Mapping out the new landscape for clean energy investment

Simon Courie, partner at law firm TLT, discuss the investment landscape for clean energy, including subsidy-free projects, co-location and power purchase agreements.

The drive towards net zero was given renewed urgency this month, with the publication of the landmark UN Intergovernmental Panel on Climate Change (IPCC) report on climate change acting as a clarion call to press ahead with decarbonisation to curb global warming. The need to ramp up the deployment of clean energy infrastructure is clearer than ever, but the good news is that developers and investors are poised to do so.

Demand to invest in assets that deliver on environmental, social and governance (ESG) grounds as well as financial performance is increasing the availability of capital and fuelling intense competition among investors, creating a seller’s market for developers. As a result, investors are becoming open to a wider range of technology types and investment stages than previously. The landscape is changing, so it’s worth exploring what this acceleration of investment will look like, how it could play out and what are the key technologies involved.

Diversity of opportunity

Private equity investors remain the most active players in the market, and they continue to demonstrate considerable appetite for good quality subsidised projects, notably in established technologies like wind and solar power that are already at the operational stages. However, there are clear signs of a growing willingness to diversify into alternative options. These range from subsidy-free wind and solar projects that offer the benefit of familiarity, albeit on tighter margins (but with potential for economies of scale), to emerging technologies such as anaerobic digestion (AD), energy storage and green hydrogen.

We’re even seeing combinations of several of technologies at once. One trend that’s becoming more and more apparent is for growing investor involvement in multi-technology co-location projects, where battery storage is sited alongside solar or wind energy infrastructure, and sometimes other infrastructure as well, such as electric vehicle charging infrastructure (EVCI). For investors this has several benefits, including mitigating price cannibalisation on solar or wind projects, and hedging against falling capture prices, while creating cost efficiencies by sharing the capex and opex costs of different technologies in one place.

Another trend is the growing inclination for investors to move downstream and invest at an earlier stage of a project, even to the point of getting involved in greenfield sites and taking on construction risk. Given that this is typically the most expensive and highest risk phase of a project, often this is best achieved through entering into mutually-beneficial joint venture partnerships with reputable developers.

Ensuring viability

Without subsidies to provide income certainty, investors need to find ways to make such projects viable, especially where they lack proven revenue streams, or where revenue streams are more complex, as with co-location projects. There are several factors to bear in mind, in order to make such projects investable. Chief among them is the need to ensure that each co-located asset is financially viable in its own right. Relying on one asset to compensate for any shortfall in another asset will not make for a sound investment proposition.

Investors will also be looking for assets that are future-proofed. For example, they will want to know if property documentation, planning permission and grid capacity allow for battery storage or other technologies to be added to a site at a later date, for example, or allow for asset life extension, should the opportunity arise. Contractual arrangements and insurance policies will also be an area of scrutiny, to ensure that construction as well as ongoing maintenance is suitably carried out.

New investment models

New investment models may also be needed, since, while subsidised projects are bond-like in nature, on subsidy-free projects, project value depends on future electricity market prices. Therefore, merchant price exposure is a key risk for any investor and one which they will want to see mitigated.

A long-term corporate PPA could be one solution to provide a long term, stable and predictable revenue stream. However, in such a nascent market there are currently significantly more projects coming onstream than there are corporate PPA opportunities – something that should improve over time as more companies go carbon neutral. Some strategic investors have the ability to source their own PPAs or organise them within their own corporate group, giving them a significant competitive advantage when bidding for projects.

Another way to mitigate the merchant risk is to build a portfolio with a mix of subsidised and unsubsidised assets. This will act to balance out the merchant exposure with other secure revenue streams within the portfolio.

Though private equity funds remain the primary players in this market, debt funders are now increasingly seeing the potential to take advantage of growth in the clean energy sector too. Debt capital is flowing in, as lenders seek higher returns than is typically possible with more conventional investment opportunities. Clearing banks and traditional financial institutions – previously the most active debt participants in this space – are now being joined by new entrants in the form of global pension funds, increasing competition even more. As with private equity, while wind and solar projects remain popular with lenders, we are starting to see a consequent, gradual shift towards diversifying lending portfolios into other subsidy-free projects and developing technologies such as EVCI and energy storage as well.

As the market develops, collaboration between equity investors and banks will be essential, in order to fund the array of innovative financial products that will be needed to deliver decarbonisation. Doing so may require compromise in terms of risk/reward expectations, for example in terms of timings on access to cash or the way deals are split.

It’s an exciting time for the clean energy market, with innovation developing apace, a wide range of new opportunities coming on stream and growing appetite from increasingly open-minded investors looking to secure bankable projects and fulfil their ESG commitments simultaneously. The conditions are right for the sector to accelerate decarbonisation in power generation and make a major contribution to tackling the world’s climate emergency. With the right investment and development strategies in place and a lot of co-operation, there’s a chance now to make a real difference. Watch this space.