While there has been growing concern around environmental, social and governance (ESG) issues in the last decade, it’s arguably Covid-19 that has really pinpointed economic and health inequalities and pricked the collective conscience. By highlighting global interconnectedness, it has not only shown us that our individual actions can have serious consequences, but also brought into sharp focus that when mass collaboration is required, it is possible to enact real and rapid change.
That’s exactly what is required in the journey to Net Zero carbon emissions. And there’s no time to lose. The goal is to limit long-term warming to 1.5°C above pre-industrial levels and the Intergovernmental Panel on Climate Change has stated that will require cutting global emissions by 50% by 2030 and reaching Net Zero by 2050.
Even a rise of an additional 0.5°C would have catastrophic consequences, including pushing up the number of people worldwide who are exposed to climate-related risks and poverty by hundreds of millions.
The size of the task to effectively curb climate change is undeniably mammoth. According to the UK government's independent climate adviser, the Climate Change Committee, £1.4trn of climate-sensitive infrastructure investment is required. It’s estimated that an average of around £40bn of private investment is needed annually in new low carbon infrastructure over the next decade. This is twice the 2019 level.
No pressure then.
Luckily, the UK infrastructure investment sector has bags of experience in large-scale, long-term projects, requiring multi-agency collaboration, particularly in the PPP model. Another potential bright spot is the UK Infrastructure Bank (UKIB). Set up last year by government, part of the bank’s mandate is to facilitate government and public bodies investing in infrastructure projects alongside the private sector to help reach the UK’s 2050 zero emissions target.
According to Darryl Murphy, managing director and head of infrastructure at Aviva Investors, which has had extensive engagement with UKIB, “our belief is that it has a key role to play as a conduit for the market into government opportunities. It is important it delivers its promise to ‘crowd in’ private investment, but we sense it has also realised that investment opportunities are relatively limited.”
That’s a shame because the rewards for getting involved could be significant, with the former governor of the Bank of England, Mark Carney, calling Net Zero the “greatest commercial opportunity of our time”. No wonder he’s also suggested that there is $170trn of private wealth ready and waiting to take part in the green investment opportunity.
It’s a bit more complicated than that, though.
Jon Phillips, deputy CEO & director of corporate affairs at the Global Infrastructure Investor Association (GIIA), feels that investor pressure on fund managers regarding ESG and Net Zero has been present for several years and it’s now a no-brainer that current and future investment strategy must encompass these areas. In fact, Phillips says that ESG is now “dominant” in the strategies of infrastructure investors.
The bigger issue, though, is how to deal with existing investment assets that don’t fit the Net Zero narrative. For Phillips, the area of most investor debate at the moment is: “How do you sensibly transition [those assets] from now to the future?”
While public money is accountable to the electorate, large infrastructure fund managers have different considerations for risking private money alongside it. One key issue has been eloquently raised by the OECD in that, “while there is increased investor interest in adopting ESG approaches, the linkage between ESG factors in infrastructure and infrastructure investment risks and returns is not well understood, and the literature is nascent”.
It’s not only the literature that is nascent - so are many of the technologies and methodologies intended to deliver us to Net Zero. Some of the infrastructure transition relies on very new (and sometimes not yet invented) innovation that is more the territory of venture capital investment rather than infrastructure funds. That usually makes it costlier capital because of the higher risks involved.
Those risks place large amounts of the infrastructure investment needed (up to 50%, according to PwC) to reach Net Zero outside the comfort zone of the ‘lower risk/lower returns’ to which infrastructure funds are generally accustomed.
Here, Phillips sees the UKIB as an important resource, as “smart governments and infrastructure banks are focused right on the cusp of investability for long-term infrastructure investors. [...] By reducing an element of risk they can unlock significant opportunity for the typical infrastructure investor.”
Murphy is well aware that some technologies are early in their development and are therefore receiving support from government funding and attracting the interest of VC/PE investors. He sees examples of this in direct air carbon capture and storage (DACCs), hydrogen production, long-term storage, and small modular reactor (SMR) nuclear.
