusted returns as the renewable energy market begins to mature in many parts of the world. As we emerge from the worst of the COVID-19 pandemic, it will be mutually beneficial to expand the participation of large private investors in the renewables sector.
RPC Chairman Shaun Kingsbury says the platform will help CPP Investments access pockets of value in the market by using flexible capital, which is the key differentiating factor in RPC’s approach. “We can create value by being able to play in all parts of the market without debt or a PPA attached," Kingsbury adds. "Others need to have more pieces of the puzzle in place before they can invest. They have to raise capital with a certain flavor, and cluster their results around a certain number — the number they promised their investors. We’re quite happy making higher returns and taking more risk, or lower returns with a little less risk, as long as we are doing something that makes the right risk-adjusted return for investors.”
Satisfying stakeholders’ appetite for risk-adjusted returns has become increasingly difficult as the renewable energy market has started to mature in many parts of the world. However, as the market emerges from the worst of the COVID-19 pandemic, it will be mutually beneficial to expand the participation of large private investors in the renewables sector.
If the sector is to continue to attract more finance, particularly from large institutional investors, market participants need to support the development of a more nuanced approach to renewable energy investment. New models are starting to help investors locate opportunities that satisfy their risk and return expectations by tackling issues such as long-term merchant risk. This will enable institutional investors to satisfy stakeholders’ growing climate risk concerns by providing the kind of “patient capital” required to support future renewable energy development and operations.
Summary
There is growing awareness among investors of all sizes of the need to consider the climate crisis and the energy transition when deploying capital. As a result, interest in renewable energy development has risen. Increasing numbers of institutional investors have pledged to incorporate climate risk concerns into their decision-making processes, resulting in new models of investment to locate opportunities that satisfy their risk and return expectations.
