The idea of a green economic recovery after Covid-19 is gaining increasing interest

GOOD NEWS
The renewables sector is showing much more resilience than it did during the economic crisis of ten years ago. Renewable energy funds are performing better than the wider market during the Covid-19 crisis

BAD NEWS
Life is likely to get tougher for new project development as supply chain disruption make investors more likely to favour operational facilities and projects with revenue certainty, such as those in markets with government guaranteed power purchase prices

KEY QUOTE
The big question is the behaviour of multilateral finance agencies, such as the World Bank, and the role of other development finance institutions in providing risk mitigation tools to investors in renewables

If history repeats itself, the next 12 months will be bruising for renewable energy finance. If investors respond to the current crisis as they did in 2008-10 — with private finance significantly slowing — the sector’s steady growth is likely to come to a screeching halt. But the signs, so far at least, suggest the story is different this time, with a more mature sector, benefitting from a greater diversity of funding sources, showing much greater resilience. “There remains strong demand [from institutional investors] for renewable energy assets across all established sectors,” says Stephen Jennings from Japanese bank MUFG. “That’s driven in part by the positive [environmental, social and governance] profile associated with such deals.” His comments are echoed by Andrew Lin, a managing director at credit ratings agency DBRS Morningstar: “We continue to see sustained interest in infrastructure and power projects (including renewables) generally. The long-term stable cash flows of this asset class are very attractive to long-term institutional investors.” The sector has recently benefited from a “wall of liquidity”, said Prashant Khorana from energy consultancy Wood Mackenzie during a webinar in late April 2020. “Perhaps that wall of liquidity isn’t as high anymore, but it remains very large.” That investment has come not only from traditional investors in the sector — such as utilities and smaller renewable energy developers — but increasingly from what Khorana describes as “passive players”. These “passive players” include listed and unlisted renewable energy funds, backed by retail and institutional investors such as pension funds and insurance companies. A number of large institutional investors also make direct investments in large renewables projects. Together, listed and unlisted funds and pension funds are set to supply around half of the $202 billion that Wood Mackenzie estimates will be invested in renewables in 2020. Not only do operational renewables projects often benefit from revenue certainty via long-term contracts with creditworthy offtakers, such as utilities, or power purchasers operating in markets guaranteed by governments through inflation-linked feed-in tariffs, they also offer diversification from equity markets. “There is no correlation between renewables and stock market prices,” adds Khorana.

SECTOR RESILIENCE “This period is showing that the sector is resilient,” agrees Ricardo Piñeiro, a partner at Foresight Group, an infrastructure and private equity fund manager with several renewable energy funds under management. Listed renewable energy funds have performed better than wider markets, he says. Foresight’s JLEN Environmental Assets Group fund, listed on the London Stock Exchange, slumped 20.5% between the start of March and the peak of the turmoil on March, 23 before recovering to end April 4.3% lower by the start of May. The FTSE All-Share, meanwhile, fell 26.4% peak to trough over the same period, posting a 14% loss by May 1. That performance will help to underpin continuing demand from investors for sustainable investments. “There will be strong interest after Covid,” says Piñeiro. “There are question marks around the impact — in the short-term — to power prices and the availability of debt financing on pre-Covid terms, and how this could affect expected equity terms.” Despite the generally positive outlook, the landscape will, inevitably, get tougher for new renewables projects, say market participants. Disruption to supply chains will make investors more likely to favour operational projects and those with revenue certainty, such as those that benefit from power purchase prices, such as feed-in tariffs, guaranteed by governments, predicts Joost Bergsma, CEO of renewables fund manager Glennmont Partners. That shift is also likely to crimp the growing market for so-called merchant renewable energy projects, which trade their output on electricity exchanges and in power pools for buyers and sellers. In a number of markets, the Nordics and parts of the United States for wind farms, and Spain, Italy and Australia for solar, projects are being built without long-term purchase contracts, able to earn sufficient revenues from selling power into wholesale electricity markets. “If we see more volatility in power prices, investors will expect higher returns to compensate for that risk,” says Piñeiro at Foresight. “I would see that as something that is more of a dip than a longer-term trend,” says Bergsma. “The future of renewables has to be without feed-in tariffs. Clearly, what hasn’t changed structurally is that new wind parks and new solar parks are cost competitive and can run even at much lower power prices. We will rebound.”

