Last year broke records for renewable energy, with the International Energy Agency reporting the creation of an additional 290GW of capacity. And with the largest-ever number of wind turbines and solar panels also being installed, the IEA set a new forecast – that if current trends persist, renewable energy would overtake fossil fuels and nuclear combined by 2026.

Infrastructure investment linked to renewable energy also jumped in 2021, by 27 percent from 2020 to a record $755 billion, according to BloombergNEF. NextEnergy Capital CEO Michael Bonte-Friedheim says there are several reasons for this: “There is a confluence of trends. These is the push to decarbonise power generation, reducing the cost of generating power; the significant increase in costs of hydrocarbons; and the impact of the Ukrainian war on energy prices and energy relationships.”

These, explains Bonte-Friedheim, have helped investors and stakeholders become “more aligned” on decarbonisation strategies and the role that renewable energy plays in these. Experts view this as a sea change for renewable energy, with ESG considerations now mainstream and a greater consensus around tackling the climate challenge.

These energy sources are not new – for decades, they have co-existed on the periphery of fossil fuels. With growing popularity among investors, and the public now largely convinced about the need to combat climate change, this may result in real transformation.

Peter Bird is a renewable energy expert at the Berkeley Research Group and has spent 36 years advising the energy industry on the issue. He says the years ahead will be “exciting” and thinks “we are really on the cusp of change”.

“All around the world, we are seeing margins falling away”

Simon Ede
Charles River Associates

Bird points out that the energy system has barely altered in the past 30 years. “If we look at 2050, it will be completely different. For example, transport systems and the domestic heating scene will be revolutionised. Between now and then, it will be exciting, and this change will overwhelm us.”

Institutional investors are bullish about renewable energy and its potential. A survey of financial institutions by the American Council on Renewable Energy (ACORE) in 2021 found unprecedented support for the theme: a record 68 percent of investors were planning to increase allocations to renewable energy, with the consensus outlook on the sector “extremely confident” among respondents.

Transition challenges

Renewable energy advocates may rejoice at this bullish atmosphere, but infrastructure investment experts point to several significant challenges that will need to be overcome.
Infrastructure investors are used to long-term horizons, with projects so complex and grand they often take several years to complete. The same time constraints apply to renewable energy, but experts say these are now worse.

68%

Most investors say they plan to increase allocations to renewable energy

27%

Jump in renewables investment from 2020 to 2021

2026

In four years’ time, renewables capacity will have outpaced fossil fuels and nuclear

Bonte-Friedheim explains that renewable energy projects suffer from bureaucracy, with inefficient permitting systems often frustrating investment. Supply chain disruption and inflation may be currently exacerbating these barriers to investment, but the NextEnergy CEO says the sector has always suffered from slowness.

“What we are building now started four or five years ago,” he says, pointing to a “dearth” of renewable energy projects to invest in now. He adds: “It is a question of organisation processes. To get a wind farm approved, from the time you start to the time you can send the bulldozers onto the site, it is around four to five years. Solar: two to three years.”

The issue is so severe that NextEnergy Capital has established its own development arm, Starlight, with a 5GW global pipeline. Rather than wait for renewable energy projects to trickle through the current system, Bonte-Friedheim and his colleagues prefer to become more involved in the overall process. “We identified that shortage, which is why we started creating our own projects. For those that don’t control their pipeline, it can cause valuation problems. This can create a significant pricing effect.”

This pricing effect refers to the valuation challenges infrastructure investors face. Investors are keen to buy access to energy transition, securing exposure to wind turbines and solar farms, but with a dearth of investable projects, and more investors clamouring to get involved, prices can climb. Simon Ede, vice-president in the energy practice at Charles River Associates, explains that recent auctions in the US and UK for offshore wind sites have become “hugely competitive”.

“You are taking a market that used to be dominated by power producers and a few infrastructure funds, but now you have a lot more buyers coming to the table, including oil and gas companies looking to transition,” says Ede. “We are seeing more competitive bidding.”

The current energy crisis, with the US and Europe rapidly weaning their markets off Russian oil and gas, has created widespread disruption and renewable energy is getting caught up in this. Larger, state-backed buyers in the renewables market may have stimulated prices at one point, but now the economics are starting to be affected.

“It is not so easy to think you can buy a wind farm in the North Sea and you will get a safe and substantial rate of return out of it,” adds Ede. “All around the world, we are seeing margins falling away. Right now, a lot of governments are staring down the barrel of energy price concerns.”

Redrawing the grid

Investors swept up in the momentum may find pricing and supply are not the only barriers to entry. Much of the infrastructure we rely on is dedicated to the generation and transportation of fossil fuels. This includes the power grid.

