What does the energy transition look like in the infrastructure sector?

From

Daniel Cave

As the world moves closer to consensus to target net zero carbon emissions by 2050, there’s a huge transformation taking place across global energy networks. While this transformation has been under way for some time, 2020 was the year where we saw this theme contribute to a noticeable performance dispersion within the global listed infrastructure (GLI) company universe.

Calendar year 2020 saw high investor demand for renewable assets (primarily wind and solar), some of which include companies within the GLI company universe. In contrast, energy infrastructure (gas transportation and storage) and gas utilities have faced headwinds owing to     their carbon exposure from fossil fuels (including methane leakages) and failed to return to pre-COVID levels during 2020. While shorter-term earnings are less of a concern for these sectors, the market has lowered its asset growth assumptions and is now considering the potential for stranded assets in their terminal values as the world attempts to move towards carbon neutrality.

Within the GLI universe, it’s not only the small handful of pure play renewables companies that have exposure to the energy transition theme. While not evident at first glance, many electric utilities have renewable assets and are exposed. This is evident in the return dispersion in the above chart, which compares the performance of those GLI companies most positively linked to the theme (renewables and electric utilities) to those most negatively impacted (energy infrastructure and gas utilities).

How do investors gain exposure to renewables in GLI?

Currently, there are a limited number of investable pure play renewables companies available to GLI managers. This, coupled with electric utilities often owning a portfolio of disparate assets operating under different business models, means investors may easily overlook the energy transition linked exposures within their portfolios. However, given the utilities sector makes up a large portion of the GLI stock universe, investors may actually have a much larger exposure to this thematic than they realise.

Transmission and distribution assets

With GLI managers typically targeting regulated earnings, a large exposure to the energy transition is within electric utilities that own transmission and distribution assets. These assets are typically regulated and are permitted by regulators to receive a return on their Regulated Asset Base (RAB). These assets are favourably positioned as there is an increasing need for further investment required to a) connect renewables to the grid and b) prepare electricity grids for the changing structure of the energy markets and networks. Investment in these projects increases a company’s RAB which in turn provides earnings growth.

Renewable electricity generation

Integrated utilities can provide investors exposure to the energy transition theme. Integrated utilities typically operate via a vertically integrated business model which includes energy generation, transmission and distribution all under a RAB. While historically these have been avoided owing to large exposures to coal fired power stations, in many cases these are being retired and replaced with renewables, turning these companies from laggards to leaders.

Contracted renewables

There are also renewable assets that sit outside RAB models, where the projects sell their power generated under long-term supply agreements. Traditionally unregulated generation is viewed less favourably than regulated, owing to higher risk earnings. However, with contracted renewables the assets have very long supply contracts, therefore have a more limited exposure to pricing and volume risk over the life of the contract than traditional energy generating assets. There are currently a limited number of pure play renewables companies of this nature that fit within the broadly accepted definitions of GLI. Many commercial renewables companies are developers which don’t fit within the risk profile GLI managers are targeting.

While these neat labels are helpful conceptually, identifying a GLI fund’s renewables exposure is a very difficult exercise given an assessment of each company’s underlying assets is required. Furthermore, we note that many of the companies that own renewable assets own them as part of much broader portfolios of electric assets.

While not overtly labelled, we believe investors are getting a measured exposure to the energy transition via their GLI exposures. The performance upside will be more constrained than that experienced in a renewables development company, however this is in line with GLI’s core characteristics of stable earnings.

By Dan Cave, Senior Investment Analyst

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