How to invest in the energy transition with infrastructure debt

At the end of 2020 the UK government announced revised carbon emissions targets to help pave the way to becoming “net zero” by 2050. Using a ten point plan, the government is hoping to trigger a “green industrial revolution”, to build a stronger, cleaner economy as the pandemic recedes.

Unsurprisingly, there is a heavy focus on energy production. Wind, hydrogen and nuclear power have been singled out by the document as development priorities for the greener future. The ten point plan goes even further than existing carbon reduction plans, targeting at least a 68% reduction in greenhouse gas emissions by the end of the decade when compared to 1990 levels.

The plans propose advances in offshore wind capacity, growth in low carbon hydrogen, and new and advanced nuclear power. In addition, there are proposals for carbon capture technology and an accelerated roll-out of electric vehicle charging infrastructure.

It’s worth noting that, although not expressly listed in the government’s ten point plan, concessions must also be made for the interim phase in moving to renewable energy. The energy transition opportunity does not only lie in renewable energy but brings a whole ecosystem.

Wind does not always blow. The sun does not always shine. Intermittency issues mean alternative methods of energy generation are also required in the transition phase. Efficient combined cycle gas turbines (CCGT) plants, for example, can ensure security of supply. Storage (e.g. batteries) and supply management tools (e.g. smart meters) will also be needed in both the interim and in the net zero state.

Private potential

Despite the ambitious nature of the government plans, successful delivery is also heavily dependent on private investment. The good news for the government is that the UK has one of the most privatised infrastructure markets in the world. A wave of privatisations in the UK in the 1980s and 1990s brought regulated infrastructure companies - providing essential public services across a range of sectors - to the market.

The government has also made it clear that the focus of the new UK Infrastructure Bank – launching in April – will be on areas that are likely to be too speculative for private investment. Private investors will be integral to advancing a large percentage of the energy projects in scope.

Indeed, of the total announced £600 billion of infrastructure projects announced by the current government for development over the next five years, the Financial Times recently stated that half are to be financed by the private sector.

Funding the greener future

Without doubt, a sustainable future cannot be attained if the next generation of infrastructure is not built sustainably. Infrastructure investment allows investors to actively drive the energy transition in the right direction, while simultaneously securing strong risk-adjusted returns.

We have written previously about the attractiveness of infrastructure debt relative to traditional fixed income, especially in the current rate environment. In simple terms, where default risk is comparable there is a prominent pick up in yield. In junior infrastructure debt, yield spreads can be similar or lower than comparable high yield debt, but crucially, investors take on less credit risk. Although junior infrastructure debt shares characteristics with high-yield bonds rated BB, losses are a fraction of those on high-yield.

Spoiled for choice

The need to deliver on decarbonisation targets within increasingly pressing timescales means the range of opportunities for responsible infrastructure are growing by the day.  In such a dynamic market, we believe infrastructure debt offers investors the ability to contribute towards the UK’s energy transition, while locking in resilient returns at a time when traditional assets are under pressure.