Climate change is undoubtedly among the most pressing challenges humanity is now facing, with collective fossil-fuel reliance clearly identified as a primary culprit. Based on findings by the International Energy Agency, the energy sector – which still represents a substantial share of fossil fuel use – accounts for around 40 percent of global carbon emissions despite the trend towards renewable generation in many regions.
Given the sheer importance of the sector for all aspects of society and development, this will involve a comprehensive redesign of the systems which generate, deliver, store and supply energy in all its forms – particularly electric power. This includes the electrification of non-energy sectors still dominated by fossil fuels, such as transport.
Finance is a critical element in the drive towards the energy transition, which will involve substantial amounts of infrastructure investment in real assets and capital-intensive businesses. Current levels of investment are nowhere near enough to support the international climate goals. Based on the IEA’s findings, it is estimated that $3.2 trillion in energy sector investments is required each year until 2050, compared with $1.8 trillion in 2015, to sufficiently decarbonise the sector. Most of this capital will have to come from private sources.
In order to address this substantial need for private capital, it is crucial to first clearly define what the target is, identify specific sectors that will help achieve that target, and then determine the drivers that define risks, potential returns, and the timing and speed of investment requirements.
The energy transition is the collective name given to several paradigm shifts, from the way energy is produced to the way it is stored, distributed and used. The end game is to create an energy system that is clean, safe and flexible, and that centres around the needs of the customer, offering individualised energy solutions at affordable prices.
Spurred by innovation, increased competition and policy support in a growing number of countries, renewable energy technologies have achieved substantial technological advances and sharp cost reductions in recent years. Consequently, their deployment speed has come to outpace that of any other energy source. At the same time, deployment of renewables is becoming independent of subsidies and incentives.
“The levelised cost of energy of renewables plants is comparable to or lower than that of fossil fuel power plants in many markets”
The decarbonisation of energy production is a powerful long-term investment trend, with onshore wind and utility-scale solar PV representing two of the main growth drivers for generation capacity deployment. In Europe, solar represents the single largest capacity addition during 2019, doubling the pace of additions from 2018, closely followed by wind. In addition, due to the coming-of-age of onshore wind generation, repowering projects using new turbines on existing, developed sites will also be required.
Having gone through a significant learning curve, the availability of reliable technologies at an industrial scale and at ever-decreasing costs resolves the historical contradiction between economic logic and ecological benefits.
The levelised cost of energy of renewables plants is comparable to or lower than that of fossil fuel power plants in many markets. This represents a tipping point and leads to a self-reinforcing dynamic that is driving the continuing displacement of fossil-fuel-based power generation by renewable energy systems. It is estimated that by 2035, nearly half of global total capacity will be based on solar and wind resources.
With increasing renewable energy penetration, power systems will see strong growth in balancing needs, such as the requirement for flexible generation and the demand to offset short-term and seasonal swings in renewable energy production. For medium-term fluctuations, capacity overbuild will be the likely answer. This will not necessarily lead to increased systems costs, given the declining marginal costs.
The antidote to short-term intermittency, and a key enabler of penetration rates at increased levels, is energy storage. Cheap and effective energy storage solutions, increasingly based on batteries, mean power from renewable sources will also be available when the wind is not blowing and the sun is not shining, thereby cushioning the swings when they are.
On the demand side, energy efficiency will be the single most important contributor to energy sector decarbonisation. It will account for almost half of the carbon emission reductions required to fulfil climate targets, while benefitting from negative abatement costs: investments in energy efficiency not only reduce carbon emissions, but lower costs for the end user.
Efficiency measures typically reduce energy consumption by existing infrastructure and cover a variety of proven technologies. Applications range from LED streetlighting to building retrofits, involving the installation of modern HVAC or onsite-generation systems.
Pillars of transition
Of late, the three pillars of the energy transition – generation, storage and efficiency – have increasingly been converging, with technologies being combined to provide integrated energy solutions and contracted directly with the end user. One of the fastest-growing is solar PV coupled with behind-the-meter storage on customers’ premises.
These trends are not only transforming traditional power and energy infrastructure systems but are reshaping customer expectations and opening up new business models. Client-centric solutions based on service models represent a significant divergence from the past, where energy was considered and sold purely as a commodity. This poses a challenge to many but also an opportunity to some of the traditional intermediaries, such as utilities and wholesale markets.
Finally, the energy transition is characterised by the increasing electrification of fossil fuel-reliant sectors, such as transport. As both personal and commercial transport move to electric systems, whether powered by onboard batteries or clean hydrogen-based fuel cells, charging infrastructure for electric vehicles and clean hydrogen generation and distribution systems represent a future investment opportunity in their own right.
Based on forecasts by the IEA, which expects between 130 million and 250 million battery powered EVs on the road by 2030, we estimate capital requirements of €80 billion-€100 billion for EV charging infrastructure over the same timeframe.
Some factors driving the energy transition will depend on a conducive regulatory and political climate for goal setting to enable innovation and progress. And although it is hard to predict how quickly technologies and regulation will evolve, and which business models will emerge, the sub-sectors of generation, transport, storage and supply are increasingly merging.
Given the dynamic nature of the energy transition, there are several pitfalls infrastructure investors need to be mindful of and address during investment efforts.
First, as in every emerging sector, there is a plethora of new companies and technologies with little track record but high ambitions. Due diligence on their respective long-term viability is certainly warranted.
Second, given the nature of zero-cost marginal power generation and the reduction in system demand through efficiency and onsite generation, the fundamental market workings to determine adequate prices are being challenged.
This is leading to outcomes such as negative wholesale power prices. Investors need to assess those dynamics with a deep understanding of markets, and not rely on overly optimistic external forecasts.
Finally, and as always, reliance on regulation and windows of market opportunity has proven fatal for many in the past. To successfully and sustainably invest in this opportunity, taking an economic fundamentals-based view is essential, even if that view can be adjusted for short-term market situations.
For an investor to be successful in this sector, both a holistic and flexible approach to clean energy infrastructure is needed. Such an approach needs to draw on deep knowledge of the market and provide suitable investment solutions to address industry needs, institutional investor requirements, and the challenge of climate change alike.