£70 billion per year. £1 trillion. £4 trillion. Some of the numbers banded around estimating the cost of the UK Government’s 2050 Net Zero commitment. But although we don’t know how much it will cost, methods of funding and investing have been developing with the energy transition. Below we highlight some of the key mechanisms and, for a more in-depth analysis, please read this article in our Energy Transition Series for the Major Projects Association.

Subsidies

State support schemes have been and remain major drivers for investment in energy transition projects and can be key at all technological stages of a project. Over 1,300 support measures (economic, financial, regulatory, administrative) have been put in place for renewable power generation in Europe since 2005 – see here for an illustration of the UK subsidy regime.

Generous state support schemes have undoubtedly enjoyed great success in attracting foreign capital to renewables investments, however, in the face of shifting political priorities or economic turbulence, some states have reneged on or rewritten established subsidy regimes fundamentally altering the returns and undermining the basis of the investment.

See our Project Execution blog for some case studies and discussion of change in law protection.

Project financing

To utilise project finance, projects need to be ‘bankable’: bankability requires contractual certainty, suitable risk sharing arrangements, sponsor commitments and enforceable security over project assets and is currently only available for more established energy transition technologies such as solar and wind power generation. Although there will always be project-specific risks, some key risks that must be mitigated to enable investment are:

  • Revenue risk - project revenues must be sufficient to repay any loans
  • Political and regulatory risk - a stable and clear investment environment with an enabling policy framework
  • Technology risk - the technology may fail to live up to expectations or become obsolete before the financing is repaid - this may be mitigated by involving a technology partner

See our Project Structures blog for more discussion around structuring.

Sustainable finance products

So, if you can’t project finance or you’d like an alternative, what’s available? Investors and companies with sustainability goals may be able to use sustainable financing instruments such as green bonds, loans and mortgages, or sustainability and climate bonds, to raise money. Some currently fashionable products are:

  • Sustainability-linked loans and bonds: costs of the financing, usually an interest rate, are dependent on predetermined sustainability performance objectives with no restriction on use of proceeds. See our blog on the Sustainability-linked Bond Principlesfor more detail on this new tool in the sustainable finance toolkit
  • Transition bonds: fund improvements in sustainability for projects that have a high carbon footprint and so can’t be otherwise sustainably funded
  • Green bonds and loans: must be used for funding eligible green projects

As there is not yet a global standard for sustainability criteria, comparisons between different products and providers can be difficult which can lead to accusations of ‘greenwashing’.

Brownfield Investment

Despite Covid-19 and the resulting economic challenges, there remains high demand from investors for stakes in energy transition-related companies and projects. Institutional investors participate through ownership in relevant companies, acquisitions and refinancings, and project funds and pooled vehicles.

Brownfield investment, ie acquisition or refinancing of existing assets with low/no development risk, provides an opportunity for developers to recuperate and reinvest capital and for investors to own a stake in or fund the existing projects – and help those organisations meet their own sustainability goals. One challenge is finding energy transition investments of suitable scale. ‘Platform’ or ‘buy and build’ opportunities exist but are more time-intensive to get to scale and require a management team prepared to step up to the plate.

So has brownfield investment, particularly in offshore wind, proved too popular? C-suite directors of major energy companies have cautioned that valuations, often up to 25 times earnings, are “crazy” because of the short supply of appropriate assets and ever-increasing competition (including from SPACs) – however, the pressures outlined above mean that market involvement can no longer be optional.

Uncertainty about the amount of investment required to reach Net Zero will remain, but connecting the money with the projects and providing the right level of support for the technology to develop is key for successful delivery of the energy transition by both the public and private sectors.