Aiming high in the low carbon economy

5 February 2010



The renewables sector is an attractive and sustainable investment opportunity. However, the current level of investment still contrasts markedly with that required for the transition to a low carbon economy, says Jim Totty


The Copenhagen climate change summit in December 2009 was a key point on the world’s road to a low carbon future. On top of the political impetus there are also many long term commercial drivers for the low carbon sector.

Culminating over a 20-30-year period, all of these drivers now provide a highly attractive and sustainable investment opportunity that offers exposure to long-term, non-cyclical investment themes. As the economics of investing in the sector have become increasingly attractive, financial investment into it has grown from US$35B in 2004 to US$155B in 2008 [1].

However, the current level of investment still contrasts markedly with the scale of investment required to transition to a low carbon economy. The Stern Review’s [2] central estimate of the costs of stabilising greenhouse gases at levels of 500-550ppm of CO2 equivalent is, on average, around 1% of the annual global GDP by 2050 (the 2008 IMF estimate of global GDP was US$69T [3]).

The international-energy-agency (iea) estimates that cumulative energy investment of over US$26T is required between 2007 and 2030 [4]. New Energy Finance considers that US$7.3T of this amount will be required for renewable energy and US$5.7T for energy efficiency, equivalent to an annual investment of US$542B [5] across all asset classes. The UN estimates that more than 80% of the required investment will need to come from the private sector [6].

Accessing private equity

Although there is an increasing interest from institutional investors looking to benefit from the significant opportunities offered by the low carbon sector, the low carbon economy is still regarded by some as an emerging sector and remains a challenging asset class in terms of access. Osmosis Capital LLP is the specialist private equity asset management arm of Osmosis Investments LLP, focused on the development of low carbon investment solutions for institutional investors.

When investing and financing renewable projects, good management skills are essential. Strong funds in the development capital sector are based around management teams with specific geography, sector and development skills which enable them to construct asset development platforms to build and then exit infrastructure in energy and water. The execution of these asset origination strategies requires the understanding of key issues such as: the management of greenfield development risk; the regulatory drivers in each jurisdiction and local access to knowledge in key markets to judge how the political and regulatory environments will change over a 5-10 year period; and the viability of debt financing for each technology in each jurisdiction at any point in time.

Furthermore, each management team has its own unique strategy and network. There has been no commoditisation of investment skills in the low carbon sector and it is highly unlikely that there ever will be.

The current economic climate has presented various challenges for this area of work. Investments have been held up due to problems in other sectors and unrelated markets, while the availability of bank debt has also been a problem, although the situation is now improving. There is no doubt that the credit crunch has had a severe impact on the market but as project financing gradually returns it will become easier to get financing for proven technologies. Many regions are looking to develop a diversified mix of renewable energy solutions and we expect to see infrastructure rollout in wind, solar PV, solar thermal, geothermal, biomass, hydro and many other generation technologies.

Diversification

Osmosis Capital is interested in geographic diversification within its area of expertise, with a main focus on Europe and North America. There are good project developers who the company would expect to generate strong returns in many countries. In regions where there has been a history of development with strong drivers and support for the low carbon sector, there will be significant investment opportunities.

Looking to the future, and financing aside, the company acknowledges that there are other challenges which lie ahead for the renewables sector. For example in order to make the most of new renewable generation, the appropriate grid connections must be developed along with smart grid infrastructure. Improvements will also be required in storage capacity and technology.

Dr Jim Totty, Partner, Osmosis Capital LLP, 8-9 Well Court, London EC4M 9DN, UK, email: [email protected]



Commercial drivers for the sector

* Energy independence and security. 78% of oil reserves are owned by OPEC countries [7]. 31% of natural gas reserves are owned by former Soviet Union countries and 41% by Middle Eastern nations [8].
* Fossil fuel, water and resource scarcity. Less than 3% of the world's available water is fresh, and 70% of this is frozen [9]. Two hundred and forty water basins around the world cross national borders and therefore pressure on scarce water resources is expected to increase [9].
* Demand increase from population and developing economy growth. The world population is currently 6.8B people and is forecast by a recent UN report [10] to rise to over 9B by 2050. The US Energy Information Administration forecasts world energy use to increase by 44% between 2006 and 2030 [11].
* Climate is recognised as a threat to the global economy and political stability.
* The falling cost of renewable energy generation.
* 'Green collar' job creation and long term national growth strategies.





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