Up to half of RES investment could come from institutional investors

According to the study, "The Challenge of Institutional Investment in Renewable Energy," while there is no lack of potential investment in renewable energy, there are a shortage of opportunities at the price and risk level that governments and energy consumers are willing to pay. Institutional investors – pension funds and insurance companies – are theoretically capable of offering solutions to this.

Overall, says the U.S.-based independent policy analysis and advisory organization, institutional investors manage a combined US$71 trillion worth of assets, thus forming one of the largest pools of private capital in the world.

Traditionally, such investors set longer-term objectives and pose distinctive risk/return requirements that might be willing to invest in renewable energy system (RES) projects at lower returns (and thus prices) than other investors, whose primary goals are short-term gains.

Through the study, the CPI investigated whether institutional investors have the potential to bridge the financing gap more cost effectively, and what would be needed to make this happen.

Direct investment fitter for the purpose

Institutional investment is highly dependent on how the investment is made. CPI identifies three channels for investment in renewable energy: (i) investment in corporations; (ii) direct investment; and (iii) pooled investment vehicles or investment funds. Each can come in different forms, such as equity/ company shares, or loans/bonds.

CPI argues that while investment in corporations through equity shares or corporate bonds is the easiest investment path for most institutional investors, it can do very little to change the current RES financing dynamics. Corporations make investment decisions based on their own strategy and financial considerations, and institutional investment may not encourage these companies to increase their share of renewable energy (if they have any at all).

So far, the experience with pooled investment vehicles, CPI finds, has been mixed, with some institutions concerned about high fees and the uncertain cash flow profiles on offer.

Direct investment, states CPI, can be fitter for the purpose of lowering the cost of capital for renewable energy. It is, however, the most difficult of all. Investors need to possess the right skills and even those who have them might be limited from the illiquidity of these investments.

That said, institutional investors who are ready to accept some illiquidity can develop direct long-term investments, thus improving their risk-adjusted return and provide, the CPI study says, at most, one quarter of the RES project equity investment and one half of the related debt required between now and 2035.

Barriers to achieving direct investment potential

The CPI study has identified a series of barriers that constrain institutional investors to achieving their direct investment potential.

In terms of public policies, CPI finds three types of barriers:

  • Policies that encourage renewable energy, but in ways which discourage institutional investors. This is the case of tax credits in the U.S., which discourage investors like pension funds that are tax exempt and for whom the credits may have less value;
  • Policies addressing unrelated policy objectives, which unintentionally impede institutional investors from renewable energy investment. This happens often in Europe, where policies intended to ensure the functioning of energy markets set limits in projects ownership. So, due to the grid unbundling policies, investors need to choose between grid assets and REs projects; and
  • Renewable energy specific policy that is lukewarm, or inconsistent and creates perceived policy risk. Retroactive tariff cuts in Greece or start-stop expiration of incentives are such examples that discourage investors.

Financial regulations are another constraint to direct investment. Pension funds and insurance companies are regulated to maintain appropriate levels of liquidity and diversification of risks.

Finally, national pension policy varies widely between countries, so the funds available to invest in renewable energy are unevenly distributed. 90% of the pension assets in the OECD are concentrated in just six countries – the U.S., Japan, Canada, the U.K., Australia, and the Netherlands – and even those assets are very unevenly distributed. Insurance assets are more evenly distributed across countries.

Steps to increase direct investment

CPI’s study has further identified five steps that could help overcome these barriers and encourage investment in renewable energies:

  • Policies have objectives outside of encouraging institutional investment. In these cases, policy fixes need to be considered, and perhaps some appropriate exemptions fir triggering institutional investment;
  • Improve institutional investor practices. Building this capacity may be difficult for institutions with less than $50 billion under management, because changing some practices like building a skilled direct investment team might affect the culture of their organization;
  • Identify whether any regulatory constraints to RES investment by institutional investors can be modified without negatively impacting investors’ financial security, solvency or operating costs;
  • Design better pooled investment vehicles that create liquidity, increase diversification, and reduce transaction costs; and
  • Encourage utilities and other corporate investors, although funding RES via corporate finance could limit the advantage that institutional investors may have in lowering the cost of finance for renewable energy.

Above all, policy makers need to consider whether their goal is to achieve enough investment, lower the financing costs of that investment, or both.

Institutional investors alone will not solve the challenge of renewable energy investment and, as the CPI study suggests, scaling up investment from institutional investors will be a difficult task.

The CPI researched institutional investors together with public policies across North America, Europe, and Australia to complete its study.

Edited by Becky Beetz.