Infrastructure assets will require "substantial investments" to achieve lower carbon emission targets and require private sector funding for many initiatives, according to new research from RARE Infrastructure.
RARE Infrastructure recently publishedThe Push for Sustainable Infrastructure, which examines the impacts of pushing for zero carbon targets was well as forecast where forthcoming investment might be directed.
RARE cited International Energy Agency (IEA) statistics stating that in order to lower emissions enough to keep with the UN climate change target to 1.5 -2 degrees of warming, "a baseline case of roughly $1.3 trillion needed to be spent annually on a global basis over the next 20 years and $1.7 trillion in the more sustainable case" needs to be invested in energy networks.
RARE took Australia as a case study, finding that under a business as usual emissions forecast, there will be a "considerable reduction in emissions. The decrease, which will be nowhere near net-zero by 2050, is mainly attributable to projected lower emissions in the electricity sector."
RARE notes that there are "tremendous opportunities" for reducing emissions in other sectors, such as reducing emissions in infrastructure.
"Our approach is to consider a range of different public policy paths to work out how that might impact the companies' investment programs, how it might impact their valuations over the long term, and that way we can take a risk adjusted approach to demining returns on equity," said Nick Langley, co-founder and senior portfolio manager RARE. "Essentially, this prices the different public policy paths and the impact it's going to have on different infrastructure returns."
The research RARE conducted has shifted some of the firm's portfolio investments, Langley noted.
"The most drastic impact has been the balance between gas pipeline companies and renewable energy companies," he said. "Our view up until we did a significant amount of work mid- to late- last year was that gas would be a bridging fuel for two to three decades in the transition from coal, as a major baseload source of power, to renewable energy."
The report noted that much of the aforementioned spending outlined by the IEA will be invested in on networks, transmission and distribution, to adapt infrastructure to the way we use electricity and gas and other energy grids. RARE notes this investment will mean growth in the underlying asset base for infrastructure companies and regulators, providing attractive returns to equity holders to help fund that growth. This presents upside opportunity for investors in infrastructure, RARE said in the report.
"As we looked at how the policy environment was changing, how the impact of environmental concerns was being picked up in shaping public policy, it became clear that the bridging period for gas was a lot shorter than we previously considered," Langley said. "What it said to us is that a lot of these gas pipeline companies were going to stop growing their asset base and enter the run-off phase a lot earlier than the market anticipated."
Under that anticipated scenario, trunk line and mainline pipe systems and major gas transmission companies will continue to be utilised, but smaller, alternative, and gathering pipelines are likely to become stranded assets more quickly, Langley said.
"That caused us to reduce our exposure to the pipeline space from 15% of the portfolio to 7-8% percent at the beginning of the year. The corollary to that is that the market was underestimating the amount of spend and development of renewable energy assets, wind farms and solar arrays, and so on, so we shifted that capital into the renewable space, and that's been an excellent trade for the portfolio through the course of this year."
Langley noted that post-COVID-19 recovery packages that governments will put forth will create a "tailwind" for green infrastructure projects, but predicts that there will be distribution of funding towards smaller, more localised projects.
"On the positive side, it has made it easier for these decisions to be made within political systems, and so it has fast tracked some of that decision making, increased the size of the public sector support for the building of green infrastructure," he said. "That's a positive. I think that support would have come over time, but COVID has accelerated that. The flip side is the nature of some of that spend is less on large strategic assets, more on stimulating economies and that will result in a larger number of smaller projects that have a more marginal benefit to the green infrastructure theme, but they're using local materials, local aggregates, local labour, local contracting companies, and thereby stimulating local economies and communities, which is critical to pulling us out of this COVID-19-induced recession."