Financial Services Update: Sustainable Finance - Funding Ireland’s Energy Transition

Most of the conversation around the clean energy transition has so far focused on the technology challenges, such as the relative merits of wind - both on and off-shore, solar, tidal, wave, bio-fuels and other renewable energy sources.

In addition to these technical concerns, there is also the challenge of how to pay for this energy transition. Markets powered by renewable energy sources will have very different characteristics to conventional markets driven by the fuel price of oil and gas. Not all the investors funding today’s conventional power markets will want to continue investing in these new market conditions. As with all transitions, there will be winners and losers.

Future investment

Over the next 15 years it is estimated that the world will need to invest around US$90 trillion in sustainable infrastructure assets. In Ireland, the figure required to fund the clean energy transition is estimated to be in excess of €40 billion. There is now an urgent need to enhance the ability of the financial system to mobilise increasing amounts of private capital for sustainable investment.

Managing the change

As we are all aware, the world is engaged in an energy transition. We are moving from fossil fuel powered energy generation to a low, and ultimately zero, carbon powered and renewable energy generation system.

There are fundamental differences between markets driven by volatile oil and gas prices and markets powered by renewable energy sources, which are more influenced by technological innovation and consumer behaviours.

These different markets will require a very different mix of energy investors and investment structures, from those currently funding the conventional power markets. This investment transition will need to be managed in the same way as the technology transition. A sudden or disorganised exit of traditional and long term investors in energy markets could threaten an orderly and smooth market transition. This would trigger the withdrawal of critical funding at a time when new technologies particularly need access to permanent and patient capital. This could happen in the same way that a sudden abandonment of conventional energy sources - before new renewable technologies are proven at scale - could threaten the sufficiency and sustainability of our critical power systems.

For context, global energy investment in 2018 was in excess of $1.7 trillion. Of that, investment in renewable energy was approximately $332 billion, or less than 20%. So, whilst investment in renewable energy installation and technologies has rocketed over the last decade from a very low base, it is still a fraction of the total amount needed to fund our energy needs.

There is no guarantee that the investors currently providing the capital necessary to finance our energy demand will find the new renewable energy powered markets attractive enough for their return requirements. So, at the same time that technologies are transitioning, we will need to transition from current investors and investment structures to those that can operate in these new market structures. These investments and investors have different characteristics to traditional investors in conventional energy projects.

Factors influencing investment in sustainable energy

Firstly, while low carbon generation systems are less risky than fossil-fuelled systems, they tend to have lower rates of return. This seems counter intuitive in view of the fact that they do not carry the huge costs of risky exploration activity that oil and gas projects do. Lower rates of return bring a different type of investor, one that is attracted to predictable stable long term returns. This results in a need for different types of investment vehicles and management structures for those investments.

Secondly, renewable energy markets are less likely to be influenced by global commodity markets and so prove more attractive to local investors restricted by currency risk.

Thirdly, as the energy transition progresses and technologies rapidly develop, there is an increasing risk of losses for investors through “stranded assets”. Investments can rapidly lose value as technologies become redundant to the next generation of innovations. This requires investors to be nimble and flexible enough to spot the next trend and be able to easily switch out of and into investments in time.

Conclusion

In order to finance our transition to clean and renewable energy generation, it is necessary to structure the transition in energy markets in a way that retains as much of the current traditional investment sources as possible. At the same time, the transition must attract those new investors prepared to adapt to the new structures and returns to be found in energy markets powered by renewable sources.

Initiatives like the Irish Government’s Renewable Energy Support Scheme, due to “go live” in 2019, seek to achieve this balance of best value for the consumer on the one hand and reasonable market based pricing and returns for the investor on the other. We believe this will create the right environment in Ireland over the next 12 months and beyond to attract the ever increasing amounts of capital necessary to fund our own clean energy transition.