Long gone are the days when an infrastructure portfolio comprised mostly of toll roads, an airport, a utility and/or pipelines. Nowadays, it feels like everything can be infrastructure if you try hard enough – from helicopters to laundromats.
In times like these, it feels easier to define infrastructure as an asset class by clarifying what it’s not – it’s not short-term; it’s not real estate (well, usually); and it’s not as risky as private equity or venture capital.
But the difference in risk profiles between infrastructure and buyouts is becoming ever less stark, as new asset types are added to the mix – and the growing energy transition sector is among the culprits.
First, the intermittency issue has made it tricky and costly to establish long-term offtake contracts for wind and solar assets. Trends affecting the length and flexibility of PPAs also pose a stark difference to the cut-and-dry PPAs of utilities past. From what used to be standard 20-year agreements, these have fallen in recent years to 10, seven or even five.
Some are forgoing PPAs altogether as large corporations strive to source clean energy for all their operations on a 24/7 basis. At a BloombergNEF Summit last month, Caroline Golin, global head of energy markets at Google, claimed that we’re “going past [the era of] PPAs” – a worrying prospect for renewables owners, given that the technology sector is the largest corporate power buyer in the world.
This means that there is quite a bit of merchant risk embedded in renewables – something that Orhan Sarayli, a managing director at Barings who handles the firm’s infrastructure debt practice, has noticed. “Most people still don’t know what the long-term merchant model is for renewables,” he told Infrastructure Investor. “Batteries will have a positive impact on conventional renewables but are also going to have some unforeseen negative impacts on how renewables are priced as well. So it’s a business with more risk than I think equity sponsors and lenders have historically assigned in terms of risk premium.”
In terms of interest rate risk, sources have pointed out that some GPs are treating renewable deals as a “discount rate exercise,” counting on either high power prices or lower interest rates to avoid financial fallout.
But surely inflation risk can’t impact infrastructure? When it comes to core assets, historically that has been true – though even that is changing. While that also ties into the merchant risk point mentioned above, the most impactful way that inflation has increased renewables’ risk profile is via construction: cost overruns and supply chain issues have hit solar hard, as well as offshore wind.
Add to that the made-in-America IRA provisions and the slow onshoring processes that will accompany them, shortages in both critical minerals and labour, as well as issues related to grid permitting and it is safe to assume that these timelines will likely remain long and costly for the foreseeable future.
And these are just the risks hidden within “plain vanilla” renewables, such as wind and solar. There are of course more in the newer and less mature technologies that infrastructure players are now setting their sights on, such as hydrogen, biofuels and stand-alone storage.
The need for renewable energy cannot be understated, and infrastructure should and will provide the capital for the buildout. But it is best if GPs, LPs and developers alike are upfront about the risks embedded in these assets – overvaluation has resulted in too-high price tags and outrageous EBITDAs, and will likely lead to buyer’s remorse all around.
In the end, if asset prices go down to accurately reflect valuations, more projects will be funded overall. The dry powder is there. The need is to spend it responsibly.