GREATER CHALLENGES Inevitably, however, both debt and equity markets will become more challenging, adds Bergsma. “It could be the case that debt will become more expensive, simply because funding costs for banks may become a bit more expensive,” he says. “There may be less liquidity — it’s simply a matter of supply and demand.” While Bergsma agrees the appetite of institutional investors for low-carbon infrastructure is likely to remain strong, the amount of capital available for them to deploy to the sector is likely to diminish because they will earn less from existing infrastructure investments. “It may be that there is less equity capital available next year and the year after simply because investors are getting less capital back from asset sales,” he suggests. Sales going through at lower prices or investors’ investment managers holding back from exiting existing renewable energy investments in distressed markets could reduce available capital. In addition, there are question marks over a relatively new source of demand and capital for renewables projects — the oil and gas sector. In recent years, oil and gas companies have been increasingly significant players in both onshore and offshore projects as they seek to position themselves for the low-carbon transition. The collapse in oil prices will reduce the capital available for investment in the sector, while underscoring the need for diversification, say market participants. That tension was clear in April, when oil major Shell cut the dividend it pays its shareholders for the first time since the Second World War, but largely spared its planned investment in its new energies business from cuts. Similarly, BP — which maintained its dividend, for the first quarter of 2020 at least — said it has left unchanged plans to invest $500 million in low-carbon projects. Regardless of whether the oil and gas sector maintains or trims its investments in renewables, Khorana at Wood Mackenzie notes it represents just 5% of the capital investment forecast for renewables in 2020. “There’s enough capital chasing renewables deals,” he said. Longer-term, however, if oil and natural gas prices remain in the doldrums, it could provide a spur to the hydrogen economy. That would pose a risk to “deep merchant” renewables projects, he says, referring to those projects relying to a large extent on revenues earned from trading in power markets.

EMERGING MARKETS It’s not only higher-risk merchant projects that could struggle post-Covid-19. International investment in renewables projects in emerging markets is likely to dip, posing a challenge to those countries without sufficiently deep local capital markets to fund local infrastructure. “Many of these countries used government support, or long-term contracts provided by government-owned utilities, to secure international investment,” says Matthew Huxham, a principal in the Climate Policy Initiative’s energy finance team in London. “Post-Covid, there will be questions about the willingness of [emerging market] governments to use their balance sheets to support renewables.” Many developing economies will face a double hit after the Covid pandemic subsidies. A slower global economy will reduce the prices of the commodities many of them rely on for export earnings, while depressed local currencies will make dollar borrowing more expensive, says Huxham. The big question is the behaviour of multilaterals such as the World Bank … and the role of other development finance institutions in providing risk mitigation tools to investors in renewables, he says. “I would expect to see them stepping up their level of ambition.”

MORE SOPHISTICATED SUPPORT The extent to which finance continues to flow to renewable energy projects will depend upon which sectors of the economy governments and multilaterals decide to prioritise in the post-Covid recovery. And there is scope for more sophisticated — and lower-cost — forms of support, argues Jennings at MUFG. “Government support can come in many ways, not just through subsidies,” he says. He notes that contracts-for-difference mechanisms have become a popular form of support for large-scale renewable deployment. Such contracts work by guaranteeing income for projects if power prices fall below a pre-agreed floor, while the project is required to pay the government if prices rise above a certain level. These mechanisms “have not come at significant cost to the public sector or end-consumer, given where wholesale prices have been,” Jennings says. “Governments will need to be more innovative in how to provide stimulus to the sector without further increased public or private sector spend; this could come through the increased support of government-backed export credit agencies and multilaterals,” adds Jennings.

PETERSBURG DIALOGUE “Globally, we’re seeing quite a move towards the idea of a green economic recovery,” argues Kate Levick, programme leader for sustainable finance at think-tank E3G, citing moves by South Korea, the EU and the UK. She also cites the virtual Petersberg Dialogue meeting in late April, where heads of state sent “very strong messages about green recovery” and similarly positive remarks from Kristalina Georgieva, managing director of the IMF. At the event, Georgieva called on governments to “prioritise investment in green technologies,” underlining that the low-carbon transition requires $2.3 trillion in investment every year for a decade in the energy sector alone. “These types of investments would boost growth and jobs during the recovery phase and help steer the world in the right climate direction,” she said. The big question — in terms of tackling climate change — is how China responds, says Levick. “China has been a massive engine for the renewables industry over the last decade. The jury is still very much out, but some of the indications is that its response has been to go back to the old playbook and turn on the taps for new coal, new dirty industries. It’s going to be a bellwether.”

TEXT Mark Nicholls