However, he says: “We should expect investment opportunities to develop over time as technologies develop further and become proven at scale. The expectation is that in the next year or so opportunities should appear in new sectors such as hydrogen.”
Time, though, is tight and in recent weeks there have been unsettling warnings that the government is falling short in driving the acceleration required.
Last month, in the Infrastructure Progress Review 2022, National Infrastructure Commission chair Sir John Armitt said: “Reviewing the current state of key areas of policy and delivery, gaps are opening up between aspiration and execution.” He went on: “This year’s progress has been too slow on key goals.”
Murphy calls it “concerningly slow”, adding that “whilst the pathway over the next 10 years is relatively clear, from an investor perspective we have not seen a real step-change in delivery leading to immediate investment opportunities”.
The review picked out a raft of areas that must be tackled and which have seen little progress over the last year, including decarbonising heating and installing electric vehicle charge points across the country. The former is labelled by the review as “the biggest infrastructure challenge for building a Net Zero economy,” and the latter as a constraint on the transition of transport infrastructure.
With a required 50% reduction in emissions from heat by 2035 and to near zero by 2050, the level of annual heat pump installations, currently sitting at 36,000, is a long way off the government’s 600,000 target. Another official objective is for all new car and vans to be electric by 2030, requiring between 280,000 to 480,000 charge points. But, by the end of 2021 only around 28,000 charge points had been installed.
The review also criticised the lack of detail in policy and funding plans and found that a successful, speedy and cost-effective heating and transport transition to Net Zero is under serious threat. The reason? Decisions on issues such as what technologies are feasible and where; how to create the right incentives for people to switch from fossil fuel heating and travel; how much investment is required and who will pay for it; have simply not yet been made at the highest levels.
In its March report, Achieving Net Zero: Follow up, the Commons public accounts committee was even more direct, accusing the government of having “no clear plan for how the transition to Net Zero will be funded”, and “no reliable estimate of what the process of implementing the Net Zero policy is actually likely to cost British consumers, households, businesses or government itself”.
There were also concerns over the government’s poor track record of engaging consumers, including overestimating buy-in to its policies. This is a potential obstacle to the increased engagement of private infrastructure funds with large scale infrastructure Net Zero projects.
Murphy sees it as an asset-specific risk. Nuclear power is a good example, with investors’ wider consideration of the ESG and reputational risks associated with the sector, requiring some scrutiny.
There is, however, a positive precedent: “Investors will also look towards the development of new technology at scale, such as hydrogen and CCUs, and ensure they are comfortable with the overall risk profile in the first instance. These markets should look to replicate the success of offshore wind in bringing investors along the development journey of the technology if they are to build the large-scale investment appetite that will be needed in time.”
Nevertheless, without firm funding and policy commitments from government, incentives for private investment to get involved could be damagingly undermined. And that involvement is crucial: after discussions with leading infrastructure funds last year, PwC stated that in the journey to Net Zero, “the key to success will be public and private partnership, with government policy unlocking the deployment of low cost and scalable capital at pace”.
Murphy reports that “there is a lot of liquidity in the market”. His view is that crowding in private funding “is going to need a greater consideration of de-risking, rather than only bringing capital alongside”.
Given their fiduciary duty to their ultimate investors, it’s perhaps not surprising or unusual that there is a tendency among large private infrastructure investors to wait for first movers to define a more investable route or for government to unlock the opportunity with incentives that de-risk it. But, according to Phillips: “There are levers that government can pull that will stimulate that kind of investment because the interest is absolutely there.”
The upshot is that a combination of public opinion, from individuals to institutions, regulatory pressure, and realisation of both the environmental and financial risks is reflected by large private infrastructure funds and investors.
However, that may not be enough for them to invest in exactly the projects and timescales the government would like them to without more and sustained government input.