Rising pressure
All around the world, but particularly in London, the world’s largest mining companies are facing intense pressure from shareholders. The screws are tightening as unwanted shareholder activism and government sanctions become a real threat that can no longer be ignored.
This pressure has largely been driven by fund managers, who are driven by their own investors. Indeed, sustainability has become a mainstream concern for Australians with as many as nine in ten people reporting that they are concerned about sustainability according to a recent report by Planet Ark. The industry body Responsible Investment Association Australasia (RIAA) backs this up with additional research that reveals 92 per cent of people expect responsible and ethical investment from their super fund, and 80 per cent would consider switching their super or other investments if their manager engaged in activities inconsistent with their values.
Australian investors are vocalising their concerns via platforms such as Super Switch and 1 Million women with their guides to help other members choose a fund that invests responsibly.
Faced with this overwhelming evidence that Australians have an increasing interest in, and appetite for, environmentally or socially sustainable investments, institutional investors have had their lightbulb moment. They can see that investing in a financial future is not at odds with investing for wider positive change and sustainability – and are chasing sustainable investments for ethical reasons as much as for return and value retention reasons.
Australian superannuation funds were among 477 investors globally to sign an open letter to the “governments of the world” stressing “the urgency of decisive action” to limit average global temperature rise to no more than 1.5 degrees Celsius. Additionally, The Investor Group on Climate Change, which includes $170 billion AustralianSuper, is placing escalating pressure on companies like BHP to take more action.
The pace of change in energy transition is gaining momentum
At the current rate, Australia is on track to reach 50 per cent renewable electricity in 2024 and 100 per cent in 2032. Renewables are the future, energy transition is already happening, and it’s a matter of when, not if, Australia moves to clean energy sources. In parallel, we see that coal is on its way out. In Australia, the Bloomberg New Energy Outlook Report 2019 predicts that nearly all existing large and emissions-intensive coal generators will have retired by 2050, causing emissions to fall by around 83 per cent. This transition to renewables is being made possible by the boom in construction of renewable projects according to Clean Energy Australia’s 2019 report.
All this is part of the inevitable global trend, and while Australia is behind some of its peer nations in this regard, it is gaining an unstoppable momentum. Globally, power demand continues to grow fast, and renewable sources will account for 77 per cent of all investment into new power generation assets between now and 2050.
The next phase of Australian energy transition is underway
A significant portion of the domestic growth in renewables will be from small-scale renewable assets (c. 50MW or less) such as solar and wind farms. Small-scale projects have several operational advantages over larger sites. Firstly, it is easier to locate them closer to areas with high electricity demand, meaning that energy is transmitted over a shorter distance with a lower loss rate. Secondly, small-scale projects can have lower grid connection costs and a simpler grid registration process, resulting in faster construction periods. These advantages are likely to result in improved returns for investors with the asset able to generate revenue much sooner.
Despite their attractiveness from a commercial perspective, smaller-scale projects struggle to access commercial bank debt. This is partly due to the relatively high cost of assessing these projects compared to large-scale opportunities, as well as commercial bank preference to deploy large amounts of capital at greater speed than is possible in smaller projects. When small-scale projects do access debt, the level of gearing typically offered is much lower than it is for their large-scale counterparts. This funding gap in the debt market presents a significant opportunity for Australian investors.
Investing for a smarter future
As an asset class, the broader category of infrastructure is characterised by stable and resilient demand, provision of essential services, and typically long-term highly predictable revenue streams. Infrastructure debt invests into senior secured loans which are the safer part of the capital structure compared to equity and provides an alternative investment class in the current low and falling interest rate environment.
Institutional investors holding pools of patient capital are now recognising the need to build out the sustainable component of their portfolios to ensure they enhance long-term overall returns. And super funds are increasingly working with specialist managers for this kind of investment, leveraging the experience and expertise of renewable energy infrastructure investment managers that are experienced in the Australian market. Not all renewable investments are created equal. Careful due diligence and loan structuring is required to deliver a strong risk-adjusted return that meets an investor’s need for yield and income.
Institutional investors in renewable energy infrastructure can access the asset class in different ways. Investors can invest directly through unlisted private debt or equity, or via listed public debt or equity depending on the investors’ risk, investment term, and yield appetites.
Traditionally, the long-term nature of infrastructure debt has been attractive to super funds, given its defensive characteristics and its low correlation to other asset classes (such as equity). Additionally, investing in infrastructure debt offers institutional investors exposure to assets with expected stable cash flows at attractive yields, while offering borrowers access to much needed liquidity.
But we’re now seeing a refinement in this long-term trend, with institutions increasingly recognising renewable energy infrastructure debt as an attractive long-term investment in a smarter future. This is supported by institutions’ fiduciary duty to act in the best interest of their members in order to provide long-term retirement benefits.
Ultimately renewable energy investments need to deliver returns to investors. Ratings agencies and competing funds are
calling out those funds with sustainably labelled investments that do not perform or aren’t truly green. Benchmarks by companies such as Fitch and S&P measure a company’s performance on ESG measures, making the investors job easier whilst applying more pressure to companies seeking green investment dollars.
Under the watchful eye of super funds, ratings organisations and consumers themselves, real and tangible sustainability changes must be evident. With an ever-growing number of renewable investment opportunities, smart money will be quickly redeployed if investors aren’t convinced that a company is taking meaningful action towards environmental sustainability.
Capital at risk. Past performance is not a reliable indicator of future returns.
