Investors Target Emerging Markets For Climate Impact

Lower costs of renewable energy infrastructure projects bring fresh opportunities for investors looking to make the biggest difference to climate emergency.

With the cost of renewable energy projects such as wind and solar farms cheaper than that of their fossil fuel equivalents, there are increasing opportunities for institutional investors to achieve long-term, stable returns on investment. However, progress on closing an estimated overall sustainable infrastructure investment gap of more than US$3 trillion a year over the next ten years has been slow.

It is likely to accelerate following Monday’s release of first part of the Intergovernmental Panel on Climate Change’s sixth climate assessment, which emphasised the importance of rapidly moving away from fossil fuel use, for all purposes including power generation. Nevertheless, investors will rightly continue to consider the factors that will deliver long-term returns.

According to FAST-Infra, a private/public group of financial institutions, governments and NGOs, the generation of bankable projects – involving renewable power, green transport, sustainable water and waste, and green buildings – is expanding. But today the situation remains “inadequate and sub-scale”. Financing of infrastructure projects is limited and lacks sufficient investment from the private sector, which is crucial to bridging the investment gap, the group argues.

The group – which includes HSBC, JP Morgan, BNP Paribas and Macquarie – is developing a Sustainable Infrastructure Label (SI Label), which will help institutional investors to identify which assets are genuinely sustainable and will drive investment into sustainable infrastructure in emerging markets. In July, the Sustainable Markets Initiative’s Financial Services Taskforce, along with State Street and Lloyds of London, wrote an open letter endorsing the Label and encouraging interested parties to engage with it.

Clean energy infrastructure in emerging markets

Investment in renewable energy infrastructure in emerging markets is particularly important, with the world’s energy and climate future increasingly hinging on the successful transition to cleaner energy in these markets, according to a report by the International Energy Agency.

Carried out in collaboration with the World Bank and the World Economic Forum, the report says annual clean energy investment in emerging and developing economies needs to increase by more than seven times – from less than US$150 billion in 2020 to more than $1 trillion by 2030 to put the world on track to reach net-zero emissions by 2050. “Unless much stronger action is taken, energy-related carbon dioxide emissions from these economies – which are mostly in Asia, Africa and Latin America – are set to grow by five billion tonnes over the next two decades,” says the report.

Fatih Birol, IEA Executive Director, said greenhouse gas emissions are rising while clean energy investments are faltering in many emerging and developing economies. “Countries are not starting on this journey from the same place – many do not have access to the funds they need to rapidly transition to a healthier and more prosperous energy future.”

The report calls for a focus on channelling and facilitating investment into sectors where clean technologies are market-ready, especially in the areas of renewables and energy efficiency, but also laying the groundwork for scaling up low-carbon fuels and industrial infrastructure needed to decarbonise rapidly growing and urbanising economies. Other supporting actions include strengthening sustainable finance frameworks, addressing barriers on foreign investment, easing procedures for licensing and land acquisition, and rolling back policies that distort local energy markets.

The role of private finance

According to ThomasLloyd, an infrastructure-focused investment manager, the public policy backdrop in Asia is increasingly supportive of renewable energy infrastructure, with governments following the lead of more developed economies that have recently made net zero commitments. India, for instance, has targeted 450 gigawatts of renewable energy capacity by 2030. However, public funding will not be sufficient to fill the clean energy investment gap, with 70% of capital required from the private sector.

Assaad Razzouk, Chief Executive Officer at Singapore-based clean energy company Sindicatum, says private sector investment in renewable energy infrastructure has been lagging for years. “The private sector has done a bit on the debt side, but the big problem is on the equity investment side,” he says. “Renewable energy projects in emerging markets tend to be small and distributed, which is challenging for equity investors.”

The perceived cost of capital with regard to renewable energy projects in emerging markets is changing, but “multiple fails in this space” remain. Razzouk notes that investment in publicly-listed fossil fuel companies far outweighs that in renewable energy companies. “The publicly listed markets are not really playing a role at the moment.” The only way to change this, he adds, is for a price to be put on the externalities of the fossil fuel infrastructures.

Tony Coveney, Lead of ThomasLloyd’s Infrastructure Asset Management team, says emerging markets in Asia offer significant opportunities. “The demand for power generation in Asia is the outcome of population and economy growth as well as increasing urbanisation,” he says. “There’s a feedback loop – you cannot urbanise without power, which makes urban life tolerable.” There also has been a “paradigm shift” in the credit-worthiness of these emerging markets. The perception of risk in these markets has changed, he says, with secure, long-term and fixed-price agreements established with governments and semi-government bodies. “Institutional investors are becoming aware of this and understand the arguments for investment in these projects and countries more clearly.”

Whereas European and North American economies rely on subsidies and other “artificial measures” to move electricity generation from fossil fuels to renewables, Asian economies are different. “Creating power from renewables is fast growing in these markets because it is now cheaper than fossil fuels and it is necessary – these markets have to generate power and they don’t rely on subsidies to build infrastructure,” explains Coveney.

Europe has spent the past 30 years mitigating climate actions, he adds, while Asia has undergone its own industrial revolution based largely on fossil fuels. Asia has 50% of the world’s population and has a ‘carbon cost of GDP’ (calculated as CO2 emissions per trillion dollars of GDP) more than four times greater than the largest countries in Europe, according to ThomasLloyd estimates.

