Stacked coins with trees on top to represent green investment motives.

Summary

  • The International Energy Agency (IEA) and Imperial College put together a paper that explores the risk and returns in capital markets for energy investing. The joint report states that institutional investors will spend an estimated $1.6 trillion on renewable energy projects.
  • The approach conducted by private equity firms and venture capital investors differs from institutional actors. Private equity firms and venture capital investors assess the risk profile of early-stage or pre-construction assets – whereas institutional actors have mandates for long-term commitments and developments.
  • Renewable energy generated a return on investment (RoI) over 5 and 10-year periods that exceeded fossil fuels. The analysis provides a baseline for developed nations and Western economies.
  • Over the past year, there have been considerable developments in the transition to renewable energy, and an estimated $750 billion will be invested in clean energy technologies and efficiencies in 2021.

Introduction

As nations pull together to fight climate change, investors recognize the benefits of supporting renewable energy initiatives for the good of the planet and as profitable investments. As a result, renewables are now taking on the majority of new global power generation investments – around 70% from a total of $580 billion spent in the energy sector.

While the overall signs are favourable for the uptake of renewables and alternative fuels, there is still a degree of uncertainty around how the energy market will develop throughout the transition. In addition, investors are questioning whether the returns of these alternative assets can hold their own against rising oil and gas prices.

Although each investor has different motivations for their investment in renewable energy, some areas within the renewable markets trigger excitement across the spectrum. For example, capital and installation costs continue to drop for solar power, and wind capacity expansion doubled in 2020 and does not look to be slowing down any time soon. Green hydrogen, in contrast, has sparked massive excitement but remains a costly ambition.

The Discrepancies of Renewable Energy Investing

The approach conducted by private equity firms and venture capital investors differs from institutional actors.

The International Energy Agency (IEA) and Imperial College put together a paper that explores the risk and returns in capital markets for energy investing. The joint report states that McKinsey, a management consulting firm, has estimated that $1.6 trillion will be spent by institutional investors on renewable energy projects. However, it is projected that only 1.3% of that total will go towards “pure-play” renewable energy companies, just shy of 30% traded on publicly available assets and around 70% on privately held assets. These figures raise concerns around institutional investors’ transparency regarding their actual “clean green” investments and returns.

The report goes on to say that the breadth and depth of listed capital markets mean they can often act as a proxy for rates of return. This suggests that while we have incomplete information for most renewable energy assets, we can count on a proxy to determine an approximate figure.

The approach conducted by private equity firms and venture capital investors differs from institutional actors. For example, private equity firms and venture capital investors assess the risk profile of early-stage or pre-construction assets. In contrast, institutional actors have mandates for long-term commitments and developments to renewable projects – they primarily view long-term outcomes as the priority.

Private equity firms and venture capital investors typically build up the position and then sell on the operational assets once they reach a significant quantum to a drop-down fund or institutional capital. Before allocating profits to institutional asset holders, private equity firms tend to seek to profit on the initial growth period of a renewable energy asset. While this endeavour still facilitates the development and deployment of renewable sources, it also raises the capital costs beyond where they ought to be.

Investment Returns in Different Regions

In recent years, renewable power companies have outperformed both listed fossil fuel companies and public equity market indices – along with having a lower volatility rate.

Magnifying glass over the planet with the letters “ROI” and graph over it.

The IEA and Imperial College study also analyzed the returns across four developed economies – UK, USA, France and Germany. They noticed that renewable energy generated a return on investment (RoI) over 5 and 10-year periods that significantly exceeded fossil fuels. This analysis provides a baseline for developed nations and Western economies. Conversely, the renewable energy levelized cost of energy (LCoE) of developing countries – such as India, China, Chile and Egypt – can outperform their Western counterparts.

Notably, the IEA and Imperial College report identifies how renewables may finally be stepping out ahead of fossil fuels. For example, the 165 renewable energy companies in the USA generated a total return (TR) of 65% on the financial value of their portfolio over five years. The average annual return (AAR) sat at 10.1%, while the annualized volatility (AV) was 26.7%. To compare these results against the fossil fuel sector during the same period – TR was -9.6%, AAR -2.9%, and AV at 28.3%.

These disparities in returns are consistent across the West. In the UK, the TR for renewable energies was 75% over the five years. In comparison, the TR for fossil fuels was 8.8%. In addition, the AAR was 11.1% for renewables compared to 0.2% for fossil fuel sources. The final nail in the coffin – renewable energy AV was 10.5% versus 25.6% for fossil fuels.

