Emerging from the shade of solar

At Infrastructure Investor’s 2014 Berlin Summit, it was pointed out that when people think about investing in the environment they tend to think primarily (or exclusively in many cases) about solar and wind. If they do turn their thoughts to other sectors, the likes of hydropower, biomass and geothermal will probably cross their minds. But if the thought process stops there, it’s quite possible that a big investment opportunity is being missed.

After all, it’s not just the energy sources themselves that will ensure the reduction of carbon emissions and a cleaner environment – it’s making sure that the delivery and use of energy is optimised. And out of this consideration, two investment themes are emerging, both of which may suit the needs of infrastructure investors and their clients rather well: namely, interconnections and energy efficiency.

The “interconnections” theme arguably has its roots in the UK’s Offshore Transmission Owner (OFTO) regime, which was launched in 2009 with the aim of meeting the need for transmission links between offshore wind farms and the onshore transmission network. By offering licences to run these links within the parameters of a regulatory framework promising long-term, stable revenues, the OFTO scheme aimed to generate required investment of between £10 billion (€12 billion; $17 billion) and £15 billion.

At least in its early stages, the OFTOs proved extremely popular, with multiple consortia competing in auctions to run the licences. OFTO tender round one, in July 2009, involved nine different projects and attracted public-private partnership (PPP) specialists such as International Public Partnerships (INPP) because of the similarities between OFTO and PPP investment characteristics. A consortium including INPP went on to reach financial close on four first-round projects.

Momentum lost

Since then, some momentum appears to have been lost. The second tender round, launched in November 2010, comprised just four projects; while the third – for which the starting gun was fired in February 2014 – comprised only two projects, both located off the Yorkshire coast. The combined investment requirement for these two projects is £400 million.

“The anticipated pathway to a greater number of projects has not materialised. At the moment there’s a bit of a hiatus and people are waiting for the next wave,” says Munir Hassan, a partner in the energy and utilities team and head of clean energy at law firm CMS in London.

Hassan points out that the fortunes of OFTO deals are inevitably entwined with those of the offshore wind farm sector – and the latter has had a tough time of it lately. “There’s no doubt that the OFTO assets are good, but when offshore wind farms are affected then OFTOs are affected too,” he says.

With political support for subsidies seemingly on the wane, the UK has seen a scaling down of ambition in the offshore wind sector. This was exemplified in November last year when utility RWE pulled the plug on the 1.2-gigawatt (GW) Atlantic Array wind farm off North Devon, which was to have been the UK’s largest offshore wind farm.

Go with the flow

But the rise of OFTOs has a) got those investors which are interested in long-term stable cash flows comfortable with the concept of investing in connection cables and b) made them more inclined to consider any similar investment opportunities that come along. And just such an opportunity may be showing itself in the form of electricity interconnectors.

Interconnectors effectively make the flow of electricity more consistent and more appropriate given the level of demand in a particular place. Perhaps the most notable deal in the sector to have been struck so far was the ElecLink joint venture between London-based fund manager Star Capital Partners and Eurotunnel, the manager and operator of the Channel Tunnel – through which a 75-kilometre interconnector between England and France will run.

The connection is designed to provide greater energy security, optimise energy production across Europe and counter supply volatility associated with renewable energy. In our keynote interview in the March 2014 issue of Infrastructure Investor, Star Capital Partners’ chief executive officer Tony Mallin said: “We’re reducing the need for additional generation in the UK and France. The link will cut carbon emissions and make it easier to reach emission targets.”

At the moment, much interconnector activity is focused on the UK where – according to energy regulator Ofgem – there is currently 4GW of interconnector capacity (2GW with France, 1GW with the Netherlands, 500MW with Northern Ireland and a further 500MW with the Republic of Ireland).

However, there is reason to believe that the sector may become significantly bigger in future. In January this year, UK Energy Minister Ed Davey said there was an urgent need to build a giant network of electricity interconnectors across Europe as a way of moving energy between countries and thereby bringing prices down – crucially allowing Europe a potential competitive counter-punch to the US shale boom.

