Energy Transition: Untangling Promises and Reality
Executive Summary:
Cautious Optimism Warranted in Evaluating Energy Transition Investment Opportunities
- Despite a vast and rapidly evolving opportunity set, buyer beware; the energy transition is not a beta play where investors should blindly deploy capital.
- Energy markets are complex and volatile. Transitioning will not change this.
- The devil is in the details; generalities can obfuscate opportunities and challenges to decarbonizing and accessing a robust opportunity set.
The world is moving away from fossil fuels and towards decarbonized sources of energy. For all the hype around the energy transition, moving away from fossil fuels has yet to become a reality, with coal, natural gas and oil consumption increasing in 2023. This is not to say that renewable energy has not experienced substantial growth in recent years, but the truth is that we have yet to reduce our consumption of fossil fuels, making a transition aspirational when viewed globally. Furthermore, although real progress is being made on exciting new technologies, unrealistic timelines for commercialization and overstating the capabilities of established technologies can create disillusionment and confusion.
Google Search Trends: Energy Transition (2010 - 2024)
In the chart above, we can see that worldwide Google searches for the phrase “energy transition" started to increase significantly in 2018, despite fossil fuel consumption increasing over the same period.
Global Energy Consumption by Source (2000 - 2022)
Why haven’t we seen more of a transition for all the talk? This is best addressed by putting things in perspective. Industrial and transportation sectors collectively consume over 70% of the primary energy supply in the U.S., with the balance coming from residential and commercial applications. Many of these sectors are more challenging to decarbonize and electrify relative to others for cost and technical reasons (electric planes, anyone?). Electricity and self-generated renewable energy comprise a small fraction of energy inputs for these sectors, suggesting the need for more complex solutions. Does this allude to vast opportunity for private investment or significant challenges? Our view is both.
U.S. Energy Consumption by Source and Sector, 2022
Amidst cautious optimism, where do we see opportunities to invest? Across the energy transition opportunity set, which encompasses generation, energy transmission and storage, de-carbonization and demand-side solutions. Despite strong tailwinds and a vast opportunity set spanning the risk spectrum, buyers beware: Facts can be obfuscated amidst the excitement to jump on the transition bandwagon. Case in point: Renewable energy developers, practically all of whom have ‘bragawatts' to boast of (although reality is often less electrifying than one may expect).
Despite a seemingly homogenous product, don’t overlook the fine print, with inconsistent project stage definitions and wildly different underwriting assumptions observed in the market. Examples of these inconsistencies can be found across key underwriting assumptions, including project costs, availability, degradation, availability, lifespan, curtailment, the inclusion/exclusion of certain tax breaks/subsidies, revenue sources and associated prices, discount rates, developer margins, etc. To make matters worse, many transaction “comp” sets referenced in the market can be meaningless at best as they fail to account for wildly different valuations commanded across markets and development stages.
Recently Observed Project Underwriting Assumptions: Solar
So, how do we invest in the energy transition? Selectively and through a rigorous and analytical approach, leveraging a trove of proprietary data, while also harnessing the breadth and depth of our relationships in the market. What do we avoid?
As infrastructure investors with a primary focus on core- plus and value-add risk, we’ve somehow avoided confusing ourselves for investors focused on venture capital, growth equity and buyout transactions, as difficult as this has been for many in the industry. Although we’re excited about an ever-evolving and increasingly robust opportunity set, discipline and experience matter. After all, energy markets are volatile, with history littered with spectacular failures and successes. A volatile market in transition should make for an exciting, albeit bumpy ride. Buckle up!
We provide further insights and observations across real estate in our 2024 Real Assets Market Overview. Please complete the form below to receive an emailed copy of the report.
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As of June 5, 2024