As nations realise the inevitable task of shifting their energy demands away from traditional fuels, the risk-reward profiles for renewable energies become increasingly enticing. Renewables are now taking the lion’s share of new global power generation investments, 70% from a total of $580 billion spent in the sector. And while there are positive signals for the uptake of renewables and alternative fuels, there remains an uncertainty around how the market may develop throughout the transition – can the returns of these alternative assets hold up against rising oil and gas prices?
While each investor will hold different motivations for what whets their appetite, it may be possible to isolate some areas within the renewable markets that may attract the excitement across the spectrum. Solar PV has soared to new lows, capital and installation costs continue fall and solar power auctions have brought consumers record low prices per kWh. Wind capacity expansion doubled in 2020, with offshore wind farms growing in utility-scale popularity. Green hydrogen, on the other hand, remains a costly ambition.
And although renewable power generation is enjoying a surge in popularity, the introduction of alternate fuel supply has been far less impressive; in 2020, 84% of fuel supply investments were still to oil and gas, 14.5% to coal and just 1.3% to low-carbon fuels. There remains a divide in how the deployment of capital is encouraging the energy transition.
Who is investing?
As a report by the IEA and Imperial College notes, McKinsey has estimated $1.6 trillion will be spent by institutional investors on renewables projects, with just 1.3% of that total going towards “pure play” RE companies, while just under 30% traded on publicly available assets and about 70% on privately held assets. The concern herein is that there is a lack of transparency from institutional investors on their true, ‘clean, green’ assets and their returns.
The report continues to state that, “the depth and breadth of listed capital markets mean they often act as a proxy for rates of return”. So while we have incomplete information for the majority of RE assets, we can rely on a proxy to determine a ballpark figure.
The approach by institutional actors versus private equity firms or venture capital investors is somewhat different; institutional actors have mandates for development and long-term commitments to projects – they view the long-term outcomes as the priority. VCs and PE firms on the other hand, “assess the risk profile of early stage or pre-construction assets. They typically build up a position and then sell on the operational assets once they each a critical quantum to a drop-down fund or institutional capital”, according to David Maguire, Founder of BNRG Renewable in a recent interview with the Climate Council.
PE firms will seek to make their profits on the initial growth period of RE assets, before distributing to institutional asset holders. While this facilitates the development and deployment of renewables, it also raises the capital costs beyond where they should be.
Returns in different regions
The IEA and Imperial College study also looked at the returns across four developed economies of the UK, USA, France and Germany found that the returns on investment (RoI) of renewables generation vastly outstripped fossil fuels over the last 5-year and 10-year periods. These provide a baseline for developed, Western economies, however we have seen that the RE LCoE of many developing nations (India, China, Chile, Egypt) can beat out their Western counterparts.
The report highlights that of the 165 RE companies in the USA, they produced Total Returns (TR) (on the financial value of their portfolio) of 65% over a 5-year period. The Average Annual Returns (AAR) was 10.1%, while the Annualised Volatility (AV) sat at 26.7%. Compared to the fossil fuel sector, where TR was at -9.6%, AAR -2.9% and AV at 28.3%. Renewables may finally be stepping out ahead of fossil fuels.
These differences on returns appear consistent in the West; in the UK the Total Returns for RE are 75% over the 5-year period versus fossil fuels are at 8.8%. AAR is 11.1% renewables versus 0.2% fossil fuels. And a 10.5% AV for RE versus 25.6% for FFs.
The IEA’s World Investment Outlook 2021 concurs, “Clean energy companies have performed well on financial markets, with renewable power companies outperforming both listed fossil fuel companies and public equity market indices in recent years, and with lower volatility”.
Now that the costs are being achieved, the infrastructure and scalability need to catch-up and provide the consistency of generation, storage and transmission that will truly set renewables ahead of fossil fuels.
Where to from here?
The expansion of the energy transition within the last year (largely due to Covid), has created a range of market dislocations that have resulted in a boon for energy investors; especially in the fields of clean energy technologies and efficiencies. An estimated $750 billion will be spent in this arena in 2021 and while renewables are expected to increase their installed capacity in 2021 – the reality is that fossil fuels, particularly natural gas and LNG, will also grow.
Energy investors, particularly those with clean energy ambitions, should consider their investments can also radically impact high emissions sectors. One need not invest in coal or oil production, however investing in carbon capture technologies, hydrogen regasification technologies or to create efficiencies in fuel transport, building materials or processes, electrification of fossil fuel production – will all facilitate the faster uptake of renewable power sources going forward.
We must consider that to accelerate divesture of oil and gas too quickly, may have the adverse effect of creating unaffordable energy prices for consumers – as we drive down supply instead of dealing with the growing demand for oil and gas by-products. Regardless, renewables provide the answers for both power generation and O&G decarbonisation. For those who seek a diverse portfolio of assets, there are ‘clean, green’ avenues within O&G investment, but for the ‘clean, green’ purist the returns will justify the commitment to saving the atmosphere
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Charlotte Aubin- 25 years of experience in environmental infrastructure investment, international financial asset management, including 12 years dedicated to international and Sub-Saharan Africa renewable energy and energy transition.
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A superb Q&A with Eoin Murray, Head of Investment at Federated Hermes - an investment manager with an exceptional global experience in the energy sector. Federated Hermes is a leading investment and stewardship firm with a vast portfolio of diversified asset under management. read more
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While each investor will hold different motivations for what whets their appetite, it may be possible to isolate some areas within the renewable markets that may attract the excitement across the spectrum. Solar PV has soared to new lows, capital and installation costs continue fall and solar power auctions have brought consumers record low prices per kWh. Wind capacity expansion doubled in 2020, with offshore wind farms growing in utility-scale popularity. Green hydrogen, on the other hand, remains a costly ambition. read more
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