Acceleration of the Energy Transition - a focus on energy and infrastructure

Acceleration of the Energy Transition – a focus on energy and infrastructure
30th September 2020 Judy Kuszewski
Judy KuszewskiMichael BatesonIvaylo Dimov
In Insights

On 10th September we were delighted to share the webinar platform again with our colleagues from leading law firm Ashurst and environmental consultants RSK to explore one of the fundamental challenges of our time: the energy transition and infrastructure needed for a greener world. The panellists:

  • Anthony Skinner, Partner, Ashurst
  • Judy Kuszewski, Chief Executive, Sancroft
  • Louis Jacobs, Director, RSK Group
  • Darryl Murphy, Head of Infrastructure, Aviva Investors

The topics:

  • How the transition is affecting the energy and infrastructure market
  • The impact of sustainability on current and future investments
  • Challenges and opportunities the transition presents
  • How the market is responding

If you missed the session, you can listen to the recording here, and if you’d like to be invited to future webinars, please sign up to out newsletter here.

How the transition is impacting the energy and infrastructure market

The energy transition provides an opportunity for change in both investors’ philosophy and behaviour; however, some changes are more difficult than others given the nature of some assets:

  • Transport in particular requires significant investment, and we are already seeing some change here.
  • Low-carbon technologies (such as CCS – carbon capture and storage – and hydrogen, two areas that have seen significant interest from oil majors) and funding structures (energy and infrastructure are often consumer-funded and government-subsidised) can present hurdles.
  • New technologies without subsidy regimes present a very different risk profile. Investing in these is generally seen as riskier, with investors tending to opt for existing assets as returns are generally more guaranteed. Financial investors can play a huge role in progressing technologies, but this needs to be complemented by government support, for instance policy incentives or direct capital funding.

A persistent challenge for investors considering new technologies is their relative lack of track record in comparison with existing, stable, high-margin investments. Furthermore, the five-year cycles common among investors mean that substantial shifts can take time. Current commitments, for example to offshore gas development, will remain in place for a period of years, even as general interest in newer opportunities is rising. The panel expects to see delivery improving, but it will take time to achieve impact. Specifically on hydrogen, we are seeing national plans emerging across Europe, and there is an opportunity for the UK to succeed by implementing the right policies.

How sustainability is impacting current and future investments

The ‘build back better’ agenda is not far from the surface in energy and infrastructure conversations at corporate and investor levels. Recovery has – in many places – caused key decision makers to double down on sustainability commitments, and one obvious lesson we must take is that resilience must be embedded across all of society; the pandemic having been an enormous stress test for our infrastructure and economy. In the UK, we’ve seen renewables overtaking less sustainable, fossil-based sources in the energy mix, but admittedly this is under strange circumstances. A well-designed infrastructure strategy is needed to ensure that progress continues and a shift back to fossil fuel dependency is prevented. A future scenario in which society must simultaneously address a significant climate challenge and a major health crisis would tax the national infrastructure beyond breaking point. This recognition has served to embed the notion that sustainability is intrinsic to resilience.

Some concrete examples:

  • Expanding green energy provision: the explosion in online/remote working due to COVID-19 has increased attention on the energy requirements of these activities, and the energy-intensive data centres that support them.
  • Energy efficiency: as an immediately powerful first step that pays dividends, efficiency still has a great deal to offer to vast numbers of existing businesses, buildings and economic activities.
  • The role of methane: frequently touted as a ‘bridge fuel’ between oil/coal and renewable energy, methane is nevertheless a carbon-intensive technology and can only be considered a temporary measure. And all energy technologies, even those inherently greener, have a responsibility to ensure their supply chains are robust and responsible, their employee wellness activities are fit for purpose, and all the other ESG elements that may present risk or untapped opportunity if left untended.

One vital factor to consider is that new technologies require new skills to be administered in the right place, and in the right quantities. Take windfarms, for example: these exist in a multitude of onshore and offshore locations across Europe, and all require local contractors for maintenance. Numerous assets on the ‘green energy grid’ currently don’t have the right workforce, which is an area that must be addressed so the transition benefits all segments of society. Circularity is also a key consideration. Current gas pipelines, for instance, aren’t suitable for hydrogen, so there’s much decommissioning, renovation and replacement of infrastructure that must happen.

