The switch away from fossil fuels and the dream of achieving net-zero carbon emissions is one of the most challenging and capital-intensive projects the world has ever undertaken.
A report published last year by Bloomberg New Energy Finance estimated that achieving net-zero carbon emissions by 2050 – the goal of the Paris Climate Accords – will require investment of $173 trillion in the energy transition. The report stated that annual investment in energy supply and infrastructure would need to double – from
$1.7 trillion annually today to between $3.1 trillion and $5.8 trillion each year over the next three decades – to achieve these ambitious targets.
BNEF’s chief executive, Jon Moore, says: “The capital expenditures needed to achieve net zero will create enormous opportunities for investors, financial institutions and the private sector, while creating many new jobs in the green economy.”
Although private markets infrastructure equity funds have been investing in renewable energy generation, transmission and storage for many years, the challenges that lie ahead will require a much broader mix of capital provision to see vast numbers of projects through to completion. For this reason, a growing number of infrastructure investment houses are launching debt funds specifically focused on lending to sustainable energy projects.
“Infrastructure is very capital-intensive, with 80 to 90 percent of the capex financed by debt,” says Jorge Camiña, who joined fund manager Denham Capital in September as head of sustainable infrastructure credit. Denham launched its infrastructure credit operation this year, after 15 years’ experience investing in energy and renewables, due to the growing opportunities and challenges facing the energy infrastructure transition.
“With the volume of financing needed to achieve net zero, much of this capital is going to have to come from institutional investors,” says Camiña.
Although banks remain active in financing infrastructure projects relative to corporate lending, they alone will not be able to meet the enormous financing demands of achieving net zero.
Fortunately, with many pensions and insurance companies looking to improve their portfolios’ ESG profiles, institutional money is flowing into clean energy. Camiña says firms have several options for accessing renewable energy. They can back corporate equity, though this has a high risk of failure; they can buy into utilities, which will give some exposure but not enough; and they can back infrastructure debt and get a better risk-return profile with an extra spread for illiquidity.
Investing for the long term
Because of the long-term nature of energy projects, institutional money offers distinct financing advantages compared with banks. “Our main advantage when lending into the investment-grade space is tenor,” says Camiña. “We can be a long-term lender that backs a project for a decade or more, whereas banks typically seek to rotate their loans and so will offer shorter tenors. Meanwhile, on the sub-investment-grade side of things, banks won’t lend but we can because we think about risk differently and see ourselves as a permanent investor in that project.”
Copenhagen Infrastructure Partners, which launched its inaugural Green Credit Fund I in February 2022, is another established infrastructure investor that has taken steps into the credit market.
The firm hired Jakob Groot as an adviser from Danske Bank in 2021 to co-head the new fund. Explaining why CIP has decided to diversify into renewable energy credit, he told us in December: “We are convinced energy transition will need both equity and debt. There are parts of the debt spectrum that banks are well equipped to serve, but others are not. We want to go down the curve of risk, with subordinated and junior debt offering a more attractive risk-return profile than equity.”
He adds that there is significant demand from LPs to gain exposure to debt focused on the energy transition.
One area where banks are less active is later-stage development and construction of energy projects. CIP says there are few funds with the expertise necessary to operate in this area.
CIP also believes its expertise in renewable energy investment gained in the equity space will prove useful in sourcing and diligencing opportunities for credit investment.
“Many of our existing skills that we use to due diligence an equity investment can be reused to perform due diligence for junior debt investment as well,” says Groot.
Role of the economy
Another reason for moving into the debt space is the way LPs are reacting to changes in the economy. CIP partner Steen Lønberg Jørgensen says: “When investors were facing the idea of ‘lower for longer’ interest rates a decade ago, they wanted an alternative to fixed income, and infrastructure equity could act as a replacement due to its relatively safe nature. However, in many jurisdictions this is now coming to an end, and investors are moving into other areas where they can generate yield and they want to have a more diversified fixed-income portfolio.”
The firm’s first fund is taking a relatively conservative approach to backing energy projects, with a focus on OECD countries in Europe and North America, while looking for projects that use developed and mature technologies.
Jørgensen explains that gaining exposure to an array of assets is crucial to managing the fund: “We already know the renewable energy sector well and we will look at a variety of different projects including onshore and offshore wind, storage and solar power, and finance both existing and new projects. When you’re creating a portfolio for credit you need to have a good mix to avoid being biased towards one area of the market or another.”
Long tenors – much longer than those for corporate private debt loans – are also crucial for lending into renewable energy projects, which often have development timeframes of 10 years or more. As mentioned, with banks looking to rotate their loans relatively frequently, private debt funds can provide a much longer and more stable relationship with both borrowers and their financial sponsors.
With many world leaders having gathered in Glasgow at COP26 to hammer out international agreements on climate change action, the momentum to invest in green energy production and services is only going to increase.
“We see a huge opportunity ahead,” says Groot. “There is a strong political will to expand green energy production, and energy transition is perhaps one of the biggest investment opportunities of the past 100 years. Moving to clean energy is a long-term trend and it’s going to need a lot of capital to execute. There’s a big opportunity for LPs to participate in that.”
While that participation may once have only been available on riskier equity transactions, the rapid development of private credit funds specialising in clean energy infrastructure offers a new avenue to gain exposure. With so much capital required to transition away from fossil fuels, tapping into the large portfolios of insurers and pension funds will be vital to helping achieve global goals to address climate change.