It is one thing to argue about shifting to a low-carbon economy, but quite another to make it happen. The shift requires massive investment in new types of infrastructure to tap and distribute energy from sources such as solar, wind, hydro and biomass. Wind farms and solar parks are starting to dot the landscapes of many countries, yet sustainable energy sources still account for a fraction of overall energy supply. Much more effort will be needed if these infrastructures are to scale up and eventually displace the likes of polluting coal-fired power stations and curb greenhouse gas emissions.
In fact, in the next 20 years over US$50 trillion in cumulative capital expenditure on energy supply and energy efficiency will be needed to place the world on a path consistent with a 2°C increase in temperature, the limit widely accepted to prevent catastrophic climate change. That is a lot of money–roughly equivalent to the GDP of the entire OECD area.
On the other hand, as the International Energy Agency (IEA) points out, the money invested would be more than offset by the massive fuel savings that would occur in a low-carbon scenario. Other studies back this view, arguing that, as energy investment would be needed anyway, there would be a lower net cost of shifting to low-carbon and climate-resilient infrastructure rather than continuing to invest in fossil-fuel sources, locking in economic systems and furthering greenhouse gas emissions.
The bottom line is that investing in sustainable energy infrastructure would be an investment in the planet’s future, so the real question is not if, but how to raise the finances. For that, policy makers need a clear view of the array of public and private financing channels available, both domestically and internationally.
Moreover, with public budgets squeezed and balance sheets of utility companies affected by falls in asset prices and market capitalisation, a range of private-sector sources will have to be tapped.
One crucial and promising source to look to is institutional investors, such as pension funds, insurance companies and sovereign wealth funds, as these manage very large savings and investment funds. In OECD countries institutional investors held some US$93 trillion in assets in 2013, and this amount has continued to grow since. However, their involvement in low-carbon energy investments has been minimal at best. Take pension funds, for instance. These had inflows of some US$2.3 trillion in 2013, but the large pension funds surveyed by the OECD put just 1% of their assets directly into infrastructure of all kinds that year (excluding listed shares, etc), and just 3% of that total amount went into sustainable energy projects.
This may seem surprising. After all, energy is a profitable sector, and there is ample ground to believe that sustainable energy will prove to be no exception, particularly when taking lower operating costs and no fuel costs, as well as health benefits, into account.
What can policy makers do to encourage institutional investors to unlock more funds and help scale up the low-carbon energy infrastructure that the global economy needs? It is a question that lies at the heart of an OECD report, Mapping Channels to Mobilise Institutional Investment in Sustainable Energy: An OECD Report for G20 Finance Ministers and Central Bank Governors.
Institutional investors may have their toes in the water, but climate change cannot wait, and convincing them to take the plunge sooner rather than later is the rub. For this, they need to be persuaded not of how green or clean an asset is, but what its risk-adjusted financial performance will look like over time. They need to feel confident that the investments are bankable, with “pledgeable” future income streams for themselves and their clients.
There are fast answers to this. For instance, unlike fossil fuels, sustainable energy sources are attractive because they are generally not subject to price volatility. Another comfort is that wind and solar projects have a 25-year lifespan, and often come with manufacturer warranties, power purchase agreements and government support, with mandates to encourage long-term contracting. Another argument is future public demand: consumers are increasingly anxious about the climate and pollution impacts of fossil fuels, which will affect long-term strategies for institutional investors, as will the energy security costs of fossil fuels.
Despite such arguments, institutional investors remain cautious. They see too many regulatory and market barriers in the way that create risk and render alternative investments, such as real estate, more compelling. Some countries restrict pension fund investment in infrastructure for instance, while some regulations treat sustainable energy infrastructure as a risky asset rather like hedge funds.
Ensuring an “investment-grade” policy environment is therefore important, as is sending the right political signals: there is nothing like uncertainty among policy makers about their own energy choices and strategies to undermine sustainable energy investment and drive up capital costs. Rather, tailored policies, instruments and funds, as well as concerted leadership, will be needed.
Policy makers must work with institutional investors, and try harder to understand their perspectives. This is not as easy as it sounds, particularly as they often do not speak the same language.
