The urgency to decarbonise the economy has never been more pressing, even against the current global macroeconomic backdrop. But are institutional investors ready to diversify their portfolios to include emerging technologies, like green hydrogen and carbon capture?

This was the question we posed to a group of clients who attended a recent RBS International roundtable discussion in London, which explored the rapidly evolving energy transition investment landscape.

At the event, fund managers and industry experts shared insights that will help to shape the conversation on the future of sustainable infrastructure investment and forge pathways towards achieving net zero targets in the future.

Emerging technology and emerging risk: getting investors comfortable takes time

It emerged that while many investors were now comfortable with areas of energy transition that are sufficiently developed – such as the electrification of transport and energy storage – newer, less evolved propositions like green hydrogen and sustainable aviation fuel (SAF) still present hurdles. The technology risk is apparent, the track record is limited, and obtaining warranties for assets is challenging.

One view on the way forward was to increase wind and solar capacity, while using clean energy for transport and in industry. Hydrogen and other emerging energy transition technologies will be important in the future, but based on net zero targets, they aren’t likely to be required until the 2030s – although the groundwork needs to be laid now.

Bryan Fashola, director, Institutional Banking, RBS International, says: “Many managers are looking into emerging energy transition assets as a broader component to the infrastructure asset class. They’re starting to think about the future and how to bring these assets in and make them part of an infrastructure portfolio.”

“But it’s still some years away”, he adds. “It will take time to scale these assets and structure them in a bankable way that is attractive to both debt and equity alike, so it's not a sprint, but more like a marathon.”

“Wind and solar energy were nascent technologies two decades ago, and it took time for them to eventually be considered mainstream investments. New technologies like green hydrogen will need to undergo a similar journey,” Brian adds.

Participants agreed that whilst emerging transition technologies may not necessarily share the traits of more traditional infrastructure assets – like low technology risk and low volatility of income at the early stages – they could still be considered viable investments as part of an infrastructure asset portfolio with a change in attitude amongst investors.

Investors might need to undergo a shift in mindset away from the traditional definition of infrastructure assets for limited partners (LPs) to embrace the risks involved in deploying capital into transition technology.

Bryan explains: “It’s very difficult at this time to demonstrate that returns will exceed  LPs benchmark return rates required for them to take that level of equity risk in a transition asset. But some of those taking part in the discussion suggested that managers should perhaps revisit some of those early definitions of what an infrastructure asset looks like, as a means to re-educate LPs.”

The dark arts of valuations

On the topic of valuations, contributors noted that the listed market has been dysfunctional in recent times which puts the spotlight on valuation concerns since many private market investors look to the listed market for comparables when valuing assets. These concerns are believed to be unfounded though, as valuations have held strong.

Nonetheless, investors are becoming savvy, with a better understanding of how various technology and revenue characteristics feed into valuations, thus preventing a valuation bubble for existing assets.

“It’s tricky to value these assets and when you’re looking at transition technology there’s the short-term challenge that you have to apply higher risk premiums resulting in discounts rate going up,” Bryan says.

“Overlay that with current macro conditions, and you’re looking at valuations in the short term that could be volatile. That causes concern because it goes against the very ethos of infrastructure investing – which is typically stable, contractual income streams underpinned by stable valuations in the underlying asset class.”

There was broad consensus at the event that relatively easy gains could be made by increasing energy generation through established technologies like wind and solar, alongside repowering existing infrastructure to prevent stranded assets over time. The expectation was that once most of the electricity generated is derived from renewable sources, it will naturally contribute towards reducing the cost of producing green hydrogen, and therefore drive increased adoption.

Angela Marchant, senior director, Institutional Banking, RBS International, says: “One of my key takeaways from the discussion was that the mature technologies such as wind and solar are still absolutely crucial to build out from a generation-capacity perspective over the remainder of this decade.”

She adds: “But while managers continue to look to do that, they are also thinking about those next technologies, like green hydrogen and carbon capture. There’s still a lot of work to be done though, and a lot of inherent risk, particularly from the technology and supply chain perspectives.”

The outlook for rewewables is bright - but technology normalisation will take time

While net zero targets still need to be met, and a lot of investors are bullish about the sector, the practicalities of the build-out are harder than perhaps anticipated, she points out. And from a geopolitical and macroeconomic perspective, sticky inflation and the persistent high interest-rate environment creates further challenges for investors.

“Until these new technologies become the norm, we need to continue the rollout of wind and solar infrastructure so that we don’t get further behind from a net zero perspective,” she confirms.

Max von Arnim, senior investment director with Aquila Capital, an investment management company focused on clean energy and sustainable infrastructure, says: “Everyone wants to do something about climate, but while a lot of technologies don’t make sense economically just now, there’s a lot more demand for product coming from corporates and private customers in addition to the political push, so it’s an exciting time to be an investor.”

“The challenge when investing in new technology,” he explains, “is that it’s a risk versus return game, and you’re competing with everything else on the spectrum. The newer technologies are finding it challenging to generate the right returns without taking too much risk, but I think that will change over time."

Investor confidence and financial returns will fuel virtuous feedback loop

Neil Wood, a partner at renewables-focused investment managers, Bluefield LLP, says: “There is still technology risk on some of these emerging technologies and the business case from a dependability perspective is not quite there yet. But it’s going to come, and probably quite quickly.”

He adds: “Investors are all grappling with the same challenges, and we will need a mix of investment firms participating, so it was great to hear a similarity of perspective on this and a commitment to move forward at the roundtable.”

“This will need government support too, in the same way as wind and solar were supported. That will give investors some confidence that there is a return that can be achieved.”

Will Fleming-Smith, director in NatWest’s Energy Transition Finance business, who hosted the roundtable, says: “It is always rewarding to be involved in discussions with equity investors, to gain insight into investment ideas, concerns and themes, and this time was no different.  Technology readiness levels, and the current regulated or policy-driven sustainable, long-term demand for what that technology delivers, continue to be key considerations for both equity and debt investors.”

He concludes: “Equity and debt providers can work together at an earlier stage to explore suitable investment structures to unlock the potential that the energy transition provides. That may mean incorporating other forms of risk mitigation, like insurance for example, to de-risk the wider investment proposition."

If you’d like to talk about any of the themes discussed in this article, and how they might impact your organisation, please contact your relationship team.

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