Many experts point to logistical issues with introducing renewable energy in this system, and explain it is a complicated and expensive route to swap one energy source for the other. Laurent Schmitt, the CEO of energy technology company dcbel, says policymakers are mistaken in their simplistic approach to supporting the energy transition, and need to look at complex and nuanced solutions.

“For those that don’t control their pipeline, it can cause valuation problems. This can create a significant pricing effect”

Michael Bonte-Friedheim
NextEnergy

“Where the politicians and policymakers are making a major mistake right now is in thinking renewable energy and the current grid will be perfectly aligned,” says Schmitt, who highlights the complexities around planning and permitting with all energy projects as proof of this.

“For example, with wind generation for continental Europe there is significant congestion around Belgium and Germany, which creates a price squeeze. Moving forward, what will be important will be renewable energy well located for the system, and which can be easily integrated into the grid.”

Financing these projects is also easier said than done. Wind turbines may be cleaner and quieter than conventional energy plants, but many people still do not want them near their homes. A disconnect is emerging between renewable energy solutions and getting this power into consumers’ residences – an issue Schmitt says infrastructure investors must confront.

“It is the elephant in the room,” he says. “How is the grid going to evolve? I’m afraid it’s going to be a big obstacle and we need to invent new models. Just saying we will build mega lines doesn’t work. We don’t have time for that. How can we distribute this energy and be smart about it? I do see a shift of mindsets now because of that end-consumer awareness.”

Ede points to discussions in the gas industry. There, Ede explains, some asset owners are exploring the use of their pipelines for hydrogen distribution in a bid to keep their value. Others prefer to explore the electrification route.

“It is much more assured that there is large-scale investment required in electricity networks rather than gas networks,” says Ede. “It feels like there is an opportunity at all levels within the grid infrastructure. All areas of battery and storage.”

At Foresight Group, this is one area of focus for the firm’s renewable energy infrastructure team. Partner Dan Wells uses the US as an example: there, wind energy is primarily generated in the Midwest of the country, but largely consumed hundreds of miles away on the West Coast.

“Even if a wind project has a lower return than a few years ago, we would still invest in it because we think there is a good risk-adjusted return”

Dan Wells
Foresight Group

“There will be increasing opportunities around interconnection and new distribution networks,” says Wells. “Ultimately, the underlying renewable energy source is often not located near the actual demand.”

For many experts in the space, this need for distribution is the emerging opportunity for investors eager to access renewable energy within their infrastructure allocation. Building and owning assets such as vast solar farms and wind farms may catch the eye, but Schmitt says the “smartness” of the connection between renewable energy and the grid is going to be “the critical point”.

“It has to be close to where the renewable energy is produced,” adds Schmitt. “You do not want to transport the energy over large distances. If you have flexible capacity and demand around you, then you may have to invest in storage.”

Facing reality

The attention given to renewable energy may be creating valuation pressures, but some experts are taking confidence from their long-term horizons. Wells – who advocates a non-sector and non-geography-specific focus – uses the example of solar power in Spain, where dealflow plateaued at a natural point in the country’s development cycle. After exercising patience, more opportunities appeared before a “second wave” of deals came online.

“Valuations in most energy assets have continued to increase, but we would expect that to happen as these technologies become more mature, the asset class becomes more mature, and it really is the market reflecting the true value of these assets,” says Wells.

“That does not create a problem for us, as we always look to make sure an asset makes sense on a risk-adjusted return basis – that is ultimately our bottom line. Even if a wind project has a lower return than a few years ago, we would still invest in it because we think there is a good risk-adjusted return.”

More immediately, investors may have to navigate challenges created by inefficiencies around construction and the dilemmas that integration poses. Here, there may be a further role for policymakers to play. Ede says government policy must properly address the massive scale of support needed to facilitate such huge change, which is something he believes is currently lacking.

However, steps have been taken in this area. Bird points to the UK government’s energy security strategy, published in April by the Department for Business, Energy and Industrial Strategy. Though not a panacea for all concerns facing infrastructure investors, the energy expert welcomed its publication and says it offers the sector real guidance.

Specifically, Bird welcomes the paper’s acknowledgement of the realities facing renewable energy investors, one of which is that a 100 percent renewables future is unlikely. He says: “The long-term roadmap is still unclear, but the paper revealed more about what the situation will be in 2050.

“We will get there, but I don’t think we will get to 100 percent. As you approach 100 percent, the intermittency and seasonal issues become more significant. There will be a continued need for non-renewable capacity.”