The risks and opportunities of investing in renewable energy infrastructure

Globally one of the most significant transitions going on right now is the shift from fossil fuel power towards renewable power. This transition is being seen across developed and emerging markets, from large scale installations of solar and wind power in India and China, to early announced retirements of coal fired power plants in Australia. Growing concerns around climate change, increasing competitiveness against fossil fuel power, strong investor and government demand for clean energy and technology improvements, are the key drivers of this trend and have led to massive capital inflows into renewable energy infrastructure.

JANA’s infrastructure team closely tracks the renewable energy infrastructure landscape through ongoing conversations with major global renewable energy managers and advising clients on renewable energy co-investments globally. We believe that the energy transition represents a significant opportunity for infrastructure investors, however renewable energy investments are subject to a number of material risks including regulatory changes, political uncertainty, and competitive power markets, all against the backdrop of a fundamental and rapid technology transition impacting the entire power sector. Strong investor demand for renewable energy assets has also driven down returns and led to a mispricing of risks. As a result, investors need to be highly selective of renewable energy investments at this point given the risks and downwards pressure on returns, and focus on areas that can still offer a reasonable risk adjusted return.

What are the key risks in investing in renewable energy infrastructure?

Our research into renewable energy strategies and investments highlights the following key risks at this point:

• Regulatory change and political uncertainty – Regulations around renewable energy are still evolving in a number of markets including Australia and there is a lack of policy consensus around how to drive growth in renewable energy. Grid capacity and stability – Most grids were built around large fossil fuel power plants but now have to adapt to two-way electricity flows and solar and wind assets that are more distributed and often located in areas without sufficient grid capacity, leading to potential revenue losses due to transmission constraints.
• Ongoing technology transition – The power sector is seeing technology evolution across a range of areas, such as smart grids, distributed generation, energy storage, and efficiency improvements. While these are opportunities for investors, they can also present downside risks for renewable energy assets.
• Exposure to competitive power markets – While older renewable energy investments generally earned most of their equity return through power purchase agreements, newer assets have shorter contracts and equity returns are increasingly exposed to power price volatility. JANA has observed this particular risk to be often misunderstood and mispriced by investors in the current market.

What can investors interested in renewable energy invest in?

The above risks and currently aggressive pricing for renewables requires infrastructure investors to be highly selective with renewable energy assets. We however continue to see select opportunities that are attractive from a risk-return. These include –

• Allocations to renewable energy strategies that focus on niche markets and complex assets that allow for high contracted returns with limited exposure to power price volatility.
• Participation in select co-investments into large and complex renewable energy platforms where the manager has more value drivers and upside opportunities to offset downside risk.
• Focus on managers with deep expertise in managing power assets. The ongoing transition in power markets requires teams with deep commercial and technical expertise.
• And as always, invest alongside disciplined managers who appreciate the underlying risks in power markets and price those appropriately.

Final remarks

The transition towards renewable energy is one of the most significant transitions of our time and will involve significant capital investments particularly from infrastructure investors. Given the underlying risks though and currently exuberant pricing for renewable assets, investors need to be highly selective with renewable energy investments.
JANA can work with client teams to further discuss our view of renewable energy infrastructure and identify investments that fit well into client portfolios.

Click here to watch the recent JANA Webinar: Investing in Renewable Energy Infrastructure.