Even as the Covid-19 pandemic drove the global economy into a recession, 2020 was a good year for renewable energy as an asset class. With new tailwinds promising to bolster the sector, we believe that 2021 will see an even greater upswing of interest from the capital markets.
Despite numerous headwinds, the global economy continued its transition toward renewable energy in 2020, with a record amount of new installed capacity around the world. The health of the sector stood in sharp contrast to both infrastructure and fossil fuels, and the subsequent flight to quality translated into floods of capital as installations continued to rise in spite of the economic and social disruptions caused by the coronavirus pandemic.
Overall, low-carbon investments – which cover renewable power and other technologies that reduce reliance on fossil fuels – increased by 9% in 2020, according to an analysis by Bloomberg New Energy Finance (BNEF). And this upward trend looks set to continue. According to a recent survey by Octopus Capital, global institutional investors plan to increase their allocation to green energy from 4.2% of their overall portfolio to 8.3% in the next five years, and 10.8% in the next decade.
AN ATTRACTIVE OPTION
One of the key drivers behind this is the surging demand for clean energy amid political pressure to meet the ambitious objectives of the Paris Agreement, an international climate commitment to keep the global temperature increases below 2%. According to Goldman Sachs, meeting those commitments will require up to US$30tn in clean-energy infrastructure investments by 2040 alone. The investment bank expects this clear growth trajectory to push spending for renewable power projects above spending on upstream oil and gas this year – the first time in history that this has been the case.
PREDICTABLE, STABLE, AND COMPETITIVE
But beyond growing demand for renewables, there are numerous other factors at play that are driving greater numbers of investors to enter the sector. The first is its stability. Traditional energy producers rarely enter pricing contracts that span decades. Renewables producers, on the other hand, can, thanks to the inexhaustibility of their energy sources.
The Octopus Capital poll, which covered investors from across the globe with combined total assets of US$6.9tn, found that more than half of respondents view the predictability of green energy as a reason to capitalize on the market. Historically, and as was best illustrated with the unprecedented day in 2020 when the oil price turned negative, prices of fossil fuels, and by extension, fossil fuel-based electricity, have been wildly volatile.
The cost of renewables, meanwhile, has become increasingly competitive with fossil fuels, as new technologies including bifacial solar panels and trackers are helping improve efficiency. Consequently, the levelized cost of energy (LCOE) from solar has plummeted from US$359 in 2009 to an average of US$40 a decade later – an 89% drop. According to Marcel Alers, UNDP head of energy, “It is now cheaper to go solar than to build new coal power plants in most countries, and solar is now the cheapest electricity in history.”
Investors are also being drawn in by the promise of outsized government spending and tax breaks for green projects, as economies worldwide seek to return to growth. For example, upon taking office, newly-elected US President Joe Biden unveiled a US$2tn clean energy investment plan, aiming for 100% clean electricity by 2035. Meanwhile, on the other side of the Atlantic, the European Union’s Green Deal includes US$572 billion earmarked for spending on green projects, among them renewable energy generation.
RISK VERSUS REWARD
Another factor is the risk involved in fossil fuels versus renewables. A recent study by the University of Oxford’s Institute for Energy Studies asked institutional investors including asset managers, hedge funds, and private equity investors in the US and Europe what the minimum hurdle rate they would require to invest in different energy projects, and found that investors are now expecting higher risks in oil and gas projects in comparison to solar and wind projects.
Indeed, for 2021, Goldman Sachs puts the hurdle rate for today’s fossil fuel projects at up to 20%, versus just 3-5% for renewables, demonstrating not only that issues such as the potential for stranded fossil fuel assets have become a key concern, but also that renewable energy is no longer seen as a fringe bet, but rather a mainstream asset class.
The macroeconomic outlook also favors renewables. As governments continue to implement Covid-related financial packages, interest rates are set to stay lower for longer. Meanwhile, stalled economic expansion has resulted in a general scarcity of high-yielding investment opportunities, leaving investors seeking out long-term, low-risk investment – which renewable projects, and solar in particular – offer in spades.
As a result, half of the investors surveyed by Octopus Capital said they expect renewable energy to generate market-beating net annual returns of 5-10% over the next 12 months, and fully 80% saying they plan to increase allocations in this sector over the next three to five years.
In Latin America, we are seeing a similar trend play out as investors seek out opportunities in renewables to meet their quest for yield. In particular, projects with revenue opportunities that are contracted for longer periods of time, and for a greater proportion of generating capacity, are becoming increasingly attractive.
GOING GREEN HAS BECOME AN IMPERATIVE
The near-inevitability of carbon pricing as well as growing pressure on firms to report on climate risk have also seen investors begin to refine their portfolios in order to avoid future losses, shifting away from fossil fuels, both upstream oil and coal, and replacing these with green plays.
According to BlackRock, the world’s largest asset manager, from January through November 2020 investors in mutual funds and ETFs invested US$288bn globally in sustainable assets, a 96% increase over the whole of 2019. In his recent 2021 letter to CEOs, Larry Fink, the firm’s chairman, and CEO announced the firm would now implement a “heightened-scrutiny model” in its active portfolios as a framework for managing holdings that pose significant climate risk, including flagging holdings for a potential exit.
Certified green investments in line with standards such as the Green Bond Principles and Green Loan Principles are also taking hold within the market. At Atlas, we have implemented our Green Finance Framework in our recently announced projects, and we are seeing a growing trend in the number of investors who seek to participate in green finance instruments, including bonds and loans.
Accordingly, as investors take stock of the extent to which climate risk is investment risk, renewables projects have become an attractive alternative for infrastructure and energy investors alike.
A BRIGHT FUTURE
Against all odds, the global shift to renewables continued apace last year, and this trend shows no signs of slowing. Given all the growth ahead, we believe that renewable energy offers the potential for market-beating returns in the months and years to come, and we expect to see no shortage of interest from investors looking for stable, predictable investments that align with their ESG-related goals.