The energy industry has always been a cyclical one. But as the world emerges from the Covid-19 disruption, it feels as though the pandemic has drawn a line in the sand for the carbon-emissions status quo.

The steep global demand decline that resulted from Covid-19, a price war between major oil producers and the oil price falling below $20/bl led to large-scale financial losses, write-downs and balance sheet restructurings across the industry. At the same time, governments and investors are creating momentum for change. The support for transition to a lower-carbon world has never been stronger.

The support for transition to a lower-carbon world has never been stronger

We are told that the technological levers to achieve this transition are in place. Renewables, battery storage, gas-to-power, hydrogen, carbon capture, decarbonisation, energy efficiency and nuclear will all have a role to play if the world is to achieve net-zero emissions by 2050. There is no silver bullet, and costs need to come down. To succeed, all options will have to be exploited on a global scale.

Finding the funding

Expectations for the pace of the energy transition are high, but the process will be challenging. All industry participants are grappling with what the real target is, how much funding will be needed to achieve that target, how much funding will actually be available, and the timescale within which it can realistically be deployed.

What we do know is that the need for funding cleaner technologies and the transition is vast. Analysis of IEA figures shows that, over the last five years, investment in the energy transition has averaged $1.8tn annually. Annual investment would need to at least double from this baseline if economies are to have any hope of meeting the IEA’s Sustainable Development Scenario projections. If net-zero emissions are to be achieved by 2050, annual investment will have to triple.

If these figures are correct, funding will be an issue for all parties participating in the energy transition, with different challenges facing various stakeholders.

Incumbent energy companies, many of which are heavily dependent on the hydrocarbons economy, will have to pivot to lower-carbon energy provision at the same time as maintaining profitability and providing returns—to some level—to their shareholders.

Financial institutions are assessing where to place money and are having to make judgement calls on newer technologies and the direction of travel of the energy transition. There is undoubted interest in financing the shift to net-zero emissions, but still uncertainty among infrastructure and pension funds and asset managers as to where they should direct their capital, especially if they are seeking to avoid being subject to the development risk attached to new technologies.

Governments, meanwhile, have made long-term carbon-reduction pledges but need to support these goals with substance and key policy direction. This is needed to assist corporates, funds and asset managers in making judgement calls.

$1.8tn - Annual investment in the energy transition

Laying the foundations

To fund the gap, if net carbon-reduction ambitions are to be realised, participants will have to draw upon equity, debt and public finance—and the magnitude of the financing required will necessitate cooperation across all these stakeholder groups in an unprecedented way.

There is a growing view that the foundation of large-scale investment in the energy transition—foundations that leverage government involvement and attract private investment—will require the establishment of appropriate risk/reward policies, particularly for new technologies where there is development risk.

Government will have a crucial role to play here, laying out the roadmap for the energy transition and supporting it with a long-term vision. Low-cost private investment can be unlocked only if roadmaps and accompanying frameworks for each new technology are in place, with investors likely to be reluctant to take on development risk if governments are unclear or unwilling to commit. The urgency and limited time remaining to boost the energy transition leave no room for retroactive changes to energy policy.

The history and track record of renewables—and their successful establishment in the energy mainstream—provide a blueprint for the role governments and industry can play to unlock private sector support, reduce technology risk concerns and drive down prices for newer technologies.

The total deal value of renewables transactions for the first nine months of 2020 climbed 54pc year-on-year, to reach $54bn. The cost of renewable energy has come down dramatically over the last decade and, with yields of 6-7pc, there is strong appetite from private investors for assets.

The pool of energy transition technologies is vast, but the various technologies are at different stages of development. The more nascent ones will rely on government backing in much the way that offshore wind did during the previous decade. Back in 2012, offshore wind, now a core part of renewables portfolios, was struggling to attract capital. Investment from the UK government’s Green Investment Bank plus the use of contracts for difference provided essential financial support to develop offshore wind into a sustainable commercial proposition for investors.

There is clearly an urgent need to better understand these newer technologies and to kick-start the process of rolling them out on a larger scale. This will take the support of government, oil and gas industry players, investors and financiers at large.

There is plenty of opportunity for all participants to look across the spectrum of technologies and find deals and projects that match their risk appetites and cost of capital requirements. 

By Michael Watson, Partner, and Sandra Rafferty, Partner, White & Case

Any views expressed in this publication are strictly those of the authors and should not be attributed in any way to White & Case LLP



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