Banking on Climate 

July 2020

Many investors and energy executives are dusting themselves off after the first, and hopefully only, major Coronavirus wave.  It is timely to raise some fundamental questions around what this all means for renewables going forward.  What now for new-build renewables projects? How should asset managers manage funds given the lessons learnt over the crisis? How can management teams handle their businesses to ensure they hit their own benchmarks?

CIOs of allocators, asset-class heads, portfolio managers and corporates are already looking to answer some of these questions and work out how to manage their near and long-term activities against this new backdrop.  Working out how to do so requires active engagement from banks and the Energy Council wanted to explore how both they, and asset managers, are providing debt and innovative capital products and how they are responding to very different circumstances than the ones laid out in their commitments published as recently as March.  

Against this backdrop, the current crisis has acted as a catalyst for some energy executives.  As one Energy Council member remarked, “the best time to have started this energy transition was some while back, but a close second is probably today”. 

Finding pockets of value and frontier opportunities 

Investors continue to observe a broad range of asset opportunities, but are having to look more than ever at their own internal hurdle rates due to a sharp decline in energy prices.  The last few years have been characterised by a wall of institutional capital competing and chasing an ever-dwindling supply of high-quality assets, and this is set to increase given renewable investment strategies have held their own over the past few months. This will impact asset managers. In particular, large pension and insurance funds investing directly will continue to drive value out of the market, and may start to spill over to impact the growth equity and venture capital side of the business. 

More and more investors will try to capture better returns by taking on increased development risk earlier in the life cycle of the renewables project.  Investors increasingly will have to take on more merchant risk driving overall returns to stay relevant as contracts get shorter; and take this on different assumptions than they did a few years ago. It is here that banks will once again play a pivotal role as they will look to help investors structure these risks to get the returns they need over the life-cycle of assets; the enhancements that storage can give to solar and wind being one such way.

Additional and new technology opportunities are coming to market, but many of these new areas still need defined business models that will enable them to become fully scalable, sustainable and commercial.  This are often found in the so called “Phase 2” technologies; those that focus on heat and industrial decarbonisation, grid stabilisation, community solar and utility-scale energy back-up.  As costs come down, more investors and counterparties, who are willing to work on contracts that are becoming more and more competitive, are entering these markets.  Urban mobility is one such area where asset quality, proven technology and demand dynamics are good, and yet it hasn’t seen the swathes of institutional capital and YieldCos of other renewable segments. 

We are also seeing an interesting dynamic in the U.S. where corporate renewable power purchase agreements have soured in recent times.  Utilities, in an effort to no longer remain side-lined, are stepping back into the market in response to this shift and are doing so by taking direct control of assets in order to offer their corporate customers 100% renewable power.  This is supporting power developers as utilities buying the projects directly in order to procure renewable power.  

Questions still remain such as what is required to get investors to commit to a project given risk and associated return linked to renewable projects? And how can investors become more comfortable with merchant risk as long-term PPAs drop off? 

The products that banks are most excited about?

There is no single way of investing and many clients are asking banks to do a variety of different things.    As the renewable investment market returns however, there will be a different set of expectations and a set of new requirements from investors, with a particular focus around stable returns.  Banks are responding by broadening their own products and platforms in order to not be ‘greened’ out of the evolving landscape.  Nature based financing solutions is one such demand driven product that is attracting more investors and which is mixing public and private balance sheets to fund suitable projects.  Suitable capital market products, including green bonds and sustainable linked loans, are examples of the products being developed by banks as they endeavour to follow the market. 

Banks recognise more than ever that if they want to fully fund the transition post Covid-19, they need to move away from largely binary solutions and move to solutions that mix several different products.  There is a need for greater cooperation between commercial banks and the public sector of course, but also between different areas within financial markets including asset management and the insurance sector.  There is also an opportunity for growing and adapting a number of alternative solutions, for example blended finance solutions, that use philanthropic concessional funding with private capital. 

Conclusion

The energy transition is a process not an act and its important therefore that we find incremental solutions that make sense financially, have the lowest impact on governments and have broadest technological reach.  The connection between renewables, sustained returns and value is changing.  This follows a general trend that sees a narrowing of the gap between investors and corporates, and sees investors becoming more directly involved in renewable projects through direct investing.

Many of our Energy Council members believe that we are now at the start of a major period of capital reallocation around climate risk. This in part will be driven by the ongoing success of ESG funds, but also through successive governments using this period to ‘fire’ up their renewable programs beginning with a fresh round of stimulus packages aimed at the sector.