Climate change: the race is on, and clean energy investment is ramping up

Kay Hobbs, partner at UK law firm TLT, says the finance sector is stepping up to invest in green energy

TLT. Kay Hobbs, Bristol. 20 January 2014.The recent report by the Intergovernmental Panel on Climate Change (IPCC) made for grim reading. It declared that climate change was now inevitable and irreversible and that humanity was losing the race to limit global heating to 1.5 degrees Celsius above pre-industrial levels, as had been agreed at the COP21 Paris climate agreement of 2015. The task ahead is both extremely challenging and incredibly straightforward – to drastically reduce greenhouse gas emissions.

While this may seem like a daunting feat, expectations are running high in the build-up to COP26 and governments have increasingly been stepping up – Earth Day 2021 saw the most significant renewal of promises to combat climate change by national governments since 2015 and the hope is that COP26 will deliver another wave of ambitious targets. So far this year, the US and Canada have pledged to reduce their carbon emissions by 50% and 40-45%, respectively (on 2005 levels), Japan has pledged to reduce emissions by 46%(on 2013 levels), while the UK and EU have vowed to cut emissions by 78% and 55%, respectively (on 1990 levels), all by the end of the decade.

The lead-up to COP26 has also seen the formation of new groups set to play a crucial role in mobilising the global financial services sector. These include the Glasgow Financial Alliance for Net Zero, which will see financial institutions with $70 trillion of assets under management register for science-based carbon-reduction certifications, and the UK Infrastructure Bank which aims to tackle climate change, support regional and local economic growth and accelerate investment by deploying an initial £12 billion of capital into infrastructure projects.

Given how fossil fuel energy remains the most significant source of carbon emissions, investment needs to continue to be channelled into the development of clean energy and green infrastructure. Continued technological innovation, deeper capital pools and competition are making clean energy and green infrastructure a competitive and attractive investment prospect.

Banking on renewables

With ESG a significant boardroom priority across the financial services sector, debt funders are looking to channel funding into green projects. Subsidised clean energy technologies such as onshore wind and solar PV continue to be a safe investment but, with subsidies in the rearview mirror for these technologies, subsidy-free projects and newer technologies such as energy storage and electric vehicle charging infrastructure (EVCI) are generating increased interest from lenders. However, the challenge for debt funders is negating the risk posed by the lack of guaranteed revenue streams that FiT and ROC accredited projects have traditionally enjoyed.

Even for those more established technologies where the funder is comfortable with the technology – like onshore wind and solar – debt funding subsidy-free schemes can still face some challenges. For new technologies such as EVCI, green hydrogen and energy storage, not only is there the risk associated with banking unknown and relatively unproven technologies, but there is also the revenue stream risk.

However, funders are feeling the pressure to find a way forward and finance green. As ESG becomes a boardroom priority, there is a need to demonstrate to a wide range of stakeholders – from investors and regulators to consumers and employees – that they are gearing towards sustainable investments. This in turn is increasing competition in the market as more players look to diversify lending portfolios into green projects, making clean energy projects and green infrastructure key lending targets.

The biggest question for lenders therefore is how do I finance green? One of the challenges has been mitigating merchant risk for technologies that do not have established floor revenues and have fluctuating power prices. There have been significant developments on this front with innovative new models that limit risk and help secure viability. For example, in the energy storage space, Santander’s model adopted a multi debt tranche approach to the tiered risk profile of the battery energy storage system revenue model.

Other routes to market include setting floor prices with debt financed corporate power purchase agreements (PPAs) – though these generally require large, investment-grade corporate off-takers – extending loan repayment periods and cash sweeps. Risk can also be mitigated by lending to a diversified portfolio of clean energy projects, encompassing subsidised and subsidy-free schemes as well as established and new technologies.

Unfortunately, there is no one-size fits all model and bankable project modelling is still on a scheme by scheme basis. However, it’s clear that the appetite from funders is there and as more projects are funded and different routes to market are presented, the risk will continue to reduce until funding subsidy-free clean energy projects and green infrastructure becomes the new norm. In addition, the Subsidy Control Bill could open the doors for funding into newer technologies such as carbon capture and storage and green hydrogen where there is still a viability gap.

In short, funders are equipping themselves to take advantage of the significant investment growth in clean energy and green infrastructure projects that underpins the UK’s road to net zero.

Private equity trailblazers

The adage that debt follows equity remains true. Equity investors have been spearheading the growth of clean energy and green infrastructure for years and as lending diversifies into newer technologies, it is the equity investors who are again leading the way.

While subsidised operational onshore wind and solar projects remain highly viable market segments, over recent years many of these projects have been consolidated into portfolios and demand far outweighs availability. When operational projects do come to market – either as portfolios or as single assets – intense competition drives up market price leaving only the investors with deep pockets able to bid.

With operational projects off the table for many, equity investors have been diversifying into non-subsidised projects and newer technologies including energy storage, EV infrastructure and green hydrogen. For those who want the comfort of investing in an established technology, albeit without the security of subsidies, subsidy-free projects which combine onshore wind or solar with energy storage (and EVCI) either from the outset, or the option to add as a future proofing mechanism, are garnering considerable investor interest. The sticking block? Ensuring the viability of each co-located asset to maximise project performance and long-term revenues.

Investors have been quick to recognise the role that storage infrastructure will play in underpinning the clean power of tomorrow and have been at the forefront of funding energy storage projects. Currently, most investors are looking at projects at the ready-to-build stage as this enables them to secure operational projects in a shorter timescale without development risk. However, as competition for projects increases, we are seeing an increased appetite to move to invest at an earlier stage.

Investors entering the project lifecycle downstream is a trend across technologies and is being driven by intense competition to secure viable and future proofed projects that have the flexibility in design, real estate documentation, planning, construction, import and export capacities to both add additional technologies such as storage or EVCI, and extend the scope and life of the project to create fresh revenue streams and boost yields. Investors are looking to enter into partnership arrangements with reputable developers at consent or even greenfield stage. And while this does come with added uncertainty in the early years of a project, it can help secure a pipeline of projects and maximise long-term returns, so it can play out as a very smart move.

Like debt funding, finance green will continue to drive investment into clean energy and green infrastructure and with intense competition and an increasing amount of capital driving the market, equity investors are poised to take advantage of the journey to net zero.

A glimpse of the future

The investment decisions of today reveal the world we will live in tomorrow, so it is vital that in the context of climate change the financial services sector turns its attention towards decarbonising the global energy system. The positive news is that investors of all kind are alive to how opportunity-rich financing green really is and are acting on this knowledge. The challenge that lies ahead is huge, but the seismic shift towards the financing of clean energy over fossil fuels and investment in green infrastructure is well under way and gathering pace. Financing green is good for our planet, our people, and, crucially, it makes good business sense.