Infrastructure managers have made huge investments in renewable power sources in recent years, but the rapid acceleration of the energy transition will require them to think outside the box. Moving to a more sustainable society will completely change the way we travel, work and produce food – and all of this will require sustainable energy.
Given that the electricity market only represents around 20 percent of Europe’s total energy consumption, existing renewable energy infrastructure will not be enough and new sources will have to be created. Meeting decarbonisation goals will depend on the expansion of sustainable infrastructure into areas such as hydrogen, heat pumps, cooling, e-mobility, and carbon capture and storage.
For Matt Hammond, partner at Foresight, sustainable infrastructure and real assets are about much more than just renewable energy. “The drive for enhanced sustainability has led to a significantly increased and diversified opportunity set for infrastructure investors,” he says. “In energy alone, the investment goes beyond renewable energy-generating assets into batteries and other forms of energy storage, as well as transmission and distribution assets. Hybrid assets seeking private finance are increasingly common as greater efficiencies are sought across the whole energy system.”
David Tilstone, head of renewables EMEA at Macquarie Infrastructure and Real Assets, says all types of infrastructure will need to become sustainable if governments’ climate targets are to be met.
“We have set an ambitious target to invest and manage our portfolio in line with net-zero emissions by 2040 – 10 years ahead of the deadline to achieve the Paris Agreement goals,” he says. “This will require us to identify pathways to reduce emissions across every asset, sector and market our portfolio touches.”
Beyond renewable energy, Macquarie is implementing business strategies in partnership with its portfolio companies to decarbonise heating and cooling, transport, industrial processes, agriculture and waste. Many of these sectors are in their early stages and deal activity is expected to be ramped up.
“Hybrid assets seeking private finance are increasingly common as greater efficiencies are sought across the whole energy system”
Rob Martin, director for strategy and ESG at Legal & General Investment Management Real Assets, says his team is “actively seeking” to invest in infrastructure that will facilitate the net-zero transition. He adds that the team is looking to mitigate cashflow volatility resulting from factors such as merchant revenues, technology risk and the stability of regulatory or contractual frameworks.
One of the benefits of investing in next-generation sustainable infrastructure assets is that they can help to diversify portfolios that are mostly focused on wind and solar.
“Early entry into these industries also allows investors to build relationships with the sponsors, regulators and other stakeholders, laying the groundwork for building and managing exposure as these sectors scale up,” Martin explains.
What are the opportunities?
Many high-energy sectors – such as roads, rail, marine, aviation, and domestic and commercial heating and cooling systems – will need to be decarbonised. The production of steel, aluminium, cement, sugar, chemicals, plastics and agriculture will also need to be made carbon-neutral.
Peter Bachmann, managing director of sustainable infrastructure at Gresham House, believes batteries are the next frontier of infrastructure and will be increasingly used by the UK’s National Grid. “The grid cannot balance itself if it is running solely or largely on intermittent renewable generation, and this is something that is starting to become somewhat well-understood,” he says. “Over time, battery storage will become an even greater asset class.”
Bachmann notes that, during the early stages of the pandemic, the National Grid was looking at how much it would cost to balance the grid by keeping old gas-fired power stations running. “This was at a time when it should have been quite cheap, in that everyone was home during covid-19, and it was quite sunny and windy so there was not much imbalance,” he says. “But they worked out that the cost to balance the grid [in this way] would have been a fraction of the price if they used batteries to supply balancing services when needed.”
Bachmann adds that, depending on which way the National Grid goes to try to manage this imbalance, other forms of storage might become attractive, such as pump storage and other technologies to provide long-duration balancing.
Another big area of opportunity is decarbonisation of the heat sector, which is estimated to cost around £1 trillion ($1.37 trillion; €1.15 trillion) for the entire UK market.
“The UK government has not really tackled the heat side of things,” says Bachmann. “A lot of other countries in Europe have district heating networks so that they can use energy-efficient centralised equipment.”
Gresham House is looking at opportunities in heat pumps, an area the UK government’s recent budget alluded to. There was a £5,000 voucher incentive scheme for air-source heat pumps, which the government has now withdrawn.
“Hopefully, the government will announce some other new mechanisms to try to encourage air-source heat pumps,” Bachmann says. “We think that they could be a really great way of taking people off oil, and there are a lot of people in the UK that still use oil burners or use oil as their primary source of heat, which is incredibly environmentally unfriendly. So, there is an opportunity to transition those people.”
