Calling All Institutional Investors: Opportunity Exists to Invest in Cleaner Energy Grid
Pensions & Investments, March 3, 2016
Pension funds and other long-term investors need to spend less time buying and selling energy infrastructure projects that already exist, and more time funding projects that need to exist. A new version of “platform companies” can partner with institutional investors to invent, design, build, own and operate electric infrastructure that can provide decades of predictable and reasonable returns. These are exactly the assets whose long-term stream of payments matches pension funds need for long-term stable returns.
Thanks to a national focus on reducing carbon emissions, tens of billions of dollars will have to be invested in the electric transmission and distribution sectors over the next decade to deploy massive amounts of clean energy in the United States, spurred by initiatives like COP21 (the agreement reached at the 21st “Conference of Parties” at the 2015 Paris Climate Conference), and the EPA’s “Clean Power Plan.” In addition, many state governments are working to reach their own renewable energy goals, such as New York, where Governor Andrew Cuomo recently adopted a goal of 50% renewable energy by 2030. It’s plain to see that the electric energy industry’s need for infrastructure capital will be enormous, and no sector of the financial industry is better suited to provide that capital than pension funds.
At the same time, there are changes occurring within the long-term investor industry that make the opportunity for these funds even more robust — by playing a leading role in the shift away from the old paradigm of assigning these investments to infrastructure and private equity funds. The old fee structure model (“2 and 20”) has been under review and some of the leading institutional investors are evaluating new approaches.
Last summer, that review led to the creation of the “Aligned Intermediary” initiative, which received White House support for its goal to “act as a matchmaker between, on the one hand, developers, companies and projects that seek debt and equity capital and, on the other hand, committed, long-term, institutional investors. Specifically, the initiative will source, screen, conduct due diligence, and structure transactions for its institutional backers so that each deal satisfies specific goals related to financial rate of return, as well as positive social and environmental impacts, with a particular focus on reducing greenhouse gas emissions.” This initiative is supported by $500 million from the University of CaliforniaRegents, $350 million from the New Zealand Superannuation Fund, $100 million from TIAA-CREF.
Efforts like the Aligned Intermediary initiative are good news and evidence of a search for ways to finance energy infrastructure more efficiently. The past practice of outsourcing the task of developing new infrastructure to fund managers was not efficient. Those managers collected management fees and earned the usual carries, but at the end of the day had to find developers who could actually get projects started. Those developers, in turn, required money and incentives to get their work done. And, because energy infrastructure projects usually take five to 10 years to develop, it was not unusual for the fund managers to lose patience with the process, usually because the duration of their fund was shorter than the development cycle of the infrastructure projects.
As a result, the intermediary (the fund manager) pulled the plug on otherwise worthy projects, leaving their limited partners bereft of the infrastructure investment they were hoping to get. Meanwhile, most of the infrastructure funds spent the vast majority of their time and money chasing existing projects in auctions where the prices paid went higher and higher, simply because there were so few projects available.
“We don’t do development” is a common refrain. The result: buy and perhaps overpay for second-hand projects.
Development is the essential activity in what the Aligned Intermediary website calls the “the resource innovation space.” This is where projects are invented, incubated, permits acquired, long-term commitments from credit-worthy customers secured, and equity and debt lined up. Development is invention, yet, to many LPs and their fund managers, it is a four-letter word. “We don’t do development” is a tired refrain of an industry that would rather buy than build. The results are predictable: too many buyers chasing too few existing projects leads to lower yields for all.
The energy infrastructure business needs more courageous investors. Spurred on by initiatives like Aligned Intermediary, more long-term investors are seeking out the inventors, the developers, the creative people that start things and stay with things that take six, or seven or even ten years to develop.
So, this is a call to long-term investors. Society has committed to move from a grid for dirty energy to a grid for clean energy. Investment opportunities of $50 billion to $100 billion are available to you with good, long lasting returns. But you will only get those returns if you finance the early years, the “resource innovation space.” The developers who have created platform companies in the innovation space need you, and you need them. You need to be direct partners, because serious energy infrastructure development cannot thrive in the too-short timelines of the infrastructure fund model.