This spring the EU Commission published its roadmap for transition to a low carbon economy by 2050. It’s an ambitious plan that will ensure that the EU can be a leader in the worldwide transition to a low carbon and more resource efficient economy.
The commission estimates that to obtain the goal of an 80% reduction in emissions over the next 40 years it will require annual investments averaging 1.5% of GDP – equivalent to €270bn. This is a massive challenge and it is unsustainable for energy and utility companies to raise the funds themselves.
Given the current fiscal challenges in a number of EU countries and the future strain on public finances from an ageing population, public sector cofinancing aiding this transition will be limited. Therefore, most investments in renewable energy sources and more effective energy infrastructure must be financed by the private sector and consumers.
If the 2050 goals are to be reached, it is crucial to get the substantial – and growing – private pension capital activated within this field. Especially, since other types of more leveraged investors can no longer finance their investments as easily as was previously observed.
Pension funds are, by nature, long-term investors. Hence, investments in renewable energy, energy infrastructure and other types of infrastructure should be useful supplements to listed equities and bonds generate a return in line with what can be expected in the equity market but with risk and sensitivity to the global business cycle significantly lower than with equity investments.
Investments in renewable energy and infrastructure appeal to pension funds when they deliver a predictable and stable cash flow. In terms of renewable energy sources the role of the government is to ensure that the power production can be sold at a fixed or highly predictable price for large part of the life of the asset.
If these conditions are met, investments in renewable energy and infrastructure should appeal to pension funds, but so far actual investments have been limited. This has also been due to lack of experience among pension funds with (direct) investments in the asset class and uncertainty about a relevant pipeline of similar investment opportunities before committing to the initial investment.
But there are already concrete business cases out there. In Denmark, for example PensionDanmark and Dong Energy have developed and implemented a model for how pension fund capital can be activated in relation to investments in renewable energy. The breakthrough came in 2010 with the investment in Nysted Wind Farm and has more recently been applied with the investment in the future Anholt wind farm. Overall, the two offshore wind farms will supply clean energy equivalent of the annual consumption of 540,000 Danish households by 2014.
The model includes the creation of a partnership between an institutional investor and the industrial partner, where the pension fund provides the capital and the industrial partner is responsible for construction and operation, while at the same time keeps a substantial share of the asset as to ensure alignment of interests.