The IEA’s World Investment Outlook 2021 supports these findings. It states that clean energy companies have performed very well on financial markets. In recent years, renewable power companies have outperformed both listed fossil fuel companies and public equity market indices – along with having a lower volatility rate.

With results being seen on the investment side of the renewable energy market, infrastructure and scalability need to play catch-up to ensure the consistency of power generation, storage and transmission, firmly placing renewables ahead of fossil fuels.

Investing in a Greener Future

It is estimated that around $750 billion will be spent on clean energy technologies and efficiencies in 2021.

There have been some considerable developments in the transition to renewable energy over the past year. This has been primarily due to Covid-19 and has resulted in a range of market dislocations that has triggered a boom for energy investors – notably in the areas of green energy technologies and efficiencies.

It is estimated that around $750 billion will be spent on clean energy technologies and efficiencies in 2021. Renewables are also projected to expand their installed capacity during 2021. However, there is also the reality that the fossil fuel industry will continue to grow – particularly natural gas and liquefied natural gas.

Energy investors, especially those with clean energy objectives, should recognize that their green investments can drastically influence high emissions sectors. Consideration needs to be given to the accelerated divestiture of oil and gas. Driving down supply instead of dealing with the growing demand for oil and gas by-products may result in adverse effects – such as unaffordable energy prices for consumers.

However, that does not mean throwing sustainability out the window and investing directly in coal or oil production. Investing in alternative green projects should remain a top priority. Carbon capture technologies and hydrogen regasification technologies are great examples of results that these investments can yield. Programs that improve fuel efficiency, building materials or processes, or fossil fuel production may be worth the investment as they will facilitate the faster uptake of renewable power sources.

Green Technology in Canada

Countries like Canada aim to be using fewer fossil fuels in the next few years, laying the groundwork for the transition towards renewable energy and other non-emitting sources of energy. Leading economies, such as China, the US and Europe, invest tens of billions every year to develop new green technologies, services and knowledge. This means Canada must continue investing to keep up with global competitors.

The global clean technology market is projected to grow to $2.2 trillion by 2022. Below, are a few of the key metrics for Canada’s performance to date in the clean energy sector.

  • Ranked fourth on the Global Cleantech Innovation Index.
  • Contributed $59.3 billion to GDP in 2016.
  • Employs around 274,000 Canadians.
  • Nearly 80% of Canadian clean technology firms are exporters and collectively generated $11.5 billion in exports in 2016.
  • Ranked fourth worldwide and first in the G20 in terms of potential to produce cleantech start-up companies over the next decade.

Final Thoughts

Although renewable power generation is rising in popularity, the equally vital transition to alternative fuel supplies has been disappointing. The overwhelming bulk of fuel supply investment in 2020 went into fossil fuels – 84% of fuel supply investments were given to oil and gas and 14.5% to coal. There was only 1.3% invested in low-carbon fuels. The deployment of capital is a good indication of the divide regarding energy transition.

Regardless of where investors spend their money, renewable energy is the best answer to both power generation and oil and gas decarbonization. There are “clean, green” investment opportunities within the oil and gas sectors for those simply pursuing a diversified portfolio. For the “clean, green” purist, the returns can be justified as a commitment to saving the planet.

Frequently Asked Questions (FAQs)

What is considered a good risk-reward ratio?

Market strategists agree that the ideal risk-reward ratio for their investments is approximately 1:3. In other words, three units of expected return for every one unit of additional risk. Investors can manage the risk-reward levels more directly through stop-loss orders and derivatives such as put options.

 

What are the three main aspects of a risk profile?

Risk profiling is considered to include three main components:

  • Risk Tolerance
    The perceived acceptable level of risk
  • Risk Required
    The risk associated with the return necessary to achieve the investor’s objectives
  • Risk Capacity
    The level of risk the investor can afford to take

 

What is involved in risk-reward analysis?

The risk-reward analysis is the method of evaluating the anticipated risks and rewards from an investment. It is usually performed via an A/B test and determines the best possible statistical strategy for the investment based on the trade-offs involved. A risk-reward analysis is carried out after deciding what the test will involve but before starting it.

 

Is renewable energy considered a good investment?

Renewable energy has a positive impact on the environment. The world needs more green energy to replace fossil fuels – and strong demand tends to make a good case for energy investments such as solar power.

 

Is renewable energy more profitable than fossil fuels?

Renewable energy investments are delivering better returns than fossil fuels. This is especially the case in the US, UK and Europe. In the US, renewables generated 200.3% returns versus 97.2% for fossil fuels. Despite the incredible RoI, the total investment volume needed worldwide is nowhere near what is currently required to mitigate climate change.

 

Westbridge Energy Corporation

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