Posted by Macquarie Asset Management
October 19, 2020
Green energy debt is a relatively new asset class, however, it has been growing rapidly over the last decade. The asset class includes debt in renewable energy, green energy, and energy efficiency projects. Green energy debt is typically unrated and sourced through private placements or bilateral negotiations.
Private market debt financing of these assets has grown alongside the scaling up of national renewable energy targets, M&A activity, and refinancing of existing debt. These factors have seen the global market grow to a size of $US141 billion of debt issued last year.1
Looking ahead, the need to reduce emissions and the growing role for renewables within the global energy mix should act as tailwinds for the sector. To give you some perspective, over the next three decades, an estimated $US8.4 trillion will be invested in wind and solar projects.2 A substantial component of this figure will be in the form of debt.
Dillon Anderiesz, Macquarie Asset Management
Private credit has long been associated with corporate lending, distressed debt, or real estate debt. That has seen many investors overlook the broader opportunities within the asset class and caused some confusion around the benefits that infrastructure debt, and specifically green energy debt, can bring to a portfolio.
It is true that green energy debt, like infrastructure debt, can offer comparably lower returns to corporate and distressed debt. However, the asset class makes up for this with low default rates, high recovery rates, and low correlation to market cycles.
Green energy debt typically provides stable, predefined cashflows, structured to ensure payments can be made under a range of circumstances and market conditions. This is especially true for assets with contracted revenues, such as those operating with power purchase agreements or under subsidy regimes. Additional consideration is required when there is power price exposure involved.
Private green energy debt also offers a premium to green bonds through its added illiquidity and complexity. Where investors may hold green bonds to meet a target or commitment to the low-carbon transition, they are often implicitly trading some liquidity to meet these objectives. Green energy debt provides a complementary way of achieving this by explicitly trading some liquidity and receiving a higher return for doing so.
It is also worth noting that returns for renewable energy equity have also fallen in developed markets and established technologies in recent years.3 This has made green energy debt an attractive alternative on both an absolute and risk-adjusted returns basis.
Around one in three institutional investors are looking to invest in renewable energy as part of their ESG strategies, with many more seeking investment opportunities that lower greenhouse gas emissions, make an impact on the environment, or align with the objectives of the Paris Accord.4
In addition to providing commercial returns, green energy debt can contribute towards an investor’s ESG aims and overall carbon reduction targets. Investors are often attracted to the asset class as they can be confident that their investment has gone directly towards financing the energy transition.
Importantly, investors also have direct visibility over the emission reductions achieved – reducing the potential risk of greenwashing and ensuring investments are actually contributing to UN Sustainable Development Goals.
For many investors, green energy debt just has not been on their radar, so one of the biggest challenges is finding a place for it within a portfolio. In the absence of a historical portfolio allocation to the asset class, investors often wonder if it fits into their infrastructure, private debt, fixed income, or impact investing allocations. The answer varies by investor and a justification can be made for each of these allocations. The important thing to remember is the value it brings to the entire portfolio.
Another challenge to consider is that green energy debt is not readily accessible for most investors. As a private market asset, it requires origination capabilities to access attractive opportunities and experience to undertake a proper credit assessment. Whilst broadly syndicated assets can be more readily obtained, the less competed and more complex assets provide the greatest opportunity. Having the right manager to navigate the market and analyse each opportunity in detail is essential.
There is no doubt that green energy debt is a buy and hold investment, which is relatively illiquid. However, that does not mean there is no secondary market. There is strong investor appetite for well-structured and priced green energy debt, which can be met by the growing amount of institutional capital being raised in the infrastructure debt market.
For fund interests, there are not many pre-packaged, deployed secondary portfolios in infrastructure and green energy debt as these portfolios take time and some level of deployment risk to develop. This makes fund interests attractive to investors seeking to make an immediate investment.
The flight to quality has seen investors seek safety in the form of lower absolute returns as a trade-off for a reduction in risk and stability. Green energy debt should be a key beneficiary of this trend, given its demonstrated resilience through previous economic cycles.
As we turn our attention to the economic recovery, it has been reassuring to see many governments around the world, such as the United Kingdom and European Union, talking about “building back better” and putting investment in renewable energy at the centre of these plans. Although COVID-19 may have temporarily stalled the momentum of the low-carbon transition this year, a green-led recovery could give new impetus to the fight against climate change, offering new opportunities for investors.
Chart: Macquarie analysis, Moody’s Investors Service – "Default research - Global: Default and recovery rates for project finance bank loans, 1983-2018: Sustainable project finance bank loans", "Corporates - Global: Annual default study: Defaults will rise modestly in 2019 amid higher volatility", "Default and recovery rates for project finance bank loans, 1983-2018"
1. Macquarie Asset Management analysis, IJGlobal
2. International Energy Agency, International Renewable Energy Agency 2017
3. Macquarie analysis, Bloomberg New Energy Finance (2020)
4. Macquarie survey of 150 investors representing $US20 trillion in assets under management (2019)
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