Indeed, it is quite a challenge to penetrate the web of technical terms that diverse institutional investors use. Beyond the usual financial jargon such as senior “secured loan” and “covered bonds” lie such notions as “transaction enablers”, who provide interested investors with the expertise they need to make projects possible, and “risk mitigants”, which are intended to enhance a project’s creditworthiness. There are “cornerstone stakes”, which pivotal investors take in a project often for a minimum period. For instance, when the UK Department for Business, Innovation and Skills invested some £50 million (US$75 million) with a no-resell clause of a year, this cornerstone investment made the Greencoat Wind Fund’s first equity offering on the London stock exchange a success, and paved the way for other similar quotes funds entering the market.
This intricate tapestry of institutional investing is explained in detail in Mapping Channels. The report explains the key actors, including the very important financial intermediaries whose job is to mobilise private finance, such as national, regional and multilateral development banks and publicly sponsored green investment banks (GIBs).
It explains emerging instruments and platforms that are driving liquidity and growth in sustainable energy. It looks at publicly traded equity funds that pool projects, known as “yieldcos” or quoted funds, for instance, which have already raised billions of dollars from investors and which some believe could, under certain conditions, drive down solar and wind costs by 20% in the US. The report describes green and “climate” bond markets, which help issuers attract new investors while obtaining risk-adjusted returns. Valued by the OECD at US$15 billion in 2011, issuance of green bonds tripled over the course of 2014 to reach US$36.6 billion, and appear on course to meet, or even exceed, this amount in 2015.
Not all institutional investors will be interested in or suited to sustainable energy projects. But for those that are interested, the OECD provides many examples of infrastructure projects to draw on. It identifies 47 investment projects involving pension funds, mostly in wind and taking place mostly in developed countries: projects as far-flung as wind farms Parc des Moulins in Canada and London’s Array, or Japan Solar, the Danish Brigg Biomass Plant and South African Touwsrivier solar plant, among others. On top of the 47, it examines another 20 investments made in sustainable energy companies to highlight the choice between investing in projects or companies.
The report presents a matrix to explain how these projects were financed using different combinations of equity, debt, funds, risk mitigants and enablers: there is the direct unlisted equity approach used by Dutch pension fund PGGM in consortium with Ampere Equity Fund to acquire a 24.8% stake in Walney offshore wind farm in the UK; the World Bank’s first Australian dollar-denominated “Kangaroo green bond” where Australian superannuation fund UniSuper was the cornerstone investor; the listed portfolio approach adopted by Teacher Retirement System of Texas to buy shares in the aptly sounding NRG Yield, which proposes diverse energy assets; the Pagdupud onshore wind farm which PINAI, a Philippines-focused infrastructure fund, invested some US$85 million in and whose limited partners include a state-owned pension fund and the Dutch APG pension fund; and many more.
To simplify this rich and detailed analysis, the authors sketch out a classification framework that policy makers can use to navigate the myriad investment channels that can be potentially used for sustainable energy infrastructure. The framework is an initial foray that is intended to be built upon and will help the OECD gather more data too, for instance, within specific investor classes, countries and technologies, and over time. The OECD strongly believes that institutional investors have everything to gain by investing far more in sustainable energy infrastructure, as long as governments keep their eye on the ball by fostering “investment grade” policy frameworks that will allow the bankable and investable project pipelines to emerge at scale. These are long-term commitments, but given the direction of climate change, the long term should start today, for all investors.
The report on Mapping Channels to Mobilise Institutional Investment in Sustainable Energy was delivered to the G20 Finance Ministers and Central Bank Governors meeting of 9-10 February 2015. See https://g20.org/wp-content/uploads/2015/02/Communique-G20-Finance-Ministers-and-Central-Bank-Governors-Istanbul1.pdf
See also the OECD’s 2nd Annual Green Investment Financing Forum 2015, http://oe.cd/19V
Kaminker, Christopher, Kate Eklin, Robert Youngman, Osamu Kawanishi (2015), Mapping Channels to Mobilise Institutional Investment in Sustainable Energy: An OECD Report for G20 Finance Ministers and Central Bank Governors, Green Finance and Investment, OECD Publishing.
©OECD Observer No 304, November 2015