“The grid cannot balance itself if it is running solely or largely on intermittent renewable generation”
LGIM Real Assets recently provided debt finance to HeatRHIght, a renewables funding scheme that supports the delivery of air-source heat pump technology to social housing.
“This is an example of a transaction where the key risks in new generation infrastructure were appropriately addressed in the financial structure,” Martin says. “In addition to clear decarbonisation benefits, that investment structure featured among others a technology with a proven track record, manufacturer guarantees and revenue stability of the underlying assets.”
Sustainable transport, which has typically focused on electric vehicle charging infrastructure, is another area from which opportunities are likely to arise. Hammond says Foresight has invested in biomethane refuelling to enable truck owners to move away from diesel and that, in the longer term, all transport will either be electrified or, in some applications, move to clean hydrogen.
He adds that opportunities in district heating and other forms of heating and cooling infrastructure are also emerging, as accepted practices in sustainability vary across the world.
Hammond says digital infrastructure is another “obvious area” with sustainability credentials that is enabling people’s lives to be more connected and resilient in the face of whatever challenges come next. It can have benefits such as reducing travel and urbanisation pressures, as has been evidenced during the pandemic.
The next frontier is sustainable agriculture, which is a big challenge and an opportunity that will last a long time, according to Hammond: “Whether it is building greenhouses or more sophisticated controlled environments for salads or fish, acquiring nutritionally exhausted fields and allowing them to recover and become profitable organic farms, or to protect and enhance existing forestry or to develop new forests in depleted agricultural lands, it all requires long-term patient capital.”
Gresham House is investing in other sustainable businesses, such as those involved in vertical farming or the production of alternative proteins, which can replace high consumption of environmentally unfriendly soy in the seafood industry.
US wind opportunities
Although renewable energy is well established in Europe and infrastructure asset managers have invested heavily in this area, there may still be opportunities in other countries or regions. For example, the US has lagged behind Europe in offshore wind.
Macquarie’s Tilstone believes offshore wind will have an important role to play in decarbonising the US power sector, which will create further opportunities for infrastructure investors. “We are actively looking to leverage our experience from the European market in the US,” he says.
Foresight’s Hammond agrees that offshore wind will play a part in the US’s move to decarbonise: “Like everywhere, as the industry scales – and as the size of the turbines grows – other peripheral opportunities [will] emerge in, for example, port infrastructure, maritime service vessels.”
However, Alistair Perkins, head of infrastructure debt and project finance at NN Investment Partners, thinks onshore projects will continue to represent the majority of the renewable energy market in North America, with offshore wind playing a smaller role in specific locations. This is because Europe had limited land available for large-scale onshore wind farms, but the market drivers in North America are quite different, with “significantly less pressure” on land availability for large-scale wind and solar projects onshore.
“In addition, grid inter-connectivity is quite extensive across continental Europe,” Perkins adds. “The North American market has significant capacity constraints with limited interconnectors between Texas [ERCOT], western [WECC] and central/eastern power grids.”
What are the challenges?
Darryl Murphy, managing director for infrastructure at Aviva Investors Real Assets, believes the opportunity set is very much about the low-carbon energy transition plus digital because government policy will want private capital to focus on these areas.
However, he points out that today it is difficult to find those opportunities.
“There is probably a lot of capital struggling to find the opportunities immediately,” he says. “Some of these markets are a little bit more nascent but will develop over the next few years, so that should be good in some respects. It just comes down to how quickly some of these new technologies will become commercially deliverable.”
Another challenge is the lack of a robust regulatory model in nascent sectors. Tilstone notes that the regulatory environment may not be well developed at an early stage, which can create challenges around the stability of these assets as an investment opportunity.
“Often they need some form of partnership between governments and the private sector to create an initial framework that helps ensure stability for investors,” he says. “As the market evolves, costs can be reduced and stabilised, and business models can ultimately stand independently in the long term. The development of the renewable energy sector is a good example of this.”
Martin of LGIM Real Assets says that in the early days of renewable energy, a robust regulatory framework was put in place to provide long-term revenue visibility and stabilisation, and that this led to the rapid scaling up of the industry and rapid capacity deployment.
“A similar regulatory framework is needed now to speed up the deployment of the next generation of sustainable infrastructure,” he says. “Support from the new [UK] Infrastructure Bank in the form of guarantees and credit enhancements could prove crucial in this early stage of deployment.”
Despite the challenges, Perkins believes the market trend for the definition of infrastructure to be expanded will continue during 2021. He predicts this will be against a backdrop of investors seeking higher returns in the low-interest-rate environment, increased competition for a finite pipeline of assets and greater scrutiny over ESG performance.