abrdn: Picking up the pace of transition

There is still a major investment gap if we are to reach net zero by 2050. However, that creates significant opportunities for investors with along-term view of value creation, says abrdn’s Ruairi Revell.

This article is sponsored by abrdn

The importance of infrastructure services makes them a vital element of the energy transition story. So, as the world seeks to accelerate decarbonisation, how is the infrastructure sector placed to support this imperative?

How can governments, regulators and standard setters create the right conditions to mobilise sufficient capital to close the investment gap that is required to support net zero by 2050? Ruairi Revell, head of sustainability for core infrastructure at abrdn, shares his thoughts.

Where are we in the energy transition today?

Ruairi Revell
Ruairi Revell

We are at a point where there is significant momentum behind the energy transition. There is a clear understanding today that net-zero economies are only possible by 2050 if we can achieve major improvements in the emissions intensity of the infrastructure services we all rely on. And I say services because the most important function of infrastructure in the transition is to enable businesses and individuals to decarbonise their own activities.

In some sectors, such as energy and waste management, we have seen impressive progress on decarbonisation – even against the challenging backdrop of increasing costs and uncertainty that we faced in 2022. A recent report by energy think-tank Ember highlighted that clean tech investment rose by 31 percent last year, annual solar deployment in the EU was up 47 percent to more than 40GW, with a prediction that it could be as high as 50GW in 2023, and there were three million unit sales of heat pumps, making 2022 a record year.

All of this is highly encouraging and suggests we have passed a tipping point. However, there is still a significant infrastructure investment gap that needs to addressed.

In the EU alone, for example, we will need at least €360 billion of extra investment annually in infrastructure to 2030 – that is over and above the current annual level – if we are to deliver net zero by 2050. That requires a step change in in collaboration between policymakers and investors.

Last year, the energy trilemma came back into sharp focus. The situation has flipped from the sustainability element of the trilemma being at a premium to energy security and affordability being harder to achieve. Yet thankfully, clean energy is also now increasingly affordable and supportive of energy security. So, despite some short-term challenges, we think that a greater emphasis on energy security will accelerate the transition.

And where does energy transition fit within your investment and asset management processes?

The energy transition is critical to the way we think about long-term value for new investments and as part of asset management for existing investments. We believe that assets that are well aligned with the transition, or that can be repositioned to be so, will deliver stronger long-term value than those that face the risk of functional obsolescence.

We are a long-term investor in mid-market assets where we are either a majority shareholder or significant minority partner. We always have board representation because we want to be in a position to influence outcomes and drive change. Because of our long-term view we assess each asset’s role in the low-carbon transition so we can help position them to benefit from value creation opportunities associated with this.

Examples in our portfolio include operational renewables in Poland and Norway, heat networks fed by biomass and energy from waste in Finland and rolling stock investments to displace historic diesel fleets. We have also invested in a Finnish utility, Auris, which aims to steadily phase out fossil gas from its supply mix. It is expanding into geothermal and is building its technology-agnostic energy services business.

What are the current challenges for infrastructure investors in the energy transition?

One challenge is the shift we saw in 2022 in the energy transition’s dynamics. The year marked the end of cheap financing and decreasing project costs. It also saw the emergence of supply chain issues and commodity price volatility.

Another barrier is that there remain delays in planning, permitting and grid connection. In the UK, for example, there is over 200GW of renewable capacity in the grid application process. That is in a market with around 50GW of installed capacity.

Filtering out the noise in the transition is also a challenge. By that I mean that there are a lot of interests competing for the attention of policymakers and investors. That re-enforces the need for us to apply strong objective logic to make decisions that support long-term value.

The debate about hydrogen is a prime example. We believe that green hydrogen has a vital role to play in displacing current grey hydrogen demand and to support hard-to-abate sectors but we need to be careful not to overestimate its potential role in applications like space heating.

We are actively exploring hydrogen-related opportunities in our portfolio, for example at Noordgastransport, a North Sea gas pipeline owner and operator. It has recently gained technical approval to use its pipeline for the transport of hydrogen and has the potential to support the Dutch government’s recently announced plans for a 500MW offshore wind and hydrogen production facility in the Wadden Sea.

What can policymakers do to mobilise more capital towards the transition and plug the investment gap?

Policymakers need to create a clear, long-term delivery plan that gives certainty to the industry and ensures a sensible level playing field. Once this is in pace, to put it bluntly, they then need to get out of the way. All too often, we have one part of government setting ambitious transition targets and another standing in the way of practical delivery.

The time for pledges and targets has passed. We need specific policy measures to unlock investment and remove unnecessary bureaucracy in planning and permitting regimes.

This is especially true for transmission and distribution infrastructure and for storage. Incentivising new renewables capacity only makes sense if you also have the infrastructure to get the energy where it is needed and to balance supply and demand – a lack of support here is a major barrier to the transition.

That said, we are seeing some progress. Some measures in the EU’s new Net Zero Industry Act appear to respond to this urgency and should help to unlock investment in the right areas.

Even though there is an investment gap, increasing amounts of capital are now targeting infrastructure supporting the transition. How is that affecting the competitive landscape?

The transition is becoming a more competitive investment environment and in areas such as renewables, investors are having to move up the risk curve. That means sourcing deals more creatively, looking at newer or emerging sectors in the transition and reassessing their approach to development and merchant risk.

We see this as a natural evolution of the transition as technologies mature and subsidies are phased out. We’re well-placed for this given our experience and track record of undertaking more complex and creative deals.

Where do you see opportunities developing in future in energy transition?

Alongside more traditional opportunities in rolling stock, heat networks and utilities, our pipeline is full of interesting potential deals in energy storage, the circular economy and biomethane production, for example.

We still see a role for greener molecule-based fuels in the short to medium term – and potentially longer for some sectors that are harder to electrify. We are exploring opportunities in biomethane in particular; it makes a lot of sense to use large existing and untapped agricultural and organic resource streams to displace fossil gas. The market for green gas certificates and biogenic carbon dioxide has a role in supporting investments here.

There are also interesting emerging opportunities to supporting the decarbonisation of the marine sector – for example, through funding battery-powered inland and service vessels or the enabling infrastructure and vessels for longer routes that use the next generation of lower-carbon propulsion fuels.

There is so much potential in energy transition and the progress made in 2022 demonstrates how much can be achieved even through challenging circumstances. Last year was an inflection point for the decarbonisation story.

The pace of change has been remarkable. We expect this to accelerate further – it needs to – and the range of solutions will continue to evolve. It will be an interesting time indeed for infrastructure investment.

Note pad team work search investigate

How are industry standards and net-zero initiatives bringing about change on the ground?

There has clearly been a big focus recently on transparency and disclosure for fund managers with the EU’s Sustainable Finance Disclosure Regulation and the Task Force on Climate-Related Financial Disclosures, along with emerging regulations in the UK and elsewhere. Improving the quality and transparency of sustainability data is extremely important. Yet we can’t assume that more and better disclosures alone will lead to more investment in low-carbon infrastructure.

The EU Taxonomy is a positive development and provides a common language for what sustainable activity looks like, even if it is complex and doesn’t cover all sectors and objectives yet. Meanwhile, we have been involved with the development of the new Institutional Investors Group on Climate Change Net Zero Investment Framework (NZIF) for Infrastructure, published in March.

The NZIF aims to guide managers and investors in setting consistent decarbonisation targets and monitoring progress. It is the first common framework for the infrastructure sector and shows the industry’s willingness to collaborate on these topics. We are looking forward to using the framework to complement our existing work on decarbonisation.