KGAL: Article 9 a must for renewable funds

Investors are clamouring for funds that comply with the highest Sustainable Finance Disclosure Regulation standards. Achieving Article 9 is fundamental but challenging, says Michael Ebner, KGAL’s managing director of sustainable infrastructure.

This article is sponsored by KGAL.

How are investors responding to the new SFDR regulation?

Michael Ebner

Interest from both existing and potential new institutional investors has increased exponentially. Indeed, our most recent fund, KGAL ESPF 5, which is regulated under Article 9, hit a first close on €260 million in December last year, securing capital from insurance companies, pension funds, impact investment managers and family offices. There is huge appetite among investors for funds following the strictest rules under SFDR, and that has created a very significant boost for our fundraising activity.

Is that appetite equally evident across all geographies?

There is no region within Europe where sustainable infrastructure and the energy transition more broadly is not a top priority. But, of course, some regions are more advanced and more educated than others, and that is particularly true of Scandinavia and the Netherlands.

Germany is currently somewhat further behind but, as a general rule, all European countries are showing huge interest in the sector. This includes not only the institutional investors that are our primary focus, but private and retail investors as well.

And how is the GP community responding? Is there enough Article 9 product available to satisfy this appetite?

Compared with broader infrastructure portfolios, it is far simpler for us to comply with Article 9 regulation because our product is following a dedicated renewable energy strategy.

However, when you start to analyse the details, it is not as easy as it looks. Constructing, developing and operating renewable energy assets such as solar plants and wind farms does not automatically qualify you for the highest impact standards. It takes quite a lot of work and that can be challenging, so not all GPs are going down this route.

What are some of the ESG considerations you have to take into account to achieve that Article 9 status?

The main objective of KGAL ESPF 5 is to contribute to climate protection by reducing greenhouse gas emissions from power generation. Therefore, the fund supports the Paris Agreement’s goal of limiting global warming by avoiding or reducing GHG emissions.

However, any renewable energy plant is going to have some impact on the environment simply because of the land required. Our industry is already very good at undertaking prudent environmental impact studies at the outset.

Another step that is required to achieve Article 9 classification is to look more closely at the entire supply chain that feeds into the plant. For example, we review the manufacturers of our solar modules, which often come from China. We have sent engineers to places such as China to ensure that manufacturing meets our ESG requirements.

Now we need to go even further, looking into the supply chain of the module or turbine manufacturers. For example, we need to establish where does the silicon come from, where are the other materials produced and under what ESG conditions?

This requires enormous effort and is one of the biggest challenges the industry is currently facing. But we are ready for this challenge, otherwise we would not have applied for the Article 9 classification.

Other than proliferating regulatory requirements, what else makes sustainable infrastructure an attractive proposition for investors?

The renewable energy sector today is mature. There is proven technology and the industry can provide stable returns. The regulated nature of most assets adds an additional layer of security. And, last but not least, renewables offer low correlation to other asset classes. Renewable energy offers one of the most attractive and lowest volatility investment propositions available today.

And within the field of renewable energy, which subsectors are most attractive?

There is a broad consensus on this question today. The prime focus of the industry will continue to be on solar PV and both onshore and offshore wind.

We do also look at other sectors including storage, but from a capacity perspective that is still a long way behind traditional solar and wind. Hydropower is also interesting but, again, we don’t expect to see any major capacity expansions coming online over the next few years.

We are also a little reluctant to invest in biomass, which is a smaller but still interesting subsector within renewables, because there are potentially some impact constraints with those assets. In a nutshell, solar and wind will account for the majority of capacity additions in the future and therefore will represent the majority of our

Do you anticipate that green hydrogen will become an attractive and investable proposition at some point in time?

Yes, I do. But hydrogen production is not a generation asset, it is more of a consumption asset.

We are actually preparing a dedicated fund which will invest in these newer energy transition technologies that are needed to close the gap between intermittent renewable energy generation and demand. Hydrogen will be essential to that equation. However, at this stage you should not combine mature renewable energy-generating assets with technologies like this in one product, since the risk profile is entirely different.

The technology risk is different and so is the offtake risk. We believe that at this point in time it is necessary to keep the two areas separate with dedicated funds that target the respective risk and return profiles.

Renewable energy is a competitive market. How are you able to continue to generate strong returns in that heated environment?

I can answer that question by sharing a couple of examples. We have a very successful investment in Italy that has involved the acquisition of a solar PV development in Sardinia. Our task was to complete the development and then procure, with a multi-contracting approach, all the modules and inverters, and contract the relevant plant services and construction companies.

In addition, we had to obtain the grid connection, secure the route to market by implementing a power purchase agreement and then finally we sought a refinancing. All of that was completed during the covid shutdowns of 2020 and 2021. There were almost no delays in procurement and construction, which we regard as a success in itself, and we were able to generate a return of above 10 percent.

At the other end of the life cycle of an asset, we acquired an undermanaged operational solar PV portfolio in Bulgaria. We analysed the existing operational set up and concluded that there was a lot of room for improvement. Our technical staff visited the site and began to reorganise the subcontractors and to implement performance measures. These measures made it possible to achieve a return that was significantly above our target figure.

Another interesting approach for us is to work with developers to secure large development pipelines, particularly in the solar sector in Portugal, Spain and Italy. Today we own development rights equivalent to almost 2GW of capacity.

We began that process back in 2018 and, today, more than 500 MW of those assets have reached the ready-to-build stage and will be implemented over the next 12 months.

The way we create value is to get involved in projects at an earlier stage and then use our experience from 20 years in the renewables market, and of course capital, to bring those projects to life over a relatively short period of time – around two to three years. This is how we generate a higher level of return than by simply acquiring operational assets in mature core countries such as Germany and France.

Are there any particular challenges you would associate with this strategy, and how can those be overcome?

The biggest challenge, of course, is that you have to assess the level of risk when obtaining project rights. You have to do thorough due diligence to understand the existing development work, and then bringing those projects to fruition requires a great deal of expertise and in-house knowledge of technology, development processes and the nuances of the individual markets.

The second challenge at this particular point in time is the increase in capex that we are seeing for almost every technology.

Capex for projects has increased 10, 15 or even 20 percent compared with 2019 and 2020. At the same time, however, the prices being paid for the electricity through the respective offtake agreements have also gone up, as everyone, at least in Europe, can see from their own electricity bill. So as long as you are aware of the changes taking place and can act on those changes, it is still possible to be successful.

What do you believe the future holds for investment in sustainable infrastructure?

We are extremely positive about the development of the sector. Policymakers across the globe and particularly in Europe have clearly recognised that they need to promote renewable energy generation more than in the recent past. There was a big push about 15 years ago, but then interest seemed to wane. Now, sustainable infrastructure is back as an absolute top priority as policymakers look to achieve net-zero targets by 2050.

And it is not just the politicians who are behind this major push. The unprecedented interest from the general public is also driving this change.

Demand for green electricity is increasing from both industrial offtakers and private households. At the same time, technology is advancing and the costs required to fund these plants is falling. So, altogether, we see a very exciting future for renewables.