The asset manager urges investors to focus on deploying capital into the markets where it will achieve its greatest impact. “Every US dollar invested in emerging Asian countries saves up to five times more CO2 than in Europe,” the firm says.

Alex Araujo, manager of the M&G Global Listed Infrastructure Fund and M&G Global Themes Fund says infrastructure is “an unruly asset class” as it is so often exposed to change; electricity generation, for example, is still the biggest contributor to greenhouse gas emissions. “The caveat is that there are also many exciting opportunities in transitioning, particularly with electricity production.”

Renewable energy is a key asset class for M&G, he says, because the returns are “robust” despite a “huge set of requirements”.

Net zero commitments as investment drivers

The bulk of financing required to address climate transition and adaptation to net-zero carbon emissions by 2050 will be allocated to sustainable infrastructure assets, such as renewable energy, and to upgrade existing assets to function in a 2°C temperature increase scenario, says Fitch Ratings.

The ratings firm expects the issuance of green infrastructure and project finance bonds to rise as more governments make net-zero commitments. This will affect infrastructure associated in the production, transport and use of fossil fuels and could constrain medium- to long-term profitability and capital access for infrastructure asset owners. “Fitch considers oil production and refining, liquids transportation, oilfield services and coal-fired power generation to be highly vulnerable to climate-related financial risk,” the company said.

There has been consistent demand for high-quality green bonds in recent years, says Fitch, adding that green project finance bonds can limit an investor’s exposure to non-green activities compared with green corporate bonds, where the issuer may have carbon-intensive operations outside of the bond’s specific use of proceeds. “As banks increasingly impose negative screening policies on fossil-fuel related activities, reallocation of capital towards sustainable investments can meet requirements under new climate-focused financial regulations,” the firm says.

Analysis and advisory company Climate Policy Initiative (CPI), also a founder of FAST-Infra, has proposed the use of municipal green bonds (public-sector or government-backed bonds that support positive climate benefits) to help address investment gaps in Indonesia’s energy transition plans. A report highlights how large-scale projects built on government assets are necessary to achieve scale and attract private investments in the long term.

“Despite their potential, Indonesia’s capital market is yet to see the issuance of municipal green bonds due to multiple challenges,” says Tiza Mafira, Associate Director at CPI. “Complex bureaucratic procedures in the subnational regions as well as the lack of adequate finance stood out as the core hurdles in our study, despite recent efforts to erase the need for parliamentary approval of municipal bonds.”

The importance of a stable policy environment

Policy stability is vital characteristic of infrastructure projects because of their long-term and inflexible (the infrastructure cannot be used to produce anything else) nature, says Dr Simon Crook, Investment Director of Earth Capital, a global private equity group that invests in the development and deployment of clean sustainable technology. “Infrastructure investors are always seeking stability and they don’t want governments to change the rules or shift the goalposts. If there are too many changes, investors will be less likely to fund projects.”

In energy generation there are many renewables-based solutions to solve many climate-related problems. The challenge, says Crook, is to connect the two through business models that provide reliable revenue streams to attract the expertise and funds available in the private sector. “The IPCC report has shown that we need to do everything pretty quickly to address climate change, but there is a huge swathe of opportunity out there.”

China and India are interesting case studies of what other governments should do, says Sindicatum’s Razzouk. Both governments have set clear frameworks, don’t change the rules and facilitate renewable energy developers by helping them to secure land and permits, in much the same ways as governments have done for oil and gas companies.

Stable policy making, with the right regulatory structure in place and the promotion of renewable power, is important to remove uncertainty for investors, says Lisa Pinsley, Director, Head of Africa, Energy Infrastructure at Actis. “Investors need to know that long-term contracts will not be subject to change or renegotiation due to a change in government policy,” she says. “This applies to both investment in power projects selling to government-owned utilities and power projects selling to companies such as manufacturers and mining companies.”

Actis, a global investor in sustainable infrastructure, manages about US$1 billion in investments in renewable energy infrastructure in Africa, over 50% in renewable energy, and is looking to double that in the coming years.

“Africa has the lowest electrification rate in the world, with less than 50% of people having access to electricity and also has the lowest consumption rate of power per person,” says Pinsley. “There is a huge demand for additional power generation in the continent, starting from a low base rate.”

There is an awareness and a debate about the need for a baseload complement – most likely thermal power such as natural gas – for the development of renewable energy (the supply of which can be intermittent) in Africa, says Pinsley. Without this, the growth of renewable energy could be hindered. “This need for gas-fired power is controversial with climate purists who don’t support any new thermal generation. However there is sometimes a conflict between poverty alleviation goals which increase access to power and the climate imperative to only add new renewable power generation, and it is important for a practical approach to be taken,” she says.

Razzouk believes that over the next two to three years there will be more action in renewable infrastructure investment by institutional investors in emerging markets. “There is an increasing sensitivity to the net zero goals of governments and institutional investors are also more aware of ESG issues than they were two years ago. The big issue is no longer whether renewable energy will happen but the speed at which we need to accelerate the transition to it.”

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