Foresight on how to maximise renewables returns

With clean energy now an established asset class, we asked Foresight partner Dan Wells how to minimise risk.

This article is sponsored by Foresight Group.

The White House may be trying to rewind the clock by withdrawing from the Paris Agreement on climate change and championing the revival of the US coal industry but there is no turning back from the clean energy revolution. Renewable technologies now compete on a commercial par with conventional energy sources, says Dan Wells, partner at Foresight Group.

The UK-based infrastructure and private equity firm is targeting £500 million ($668 million; €572 million) from its latest fund Foresight Energy Infrastructure Partners with the aim of combining these technologies. The European Investment Bank is a cornerstone investor.
Here Wells explains how the sheer complexity of the renewables market can yield some tempting investment opportunities.

How has the clean energy market developed over the last 12 months?
The biggest single change over the past year or so is the recognition that there is no longer a trade-off between economic development and sustainable development. Clean energy is in many places the cheapest form of energy.

Three key trends that underpin the clean energy market – the domination of renewables in new-build generating technology, a rising requirement for infrastructure to accommodate its intermittent and distributed profile and increasing complexity – are accelerating. Within that complexity lies opportunity.

As energy transition continues apace, how do you put together a compelling investment strategy?
A clean energy system requires three components: generation; renewable enabling infrastructure and flexibility, such as storage and peaking power; and connectivity, transmission and distribution, which could be everything from small-scale electric vehicle charging infrastructure to large structure transmission cables.

Renewable generating assets are pretty long-dated and low volatility and form the backbone of our portfolio. We invest about 60 percent of our portfolio in solar, wind and bioenergy, and within that we might have a small carve out for the less mature generating assets like tidal energy, for example.

Mature technologies like wind and solar are very established and the returns on those assets are squeezed. Investing in greenfield projects and other technologies – and not just in wind and solar – helps drive capital growth and enhanced returns. The returns need to be higher from renewable enabling infrastructure and flexibility assets – like batteries – as there is more risk of technology redundancy and greater volatility in cash flows. These shorter duration assets account for around 20 percent of our portfolio.

We can reduce risk by putting non-correlated assets like wind and solar together and go even further into negatively correlated assets. An example is a portfolio of batteries sitting alongside a portfolio of solar plants.

The third bucket is transmission and distribution infrastructure. These are typically 40-50 year assets with lower returns, such as an availability contract on a cable. This third basket anchors the portfolio and de-risks it. We are also looking at new forms of technology such as high efficiency direct current infrastructure.

Where is the market headed?
The next and more difficult phase is the integration of technologies, which requires an increasingly sophisticated investment approach. In the UK, there’s been a big build-out of renewable generating assets, which means now the opportunity is about integrating assets into the system. In Australia, the opportunity around flexibility assets is expected to arise in a year or two. In the US, we’re looking at storage and hybrid technologies. We are looking across our whole platform to see how we can layer in new technologies and examining our portfolio of well over a gigawatt of solar generating capacity to see which assets are suitable for batteries.

Why are batteries such a hot topic?
There is inertia built into the energy system that accommodates for immediate fluctuations in demand. As the amount of fossil fuel in the system reduces there is less inertia. Installing batteries provides a frequency regulation service.

At the moment, peaking power – when the system needs a boost for four or five hours – is mostly provided by pumped hydropower or small-scale gas plants. There is an opportunity to install batteries alongside small-scale gas plants. The batteries can provide the instantaneous response while the gas can provide the multi-hour higher duration power supply.

Over the past 12-18 months, we have captured a big opportunity in the UK where we have 45 megawatts of grid-connected batteries. We expect over the next year or so for batteries to provide more peaking power services in the US, for example.

When people talk about batteries it’s typically lithium-ion technology. We are evaluating flow batteries that have the potential to provide more long duration, multi-hour storage, because they don’t degrade and discharge like lithium-iron. However, the cost profile is still early-stage.

What other new technologies are on your radar?
One that we’re not currently looking at but could be in the future mix is grid-to-gas, where you produce hydrogen gas from electricity. That could be a solution for the longer duration seasonal balancing, where there currently aren’t effective technologies to shift power over long periods of time. But that is still a long way off being viable.

Has the regulatory environment kept pace with technological advances?
Many of these revenue streams are new and regulators have had to play catch up. For example, legislation written a while ago doesn’t contemplate batteries. In the US, FERC [Federal Energy Regulatory Commission] has instructed states to devise new rules so batteries perform on a level playing field with other technologies. In the UK there were concerns that putting a battery on a solar project would impact income from subsidies. We are seeing really good progress from OFGEM [Office of Gas and Electricity Markets] to give us comfort that in future we can install batteries on solar parks that already have Renewables Obligation Certificates contracts in place.

What is your approach to ESG?

Sustainability is a central part of the due diligence process, says Foresight partner Minal Patel

“For many private equity or infrastructure investors, ESG is about managing the footprint of an asset and ensuring it doesn’t cause any harm. We go beyond that. We’re looking long term to create compelling investment strategies that positively reinforce the global consensus that there is a need to address climate change. We are consciously building portfolios of complementary assets in new energy infrastructure to drive the next phase of decarbonisation in developed market power systems and divert waste away from landfill. Sustainability goes hand-in-hand with our financial assessment of an investment.

At the same time, we do look very carefully at the ESG footprint of our assets. This requires a slightly different mind-set in infrastructure to private equity investing. We look at the interface with the local community very carefully; the social licence to operate is very important. We have education and biodiversity programmes. Solar farms, for instance, are protected parcels of enclosed land that become real wildlife havens. We can re-wild the land under the panels and it’s a great environment for beekeeping. This has multiple benefits which not only include improving pollination for neighbouring agriculture but also the occasional pot of wild flower honey for visitors and the local community.”