When put in the context of ESG integration, coal and gas are rapidly becoming untouchable, making stranded asset risks very real for a lot of investors. Technology also presents huge opportunities for value creation, however guaranteeing secure returns from, for example, EV charging are tricky as the route to market is not always obvious. Investors and capital providers will have to adapt and realise that fixed revenue streams are not necessarily achievable. Adjusted thinking is needed – should lenders for example have different repayment profiles to support the changing reality?

Panellists cautioned again overstating the demise of hydrocarbons. Parts of the world such as Africa are still going to need hydrocarbon-based fuels for decades to come to cater for growing energy demand, which would not be possible otherwise. Oil and gas projects – on a global basis – will be needed, so the transition will unfold for a while to come.

Challenges and opportunities the transition presents

The unproven nature of technology solutions means industry lacks familiarity with them, making adoption and growth more challenging, and knowledge and skillsets will take time to develop. Efficiency of energy distribution will need to be considered, with local generation very likely become more important as we transition to Net Zero. Global policy frameworks around technology are neither matured nor consistent, so cross-border energy distribution presents another challenge.

On the positive side, however, there is a groundswell of support from all stakeholders to push the transition forward. The pandemic has highlighted global vulnerabilities and the transition is now more of a priority than it was a year ago. Governments are seeing an opportunity to ‘rip up the old rule book’ and move to a low carbon future. Policy, however, is not keeping pace with commitments that are being made, showing that expectation may be ahead of ability to deliver. Huge levels of investment are required to operationalise technologies at the necessary scale to achieve Net Zero, and investments here are “high risk”.

A big challenge for governments is that they are caught between the desire to achieve impact, but be simultaneously cost efficient. Security of supply, decarbonisation and affordability – the energy trilemma – have had a lot of airtime, and many of the ideas within this still ring true, with success relying on striking the right balance between affordability and innovation.

Broadly, the general public is on board with Net Zero as an objective, but nevertheless unclear on what it’s going to take, how much time will be required, and how much it will cost. Consumers will bear a lot of this cost – a slightly different narrative to what we’re used to – and governments should not shy away from that fact.

One clear takeaway from the pandemic is that governments will be looking for many new opportunities to generate revenues in order to recover the costs incurred during the pandemic; and the capital needed to fund the transition has to come from somewhere. Consumers, and indeed businesses, must therefore be brought on the journey, so that the new taxes, fees, royalties and other revenue arrangements will achieve legitimacy and public acceptability.

The transition presents an opportunity to take the moral high ground and the long view, but government and industry must evaluate what’s practical. If one country takes more pioneering steps ahead on renewable energy and Net Zero, what happens to others? Organisations must similarly take decisions, but it’s tempting to think only about what fits in with their business model and ambitions. Individual actions must all – collectively – scale up to help achieve national and international targets, but there must be an overarching framework to guide this.

How the market is responding

Ashurst research of more than 1,000 senior executives in key economies showed that 82% of people see the pressure to act on the energy transition as either serious or extreme. Much of this pressure is said to stem from governments, however they’re also seen as the biggest barrier to progress. Eighty-eight percent of respondents have changed their strategy towards the energy transition in the last 12 months and there’s a feeling that policymakers must also do more.

Whilst many are looking to invest in the energy transition, capital must be directed in right ways, and it must be supported by the right policy frameworks. Electrification of heat, for example, has huge potential.

The upcoming Energy White Paper – expected alongside this year’s Autumn Statement – should shed some much needed light on the UK’s approach. The government tends to prefer market-based solutions and fostering innovation, however in this area, it needs to do more to work out how it can access and catalyse the levels of capital required. It needs clear policy, and the solution will not be ‘one size fits all’. It will need much more granular detail, and certainly new subsidy structures. A carbon tax of some description will also be necessary, but none is currently agreed on a European or global basis that encourages the transition. Whether this is facilitated within the UN, the EU or others,  it needs to happen.

We are once again grateful to our colleagues at Ashurst, RSK and Aviva Investors for sharing their insights. We shall be sharing details of our fourth ESG webinar through our website, newsletter and social media channels soon, so keep your eyes peeled! For more insights and events from Sancroft, please sign up to our newsletter here.