In October 2021, the UK government published its Net Zero Strategy – Build Back Greener. With the target of being carbon neutral by 2050, it put heavy emphasis on investment in renewable energy, new technologies and energy efficiency. It was also clear that the country and the world were still going to need carbon assets to support the energy transition, and Russia’s invasion of Ukraine quickly brought security of supply and the cost of oil and gas back into sharp focus.

At the start of this year, there was much publicity and political focus around the profits announced by BP and Shell, given the continued impact of energy prices on the cost of living. BP announced record profits of $27.7bn at the start of February. A few days before, Shell had announced profits for 2022 of $39.9bn – double the previous year’s total and the highest in its 115-year history. They were not the only ones. Last November, SSE announced pre-tax profits of £559m for the six months to September, more than triple the profit made in the same six-month period in 2021. In January, RWE announced preliminary results for 2022 that showed profit had doubled to €3.2bn.

Pause for thought

Aside from the debate about the levels of profit and potential windfall taxes, it means the big energy companies have significant cash on their balance sheets and are still investing heavily. But in what? Have their investment plans changed? RWE increased net cash investments to €4.4bn last year, compared with the €2.9bn deployed in 2021. The company says one driver of the growth in its 2022 earnings year-on-year was the increase in its renewable generation capacity.

BP was one of the first oil and gas giants to commit to cutting emissions to net zero by 2050, and as part of that plan had previously stated that emissions would be 35-40% lower by the end of this decade. However, it effectively announced a slowdown in renewable investment, revising its end-of-decade target to a 20-30% cut. The company said this was because it needed to invest in oil and gas assets to meet current demands. There has definitely been a pause for thought on energy companies’ plans over the last year.

Now there is continued uncertainty on how to price energy assets due to this flux. What will future revenue streams will look like? How will the price of energy move in the short, medium and longer term? We have seen falling prices in recent months, therefore this might mean strategies and investment plans may change again.

There are several investment drivers for energy companies. As well as deploying capital on future pipeline and platform value justification, they are working hard to protect themselves from disruption from external events beyond their control.

Losses in auctions where projects sit in the near-term defined pipeline have a knock-on impact of reducing size for the ‘undefined’ pipeline. As a result we have seen increasingly aggressive government auction pricing being achieved – one example is the US federal government’s sale of Californian offshore wind. Over the past two years, RWE has paid or committed to £2.5bn of auction fees. But, over the same period, its market cap has increased by £4.5bn.

Net zero targeted

It is clear that, due to the significant scale of the task at hand, energy transition is no short-term investment. Everyone is on their own individual energy transition journey, but they are all moving at different speeds and there is no defined investment horizon common across all of them. The rise of the specialist energy transition investment funds, which have historically seen longer-term hold periods, is something that has benefited the sector.

The growth of the renewables funds over the past decade has been incredible. Examples include Bluefield Solar Income, which is in the FTSE250, with a market cap of more than £800m and was listed on the LSE 10 years ago this year. Also in that first wave of London-listed renewable investment funds was The Renewable Infrastructure Fund, which announced its results for 2022 in February – earnings per share more than doubled to 21.5p. Launched in 2018, the SDCL Energy Efficiency Income Trust was the first to focus purely on energy efficiency. Launched on the LSE two years ago, the ThomasLloyd Energy Impact Trust offers access to Asia, targeting renewable energy infrastructure in Asian countries, including Indonesia and India.

Oil and gas is working to a longer horizon, as it looks to create sustainable, profitable businesses to replace slowing core businesses over the next two decades. The large, listed power majors are more focused on short- to medium-term shareholder value, as a more significant part (or all) of their value is linked to deployment of new renewables.

Debt markets tighten

The liquidity of debt markets has been a key driver for renewables investment in recent years. However, while lender appetite to support renewables remains strong, the current economic situation has inevitably raised the bar on projects they will support and the debt terms available. I fully expect this to create opportunity for those with strong balance sheets, and without the need for leverage in the short term. And longer term, recovery in debt markets will be key for deal volumes to return. The hope is that this will be at some point this year, but time will tell.

Energy is now a well-understood asset class that has come into sharper focus over the past five years. If the energy sector is looked at from a risk perspective, it is a broad church with ‘something for everyone’. The risk profile for established assets such as wind and solar power is well understood. This also applies, but perhaps to a lesser extent, to some of the emerging and less-developed technologies, such as carbon capture and storage, which in particular is seen as essential technology required to decarbonise industries and meet net zero targets.

This is evidenced by the ‘mega’ fundraises seen across the sector, reflective of investor appetite for energy transition investments. Examples include Brookfield’s $15bn mega fundraise in 2022, focused solely on the energy transition, set to be followed by others including CIP, whose €12-15bn green mega fund is due to close later this year.

Changing focus

I fully expect there to be even more private equity capital going towards the energy sector over the coming years. One reason for this is the current economic situation. As other sectors such as consumer, retail and entertainment become less active, the private equity sector will naturally start to focus more of its attention, resources and capital on the energy sector. This in turn will inevitably bring even more investment into energy transition – incredible news for the sector and deal makers.

Most private equity firms are raising energy transition funds. There is a wall of capital emerging that is not focused on ‘core’ renewable infrastructure anymore, but rather on growth opportunities in the sector as governments mandate carbon neutrality around the world with no ‘one size fits all’ in terms of technology.

According to BloombergNEF, in 2022 there were more than 2,000 transactions in clean energy. With capacity expected to double over the next five years from 2,400GW to 5600GW according to the International Energy Agency, it’s certainly an exciting time to be in energy. 

The energy transition has a long way to go and there is a significant amount of capital available to enact it, both on corporate balance sheets and in investment funds. This dry powder is looking for a home and the energy sector provides the opportunity to deploy it. Energy, of course, is an essential and the transition to net zero is driving investment – there has never been a more exciting time to be working in the energy sector – and it will continue for a long time.