Peter Bachmann, Managing Director, Sustainable Infrastructure, Gresham House, outlines the opportunities for private market investment in the clean energy transition.
There is increasing pressure on governments, institutional investors and listed companies to tackle climate change and demonstrate their commitments to reducing their negative impacts on the environment. One of COP26’s focus areas is the clean energy transition, ensuring that we will be able to shift from fossil fuels to renewables in a sustainable way. There is undoubtedly significant pressure on public finances to deliver on their commitments, which has led to increased demand for private finance to support the shift.
As the landmark report by the Intergovernmental Panel on Climate Change (IPCC) highlighted earlier this year, we have less than 11 years to reduce greenhouse gas emissions, creating an urgent need to invest in renewables and the infrastructure to support this transition. The International Renewable Energy Agency (IRENA) estimates the total capital needed to achieve a net zero world is up to US$130 trillion.
But public deployment isn’t moving at the pace our planet needs. Of the UN’s US$100 billion commitment from developed countries to tackle climate change in developing countries, only 34% of the UN’s climate projects have been funded by the private sector. This has created significant opportunities for private markets to support global funding efforts.
Reducing pressure on public funding
The private markets are an area of growth which has also been highlighted in the lead up to the COP26 conference in Glasgow. The opportunities for investors in the private markets are significant, to support advanced economies and international banks in financing the global shift towards greener technologies and allow smaller companies to rapidly scale and deliver innovative solutions for a more sustainable world.
For example, agriculture must become more efficient to protect our global food supply; housing needs to be built with more sustainable materials and retrofitted with low carbon technology and waste production needs to be reduced or be seen as an energy resource.
The International Energy Agency (IEA) recently predicted that 70% of funding the clean energy transition will need to come from private finance, to reduce pressure on public funding from developed nations. Investor allocations from institutional and retail investors to private markets are steadily increasing, but they need to ramp on a huge scale otherwise we will not mobilise enough capital to invest in the new sustainable solutions. We need allocations to increase materially in clean technologies to support decarbonisation through investments in areas such as sustainable infrastructure, renewables, battery storage and vertical farms.
Recent figures by research company Preqin reported that over the past five years, private investment into Europe-based infrastructure has reached almost €250 billion assets under management (AUM). This points to increasing demand for infrastructure from both retail and institutional investors. Both types of investors see value in the asset class and are becoming increasingly familiar with alternatives.
Focus on sustainable outcomes
The private markets hold several advantages that are increasingly attractive to investors. While public companies must play a significant part in tackling carbon emissions and have access to the capital needed to invest in change, investors cannot always be sure that public companies or public funds will invest in ESG or sustainable initiatives. Furthermore, unless an investor is investing in a public company or fund that is investing in new/greenfield assets, there isn’t any additionality.
While this can also be the case with private markets, which is subject to less regulation than listed companies, investors typically benefit from substantially more control over private companies which aids focus on sustainable outcomes. We need vast scales of all-new low carbon products and services to truly impact our rapid need to decarbonise and therefore need both public and private capital to facilitate this.
Investing in greenfield clean energy projects is a very time-consuming process and requires patient capital due to the delays in earnings from construction projects. The private markets can support a more patient deployment of the huge volume of capital needed for this clean energy transition.
Areas of private market investment such as sustainable infrastructure and renewables can be invested in through unlisted and private market funds such as the British Sustainable Infrastructure Fund (BSIF). These offer low correlation to public markets, highly predictable cashflows and are positively linked to inflation.
Smaller companies are more nimble, able to innovate more quickly and may be better able to drive progress by identifying and developing innovative climate solutions. However, this area of the market requires substantial investment to scale the solutions that will help bigger businesses to decarbonise sooner. These highly innovative companies are also developing new technologies that can replace existing high-emitting industries and provide solutions for the future.
Undoubtedly, some challenges remain for investors wanting to allocate to private, sustainable investments. The lack of uniform sustainability reporting and measurement can be an obstacle for institutional investors, who are increasingly required to demonstrate that they are taking tangible actions to contribute to the transition to a low carbon economy. Additionally, access to private and unlisted funds remains limited to a small pool of investors, so access must be improved to drive progress.
Fund managers will need to consider how they can enable a wider pool of investors, such as the defined benefit and defined contribution pension schemes, to access the private market strategies which have the most chance of creating additionality. There is over €8 trillion alone in pension funds in Europe that need to be unlocked to meet the global decarbonisation challenge.
Private markets investment is yet to reach its peak, but we are seeing increased recognition from investors of its potential. Until now, private companies have lacked the funding they need to scale, but we have seen investor allocations begin to shift as net-zero ambitions grow. While significant capital still needs to be driven by the public markets and the government, the private markets have an opportunity to drive real change as we shift towards clean technologies and a more sustainable future.