Changing energy landscape fuels infrastructure investing

Asset owners are pushing hard into renewable energy and sustainable infrastructure while still committing capital to other projects supporting the fossil-fuel energy segment, albeit at lower levels.

Sustainability is a big theme right now as investors become more attuned to the risks and investment opportunities inherent in a changing energy environment. At the same time, they are attracted to infrastructure as a whole to shield their portfolios from inflation threats and potential increases in interest rates.

As a result, infrastructure fundraising reached $31.8 billion in the second quarter, beating the previous fundraising high point in the first quarter of 2020 and the quarterly average of $24.5 billion since the start of 2016, according to data provider Preqin. Renewable energy has been taking a bigger share of the fundraising capital commitments. In the first quarter, 65% of the infrastructure capital raised was for renewable energy, with 9% for utilities and 8% for conventional energy, according to Preqin.

Of the infrastructure energy funds closed in 2021 through Sept. 16, 80% were renewable energy funds, compared with 14% mixed renewable and traditional energy and 6% non-renewable energy funds.

Energy infrastructure portfolios will not be made up entirely of renewable energy investments with zero fossil fuels for quite a while, said Lisa Bacon, San Diego-based principal and private markets consultant and infrastructure program lead at consulting firm Meketa Investment Group. Coal is the only energy infrastructure category failing to attract much investor capital because many coal projects are being decommissioned, she said.

Traditional energy infrastructure is also changing. Natural gas facilities are moving to a decentralized platform with smaller plants. There is a trend toward building smaller gas facilities for community-based systems, she said.

"It gives investors more flexibility and more of an ability to take advantage of newer designs," Ms. Bacon said. Smaller plants can be located wherever there is room, making them more cost-effective and easier to link with other energy sources, Ms. Bacon said.

As the energy infrastructure has changed from a sector dominated by midstream investment involving processing, storage and transportation of oil and gas, Meketa has been focused on infrastructure managers investing in multiple sectors, including renewables, she said.

Many of these managers have "evolved with the times," increasing the number of renewable projects for each fund over the years. Those managers provide investors with flexibility to participate in sectors that are "most promising and have the most longevity," Ms. Bacon said."We are looking for managers with that kind of foresight."

Five or more years ago, midstream energy "was kind of it" for investors wanting to get into energy infrastructure. There were multiple funds that invested only in midstream energy. But today, Meketa executives would not invest in midstream-only, she said.

"It's not a knock on midstream," Ms. Bacon said. Meketa investors already have exposure to midstream from earlier investments as well as exposure to the newer types of natural gas plant investments in diversified funds. Plus, there are a lot more investment opportunities competing with midstream for capital, she said. Investors can get into a whole range of opportunities, including newer natural gas plants that can run dual fuels, utility-scale and investment-scale wind and solar projects, and hydroelectric plants.

"There's a lot more offerings today than five years ago" when Meketa began investing in renewable energy-only funds, she said. There also are a slew of funds labeled "energy transition," with some funds more dedicated than others, Ms. Bacon said. Some energy transition funds have businesses operating vehicle charging stations, which is considered infrastructure, she said.

For many investors, their energy investments did not meet expectations. Energy funds have been among the hardest hit real asset sectors due to lower oil and gas prices resulting from the price war between Saudi Arabia and Russia and a drop in consumer demand, according to a June real assets performance review by Aksia for the $21.5 billion Orange County Employees Retirement System, Santa Ana, Calif.

OCERS' real asset portfolio earned a 0.7% return in calendar year 2020, with its largest real asset manager, energy manager Kayne Anderson Capital Advisors LP, producing an internal rate of return of -3.8%.

At a June investment committee meeting, CIO Molly Murphy said when the early investments were envisioned, investors expected "very much a private equity-like experience" with funds lasting 10 to 15 years and producing midteen returns.

OCERS only earned single digits on these investments, affected by falling energy prices that have just started to rebound as well as manager selection, she said. Energy represents the largest sector in OCERS' $822 million real asset portfolio as of Dec. 31, accounting for 42%, the Aksia performance review said.

David Fann, vice chairman of OCERS' real asset consultant Aksia, noted at the same OCERS meeting that oil price volatility had a lot to do with disappointing return expectations.

Investors confronted more volatility and price drop over the last two years than they did with earlier investments in the sector, Mr. Fann said.

There were also faulty execution by managers and teams on the ground in the oil patch, Ms. Murphy said. In addition, some managers such as EnerVest Ltd. ended up taking huge write-downs because they used all of the investments in a fund as collateral. Credit lines were called by the banks that lent to the EnerVest platform, resulting in the collapse of the platform, she said.

"We have been very careful not to repeat that mistake," Ms. Murphy said.

Scott Barrington, Minneapolis-based CEO and managing director of infrastructure and impact manager North Sky Capital, said investor demand for renewable energy has been strong despite a brief pause from March 2020 through May 2020, as investors considered the potential effects of the pandemic. Some 60% of North Sky's $1.5 billion assets under management is in renewable energy infrastructure.

While there is continued interest in mainstream renewable energy — solar, hydroelectric and wind energy generation — "the keen areas of interest recently have been environmental infrastructure," Mr. Barrington said.

Those sustainable infrastructure investments include renewable natural gas captured from landfills and wastewater treatment plants, waste-to-value projects such as turning manure and poultry litter into energy and fertilizer, and water purification, he said.

Renewable natural gas strategies are relatively new and started to catch the attention of some institutional investors in mid-2020, Mr. Barrington said.

"Also, we are seeing opportunities in energy storage and think that will be a long-term trend with significant policy support at both the federal and state levels," he added.

In addition to sustainable infrastructure, the firm also has a private equity impact secondary market business that invests in renewable energy, including storage and electric vehicle charging infrastructure.

While his firm does not invest in oil and gas extraction infrastructure, other energy infrastructure managers are using carbon sequestration — a method of reducing the carbon dioxide in the atmosphere by capturing and storing it — in conjunction with fossil-fuel extraction.

"The renewable energy industry is in a transition period where the world is moving from internal combustion engine vehicles to electric vehicles" and like many technological adoption curves, this transition will be shorter than many people currently expect, Mr. Barrington said.

"It will seem gradual and then all of sudden the transition will occur at a very rapid pace," he added.