Investing in real assets for the energy transition
The global green energy transition is driving the formation of new real assets. This shift toward an asset-rich electric economy is here to stay — but investors need to look out for some pitfalls along the way.
The replacement of fossil fuels with clean energy is the most important element in the decarbonization of our economies. To stem the impacts of climate change, almost all power generation will have to come from renewable sources like wind and solar. This transition is already well under way. By 2030, more than half of the world’s electricity is expected to come from renewable or low-emission sources. Beyond 2030, clean energy is expected to meet all further growth in global demand. As a result, the next 25 years will see an investment boom in clean energy assets.
“The energy transition space is huge,” said Minesh Mashru, Global Head of Infrastructure Investing at Cambridge Associates. He estimates it will require investment outlays of USD1.7 trillion a year, with about USD700 billion to USD800 billion a year going to renewables. “Then there are also huge amounts of investment on other real assets that are transition-related,” he said.
But for decarbonization to be complete, energy-intensive sectors of the economy such as transport and heavy industry will also have to switch to cleaner fuels. This will require using new technologies that are still evolving, like clean hydrogen fuels, and business models that have yet to be proven. For real asset investors this amounts to a classic challenge: a once-in-an-era opportunity bound up with a host of uncertainties and risks.
Political risk — or political noise?
Political risk is part of that challenge, because energy transition is as much about public policy as it is about private investment. On some measures that political risk is rising. This factor is captured in the World Economic Forum’s Energy Transition Index, which tracks transition “momentum” — a combination of current pledges, public policies, and real-world energy transition investments. The Index shows that momentum remains positive, but has slowed significantly in the past two years as some governments and large companies have scaled back their carbon and fossil-fuel reduction targets.
Many investors counter that the shifting politics of energy transition are unlikely to disrupt the longer-term investment trend. What matters is the cost of alternative energy sources, because investors will back the lowest cost of generation, whatever the political mood.
“Regardless of what politicians say, their governments are still investing in transition,” said Vipul Shetty, Head of Energy Transition Solutions at global insurance broking firm Howden. “There’s massive funding in Europe and government support in Asia is starting to increase. The US is still going forward with many carbon capture and hydrogen projects, and Japanese developers are coming in with new technologies. This is all regardless of political changes.”
While politics may blow hot and cold, recent forecasts suggest that energy transition real asset formation will continue at an extraordinary rate. According to the International Renewable Energy Agency (IRENA), cumulative 2024–30 global investment in renewables and associated carbon-reduction technologies under the 1.5°C warming scenario set by the Paris Agreement will need to amount to USD47 trillion.
Energy transition is complexity squared
One of the great challenges of energy transition from an investment analysis perspective is the complexity of the shifts underway. There are multiple interacting power operators, technology developers, supporting infrastructure options, and regulatory uncertainties. The investment analysis workload is high.
“Investment in energy transition can be unusually complex,” said Howden’s Shetty. “If you take the example of carbon capture, there is one developer on the capture side of business, you have another developer on the aggregation side of business, and then another on the sequestration side of business. There are different OEMs and developers, maybe they’re not talking to each other, but the risk is being transferred from one partner to another. That all causes complexity in the value chain.”
Why business models are critical
Very large investment flows into transition-related real assets may seem near inevitable — but which investments deliver an acceptable mix of risk and reward is another matter. This is an area where granular analysis of the underlying viability of transition technologies and projects is vital. Project costs, ongoing operating costs, likely demand, and demand stability will determine the exact path of the energy transition and the viability of transition assets.
“For example, you may be able to produce renewable power, but you do have to sell it to someone and you need to know what price you’ll get,” said Mashru of Cambridge Associates. “That’s an investment risk issue, but you can mitigate that risk. If Amazon or Microsoft is your largest buyer under a long-term contract, then these are more or less triple-A companies and you can be comfortable that you will get your contractual value, supporting your expected return.”
While the total investment needs of the energy transition are very high, a relative shortage of investments that will deliver a clear return means there’s a risk of investment overcrowding. “There is inevitably a tendency to see capital focused on those projects that are clearly bankable, and you can end up with a kind of gold rush into places like Chile or Brazil, for instance,” said Andres Garcia-Novel, Chief Investment Officer, Global Lead, Energy Networks & Infrastructure at the International Finance Corporation (IFC). “There’s a risk of overshoot and over-investment in specific segments, sometimes taking the system out of balance. The bottleneck for impact is clearly not the lack of funding but rather the lack of investable, bankable opportunities. In the end what’s important is to understand the risks and mitigate them — and to do that in specific national contexts.”
Uncertainty is the only certainty
There may be consensus that energy transition is already driving an unprecedented wave of real asset formation across the globe, but that tells investors little about potential rewards. The rate of technology and policy change is so fast that an informed scrutiny of risk, and whether risk matches investor needs and mandates, is essential.
“I think the thing to understand about this is that decarbonization creates all kinds of different assets and all kinds of different risk profiles,” said Rob Martin, Global Head of Investment Strategy and Research, Private Markets at Legal & General Asset Management. “That means for an investor it’s very much about identifying what their risk appetite is and how to bring together the opportunities that the market creates with the objectives that the investors have.”
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