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By 2050, the EU has pledged to be a carbon neutral economy.
For investment teams at Europe-based insurance organisations, this radical shift will mean a broad rethinking of their allocation strategies, at the very least for regulatory and compliance purposes.
This means that with the mid-century target looming on the horizon – and global markets still reeling from post-pandemic turbulence – institutional investors are looking for new growth options and asset classes.
Renewable energy, mainly derived from the sun and wind, is an increasingly attractive option, with global investment in transition technologies (including energy efficiency) reaching a record high of $1.3 trillion in 2022, according to data from the International Renewable Energy Agency (IRENA).
However, enhanced adoption to this growing asset class doesn’t come without its own set of challenges.
“As the energy system decarbonises, it becomes more complex
and more interconnected.”
“As the energy system decarbonises, it becomes more complex and more interconnected,” said an S&P Global Commodity Insights report on “Accelerating progress in the new energy era”.
There are also recent loss trends to consider, with many segments of the renewable energy industry seeing rising concerns in the past five years over deductible and rate adequacy, said an Allianz paper on green energy. “From large hurricane losses to PV plants in Puerto Rico during Hurricane Maria in 2017 to fires devastating onshore wind turbines and repeated theft claims, the renewable energy industry suffers from frequency as well as severity events,” it said.
However, IRENA, which published the “World Energy Transitions Outlook 2023”, took a different stance, arguing that there wasn’t enough adoption. The organisation noted that “investments [into renewables] are not flowing at the pace or scale needed to accelerate progress towards universal energy access.”
“Institutional investors have the potential to scale up
major investments.”
Its analysis added that scaling up renewable energy investment – on the foundation of “sound enabling policy frameworks” – was critical to accelerating the transition, as well as fully reaping its financial benefits.
Furthermore, both public finance and investments from the private sector, often in the form of public-private partnerships (PPPs), will have critical roles to play going forward. “Institutional investors, such as pension funds, insurance companies, endowments and sovereign wealth funds, have the potential to scale up major investments,” said the report.
One of the largest renewable energy projects is Hornsea 2 and Hornsea 1, offshore wind farms off the UK’s Yorkshire coast. Hornsea 2 can generate enough energy to power more than 1.3 million UK homes, whilst the Hornsea 1 can cover more than 1 million.
The initial Hornsea project was part of a $8.7 billion investment to transform the Humber region into a renewable energy hub – and was the world’s first offshore wind farm to surpass 1 GW in installed capacity. These plans connect to the UK government’s levelling up project as well, contributing to the social impact element of ESG – and could represent some of the social infrastructure projects financed by potentially soon-to-be-released Solvency II capital.
“[There is] a historically clear link between countries highly
dependent on nature and poor credit scores.”
These capabilities have become especially important after the EU energy crisis that occurred when Russia invaded Ukraine – and, according to many investors, they provide valuable new growth paths for enhanced investment in the renewable industry.
John Willis, Director of Research at the non-profit financial thinktank Planet Tracker, said that he believed that a good understanding of a country’s dependency on nature exports – and, conversely, its adoption of renewables – was necessary when assessing a sovereign’s long-term financial outlook, stability, and investment potential. “[There is] a historically clear link between countries highly dependent on nature and poor credit scores,” he said.
For insurance investment teams, this means that sovereign investing could change in the future, especially with certain countries favouring the adoption of so-called ‘clean’ energy, and others lagging behind.
It could also offer new areas for insurance coverage, with Lloyd’s of London commenting that “unquestionably, the rapid growth in the renewables industry, the changing nature of risks, and the fact that insurance is often a prerequisite for provision of project finance mean that there might be a growing need for insurance.”
This risk and reward cycle, the re/insurance market said, could ultimately stimulate growth in the asset class, offering institutional investors a value-add opportunity, as renewables “take over the majority of energy production”.
From October to December 2022, a UK government report on energy trends noted that production from renewable technologies broadly matched the previous record high of 2020, with “renewables’ share of electricity generation increasing to 41.4% from 39.6% last year, largely due to wind and solar generation reaching new record highs.”
“Wind generation hit a record high share of 24.6%, and generation from fossil fuels fell slightly down to a share of 40.8%, but generation from gas remained the principal form of UK generation at 38.4%,” said the paper.
“A key issue for renewable energy is that is remains driven
by policy instruments.”
It added that the energy trade had been impacted by several key factors, including exports of crude oil reaching a record low due to low indigenous production, whilst gas exports reached a record high as the UK operated as a landbridge for transfers of gas arriving into the country and onto the continent.
However, one of the largest factors hindering additional growth was seen as slowness on the legislative front – the gap between regulatory development and financing. “A key issue for renewable energy is that is remains driven by policy instruments,” said the Lloyd’s report.
Still, insurers are cautiously optimistic about the area’s viability, especially as new technologies encourage global uptake and streamline investment options. “Renewables are playing a disruptive role in energy markets, and are likely to become more competitive into the future,” Lloyd’s forecast.
As individual renewables markets take shape, it remains to be seen where the best investment opportunities lie – but there are likely to be winners and losers. Given the growth factors to consider, renewables have a bright future ahead, however, it will be up to investment teams with thorough due diligence processes to make the most of these opportunities.
