This article is sponsored by Ridgewood Infrastructure
Energy consumption in the US may have faltered in the early stages of the pandemic, but consumer demand is set to soar over the next few decades as President Joe Biden’s net-zero target looms large.
If the world’s largest economy is going to wean itself off fossil fuel consumption by 2050, it needs to radically transform both its energy sector and national infrastructure. Eliminating greenhouse gas emissions cannot be restricted to just energy production. Infrastructure leakage, particularly methane, is a major contributor to climate change, while upgrading legacy facilities can play a key role in reducing businesses’ carbon footprint and slashing unnecessary costs.
US lower mid-market specialist Ridgewood Infrastructure believes this focus on energy efficiency has to be a central pillar of climate action. Tackling energy loss across the commercial and industrial sector will have a decisive impact on carbon emissions and provide crucial cost savings for businesses and consumers.
Ridgewood managing partner Michael Albrecht examines some of these trends and why the lower mid-market is such an exciting prospect for investors.
What are the benefits of focusing on the lower mid-market?
Focusing on controllable and replicable value creation in the lower mid-market can create compelling exposure to essential infrastructure with long-term contracts and regulated protections with the potential to deliver beneficial outcomes on both absolute and risk adjusted bases.
At the highest level, within the US infrastructure market, approximately 40 percent of completed transactions have an equity value of $150 million or less, which represents a deep and fragmented opportunity set. And despite this relatively large chunk of the market, only 10 percent of capital raised is focused on that investment opportunity universe.
This structural inefficiency in the market can be true across sectors, including the energy transition. For example, we recently completed an EV charging infrastructure investment under long-term contract with a US state agency. The counterparty was strong and the duration of the “take or pay” contract was long, which are elements of a highly attractive opportunity.
However, the total cost of the project would be too small for most infrastructure investors. We focus on investments in the range of $50 million to $150 million and are thus well positioned and “right sized” to target such opportunities at the smaller end of the market.
What makes the energy transition, in particular, an attractive investment opportunity?
The energy transition is attractive for many reasons. For one, demand for energy efficiency infrastructure solutions in the US is large and burgeoning. What we are seeing is interdependent social norms, policy initiatives, and cost competitiveness facilitating the ongoing energy transition.
The US energy transition is also comprised of a highly diverse and fragmented set of potential customers seeking to improve their ESG characteristics and reduce their carbon emissions. The number of municipalities, universities, schools and hospitals (MUSH) seeking to green their operations is enormous. In addition, there are many millions of commercial and industrial players focused on achieving similar goals.
Against that backdrop, investors are focused on a diverse opportunity set, which presents a broad spectrum of risk/reward profiles. At Ridgewood, we focus on investments in essential infrastructure with the potential to generate long-term, high-quality, non-correlated cashflows. As a result, we tend to own long-term contracted and regulated assets and businesses.
How important is energy efficiency infrastructure to achieving net-zero carbon emissions?
Within the energy transition, we have recently focused our efforts on supporting MUSH, as well as commercial and industrial customers that are seeking to enhance and renew ageing infrastructure. This is one area where we have created opportunities to invest in energy efficiency infrastructure solutions with a compelling value proposition that combines both cost savings and greater sustainability.
In the short term, energy efficiency infrastructure can drive greater profitability. In the medium term, further benefits – be they social, branding or other – may accrue to customers.
Over the longer term, energy efficiency infrastructure is enabling customers to be more robust to a range of potential disruptions. But crucially, all the while, it is reducing energy consumption and attendant carbon emissions and therefore slowing the rate of climate change.
Energy efficiency solutions are not always the flashiest, but they are critical to achieving net-zero carbon emissions. For example, one of our portfolio companies, Ecosave, installs, owns and operates long-term contracted, mission-critical high-efficiency infrastructure including boilers and chillers. This underlying infrastructure is essential for customers to conduct their businesses and provides a safe operating environment.
It is also relatively low-hanging fruit. The US Environmental Protection Agency has reported the average building in the US wastes 30 percent of the energy it consumes.
Energy efficiency often focuses on upgrading legacy infrastructure. What is the scale of the problem and opportunity set in the US mid-market?
Addressing emissions from the commercial and industrial sector is critically important for achieving net zero. To put this into context, electricity consumption in the US is currently more than five times the combined domestic wind and solar capacity. The International Energy Agency states that energy efficiency solutions are expected to be the single largest pathway for companies to reduce their emissions and carbon footprint.
This is particularly well suited to our focus on the lower mid-market, given our ability to address such a fragmented marketplace where opportunities are often too small for larger investors.
How can technology and software play a role in improving energy efficiency?
Technology and software play a complementary role. It is critical to utilise these resources to ensure customer benefits, including lower energy consumption and reducing carbon emissions.
Our portfolio company Ecosave, which is an energy efficiency infrastructure company, utilises its proprietary software to automate and monitor equipment and energy conservation measures it installs at client locations.
This helps clients improve their energy efficiency in multiple ways. For example, if an energy conservation measure (ECM) is not operating at the expected efficiency level, we know this immediately and can service it. If a client inadvertently alters an ECM, we can see that in real time and remotely reconfigure.
Ecosave’s utilisation of technology and software allows it to monitor and therefore make proactive adjustments to each of the underlying ECMs, helping to exceed their clients’ expectation of CO2 reductions and lowering energy consumption.
What about ESG and sustainability: how do they align with investing in energy efficiency infrastructure?
ESG and sustainability are embedded in our culture. Energy efficiency fits squarely into our strategy given the positive ESG and sustainability impact this subsector has on the planet. Crucially, the positive impacts on the planet and earning an attractive return are not mutually exclusive.
Our view is that focusing on ESG and sustainability increases returns as the marketplace values the benefits that accrue to society. Every investment theme, which underpin our origination, includes an ESG and sustainability overlay to ensure the impact of the underlying business is creating a positive result for society.
We view climate change and ESG through a similar lens. They are critical to understanding the impact of underlying investments and the business model we are executing.
We think about whether we are making a net positive or negative change. That is the filter through which we consider what infrastructure to focus on.
Even the Biden administration’s green energy framework is a tailwind to energy efficiency investing. One of the government’s key goals is to achieve net-zero buildings. We believe this is a positive trend, but our investment strategy does not underwrite policy decisions given they can potentially be altered in the future.
Which infrastructure assets do you see providing the greatest opportunities to cut costs and lower carbon emissions?
I would highlight the energy efficiency infrastructure companies focused on the critical infrastructure marketplace. There is a $60 billion addressable market, which is highly fragmented with more than 20 million customers and is growing very quickly as more critical infrastructure customers seek ways to reduce carbon emissions and reduce energy consumption. The underlying buildings represent one of the largest carbon emitters in the US and companies increasingly recognise this.
Thousands of companies have committed to achieving sustainability goals as set by science-based targets, which involve the development of emissions reduction targets and annual sustainability reporting. The energy efficiency sector provides a unique opportunity to tackle this area of the market and make a real difference for the planet.
Finally, is that something you see across the country, or does the opportunity set differ across the US?
Certainly, at a high level, regions with high electricity costs tend to be more fertile areas for energy efficiency because not only are you reducing the carbon emissions of clients, but you are also reducing their energy spend materially.
However, there can be major idiosyncratic differences between states and local municipalities, and it is critical to have deep knowledge, as well as strong relationships to access and successfully execute opportunities.