A changing landscape
The need to decarbonise and transition our energy systems is having a profound effect on industries across the board. But how is this shift reshaping private markets themselves?
With trillions of dollars needed annually to fund the world’s energy transition, it’s clear that private markets have an important role to play in financing a range of solutions, from installing renewable energy capacity and helping reduce emissions in industries that are hard to abate, through to backing the development of new technologies that could accelerate economies’ decarbonisation efforts.
And it’s this role that is helping to create an energy transition and decarbonisation ecosystem in private markets. “Energy transition has gone from being a niche corner that attracted impact capital to a proven thematic strategy where increasing amounts of institutional capital are flowing,” says an investment professional at a large asset manager. “Each fund can only scratch the surface individually in the move towards decarbonisation, but more funds are now showing they can generate strong private equity returns here. That will attract further capital.”
A broadening field
While it may sometimes be challenging for investors to get under the hood to determine exactly what energy transition means for their portfolio, the fact that their options are increasing so rapidly means they can target the theme across a range of risk and return profiles, including venture capital, growth, buyout and infrastructure. “Energy transition can be a little fuzzy as a term,” says a managing director at a large firm. “Different people will give you different answers as to what it entails. Historically, a lot of the focus was on renewables, but the agenda has expanded massively over time to encompass a lot of adjacent solutions and technologies to achieve decarbonisation.”
That’s because, according to Nazo Moosa, Managing Partner for Europe at Energy Impact Partners, “it will take everything to reach decarbonisation, including taking companies that are highly polluting today and making them greener”. She adds: “This is not our fund’s focus – we target technologies that are at the heart of Scope 4, including those that remove and mitigate carbon and build the circular economy.”
It will take everything to reach decarbonisation, including taking companies that are highly polluting today and making them greener
And there are certainly investors that see opportunities in the former category. “There are a lot of transitional activities where investors can drive decarbonisation,” says Joana Castro, Head of Primaries and ESG at Unigestion. “These are quite niche and there is less competition here and lower entry multiples than in other parts of the private equity landscape, but there is execution risk – you may not, for example, get a business that is brown today to green. There is a lot of transition needed in areas such as concrete, steel and aluminium manufacturing.”
Policy is only part of the story
Policymaking is helping to build some of the markets that private markets firms are targeting, helping create new business models and supporting the development and commercialisation of new technologies. “Current legislation, such as the Inflation Reduction Act in the US and efforts in the EU to match this are helping to build a more stable outlook for market participants and for entrepreneurs to build and scale businesses and to help them reach profitability,” says the investment manager. “They are encouraging capital to flood to energy transition themes and some of this will go to technologies that are on the cusp of commercialisation, such as hydrogen-based fuels.”
Yet while policies are providing a tailwind to many of these kinds of investment, GPs and LPs are circumspect about leaning too heavily on subsidies and government support – they have learned the lessons of over-reliance climate tech 1.0, where the removal of incentives and fluctuating levels of government support affected returns. “Government policy will drive capital and innovation,” says the investment manager. “But we have to focus on businesses that are solving a fundamental issue for their customers – helping them be better, faster, more efficient – so that even if they didn’t claim to be an energy transition-related companies, they would still be important for their customers.”
Why investors need to be agile
This, combined with rapid technological advancements and more capital coming into the market, will require companies targeting energy transition and decarbonisation – and their private markets backers – to be agile. And this, in turn, is having a fundamental impact on investment strategies. Where once, for example, infrastructure investments focused solely on hard assets that changed little over a fund’s ownership period, there is now a whole spectrum of infrastructure-related themes with different risk and return characteristics. Even the most conservative of strategies often now include some element of technology risk. “We like proven business models,” says Constantin von Wasserschleben, Chairman at IKAV. “We started with feed-in tariff solar parks, but today we focus on more concentrated solar power. It’s late stage, but it still has some exposure on the technology side.”
And while the amount of capital required to transition our energy systems means there will continue to be significant opportunity, investors are likely to need to shift their strategies on a regular basis as other parts of the economy crowd in. “There will be more investment coming into this space,” says the managing director. “That includes big corporates with a decarbonisation agenda. That’s good, but it does mean more competition and where you focus will increasingly matter. Certain risk profiles, such as for offshore wind, used be extracted on a contracted basis, but increased competition means that’s no longer possible and you can only get these on a less attractive contracted basis. It’s upon us to pivot to address adjacencies. They are fertile ground for us today, but they may not be in a few years’ time and we may need to pivot again.”
Rapid changes are reshaping private markets
There is clearly much more change to come. “Infrastructure will be impacted by artificial intelligence,” says Steffen Meister, Executive Chairman at Partners Group. “In renewables, for example, storage is becoming more important. The key here is the material used for storage. Over the last 50,000 years, we’ve created materials through trial and error and that can take many years. Using AI modelling, we can test crystal structures or polymers – or any other new materials – and bring a five-year process down to five days. Hence, you must assume that if you buy a distributed energy business or a large-scale storage business that you will have to constantly evolve that business in the coming years. That’s more of a private equity mindset than an infrastructure way of thinking.”
Infrastructure will be impacted by artificial intelligence
Indeed, the energy transition, combined with the pace of technological change, is reshaping private markets. While the industry has been consolidating for some time, with many secondaries firms snapped up over the past few years, moves bringing infrastructure firms into the private equity fold look set to be far bigger. BlackRock recently announced its acquisition of Global Infrastructure Partners for $12.5 billion, with the asset manager’s chief executive Larry Fink commenting that “infrastructure is one of the most exciting long-term investment opportunities”. Meanwhile, General Atlantic just announced it was buying Actis, and Foresight acquired Infrastructure Capital Holdings in 2022.
Increased interaction
Yet even where M&A isn’t taking place, different parts of the private markets space are calling for greater co-operation. “My biggest concern is whether there will be enough hybrid capital to support the energy transition,” says Moosa. “People are so used to talking about infrastructure or buyouts or growth. But we need hybrid capital – infrastructure funds need to interact with venture capital funds. The dynamics of this market are different.”
It's a point picked up by others. “Decarbonisation is different from broader private equity,” says Castro. “It needs to be a community effort, where joint co-operation is important across the risk and return spectrum.”
“We have different pools of capital coming in at different stages, as well as corporates looking to invest directly,” agrees Joerg Metzner, Platform Partner at TPG Rise Climate. “We need to think about the whole lifecycle. A lot of capital is needed to de-risk technologies, we need to think about offtake and feedstock agreements and we need to think about how infrastructure can scale up opportunities once they are de-risked.”
We are only at the start of a multi-decade energy transition and decarbonisation journey and it’s clear that it will present significant opportunities across private markets. This will result in far-reaching changes in the world’s economies, but it’s also becoming apparent that it will shape private markets profoundly, resulting in M&A and more collaborative ways of working with peers in other firms.