Range of risk

The future for infrastructure investors wanting stable, long-term revenues could be the prospect of “cap and floor” regulation – which has been jointly developed by Ofgem and Belgian regulator CREG for the proposed NEMO interconnector between the UK and Belgium.

“Cap and floor provides a range of risk that might make it easier for pension funds to invest,” suggests Hassan. “It’s designed to offer the kind of minimum return that would be attractive to those kinds of investors without allowing super profits.”

Indeed, Ian Temperton, head of advisory at Climate Change Capital, the UK-based investor and adviser, believes that the regulatory aspect of grid-related transactions is potentially more attractive to infrastructure investors than the likes of wind and solar. “The latter are 50 to 60 percent supported and the rest is wholesale power risk,” he says. “Whereas, if you connect to an offshore wind farm (the grid piece), then the contract is 100 percent regulated income. So grids are even closer to core infrastructure.”

Energy efficiency is another emerging area of investment for those wanting core infrastructure-type characteristics and prepared to look beyond the more mainstream choices. The investment case was outlined at the Berlin Summit 2014 by Tobias Reichmuth, chief executive officer at SUSI Partners, a Zurich-based fund manager whose €300 million-target energy efficiency fund posted a first close at the beginning of this year on €65 million. The closed-ended fund has a 12-year life.

Calling the institutions

“Greenhouse gas emission reduction targets can only be achieved through energy efficiency and it’s a huge opportunity for institutional investors,” Reichmuth told those gathered.

Energy efficiency projects involve investing in existing infrastructure – especially buildings – in order to drive lower energy consumption and reduced operating costs through the installation of new technologies.

Reichmuth added that SUSI began looking at the energy efficiency opportunity a few years ago and found that “huge savings” were available. He presented figures from Siemens showing that the average school could make savings of 52 percent on its energy costs over an eight-year period. (“A school classroom does not need to be 21 degrees centigrade at 2am,” he said as an aside). In addition, he referred to New York’s iconic Empire State Building, where energy efficiency had driven a 38 percent reduction in energy costs in just three years.

While energy efficiency investing has existed for around 30 years, a new opportunity has arisen for institutional investors to participate – giving rise to funds such as SUSI’s as well as Ingenious Capital Management’s Clean Energy Income PLC, which has a target of £160 million to £200 million, and a £50 million financing joint venture between the UK Green Investment Bank and Societe Generale Equipment Finance.

The opportunity results from the companies responsible for installing the technology – typically the likes of Siemens, Honeywell and ABB – no longer being prepared to carry out their traditional “pre-financing” of projects due to budget pressures and credit rating restrictions.

This has led to a financing gap well suited to the needs of institutional investors. SUSI describes the investment profile as “a stable return (IRR) of 5 to 6 percent per annum with a low correlation to existing investments and a runtime of approximately 10 years”. Reichmuth adds: “There’s enough projects around, there’s no j-curve and it’s a good return from day one.”

Like SUSI, UK-based fund manager Ingenious Clean Energy entered the energy efficiency space in 2011 – drawn to it by the combination of strong government promotion coupled with the fact that “you don’t need a government subsidy to make it work” according to James Axtell, an investment director at Ingenious.

‘On the cusp’

Expanding on what he sees as the compelling nature of the investment theme, Axtell adds: “We either have to produce more electricity in a different way (e.g. renewable energy) or make better use of the electricity already being generated (energy efficiency). It’s very difficult to find someone who thinks it’s a bad thing.”

Axtell says he believes energy efficiency is “on the cusp of something big” and that it is moving more into the investment mainstream. However, he also believes that the number of investors operating in the space does not yet reflect the potential. “Few can do it at this point in terms of having the relationships and identifying suitable projects,” he says. “It’s not as simple as putting a few solar panels in a field.”

As it moves into a “post-subsidy” regime, many investors are putting the implications of renewable energy investing under the microscope. At the same time, they may be tempted to take a look at distinct – but not entirely dissimilar – investment options. As a result, expect areas such as grids, interconnectors and energy efficiently to emerge blinking into the spotlight.