How to invest into the energy value chain during a period of change

March 2020 | SPOTLIGHT | FINANCE & INVESTMENT

Financier Worldwide Magazine

March 2020 Issue

There is no doubt the energy transition years are firmly upon us. When discussing investment strategies, we are cognisant that a transition requiring decades to achieve is increasingly being impacted by public pressure to deliver affordable solutions yesterday.

This dynamic is set against a backdrop of divergent political imperatives resulting in considerable uncertainty. While this all makes investment decisions difficult, considerable amounts of capital have already accepted at least a blurred outline of the future and moving forward, driven in no small part by greater environmental, social and governance (ESG) adherence.

So, how should an investor deploy capital in line with their risk preference across the energy value chain? There are some clear guiding principles and thematics that should be considered, under the overarching rule not to underestimate the speed of change coming to this market, given the speed at which capital is changing course.

We see the following guiding principles for investments into the energy value chain: (i) the energy industry is moving away from one that is commodity dependent to one that is technology driven – as a result, risk and return dynamics will be significantly different, especially in a more decentralised energy market; (ii) energy transition is exactly that, a ‘transition’ – a pureplay renewables investment may not be as sound as an investment into a broader energy service company; and (iii) the old rules still apply – management teams make a difference, overleverage can destroy the potential of even the best teams, while the specific risks and challenges of verticals remain, be it original equipment manufacturers (OEMs), asset-heavy owners or people-focused service providers.

With these principles in mind, what about investment themes? Clearly, these differ for each phase of the business lifecycle that an investor focuses on. For angel and venture capital, the challenges of picking the future industry-standard product or service for such a young sector as offshore renewables is difficult, when multiple deployment strategies exist and many of the problems of erecting and running the next generation of offshore windfarms have not yet been encountered. However, what remains true is that products and services need to have a quantifiable impact, solve a problem that actually exists or simplify a process. Above all, they should have a direct and preferably upfront impact on a client’s bottom line.

One major focus for investors has been the development of more efficient energy storage technology. Here, there is a clear problem that needs to be solved to make renewables a more consistent provider of energy. However, one should not underestimate the enormity of the transition to a global position of zero carbon emissions or a world where the majority of energy is produced from renewables – a process that will cost tens of trillions of dollars. To make such a transition affordable, companies that have significant existing interest in hydrocarbons will need to be part of the solution. As a result, carbon capture technology will play a significant role in the energy transition story and successful technologies will find willing buyers looking to protect their reserves.

With the move toward a more technology driven sector, away from pollution and expensive downtime concerns, the adoption of new processes, procedures and technology will happen faster than before. This is already evident in the speed at which costs have reduced across the renewables spectrum during the last decade. This technologically supercharged cost deflation has flipped the discussion on the arrival of ‘peak oil’ from supply driven concerns to one impacted by material demand reduction, as easily as contango has flipped to backwardation.

When considering the offshore renewables market, there is a very broad value chain from which to find opportunities. Many of the service companies that exclusively served the oil and gas industry now have 20 percent or more of their revenue streams coming from renewables. However, not all leaders will understand the renewables opportunity enough to keep their coalface senior management teams happy. Expect to see those who consider the future brighter in renewables look to create start-ups and find backing for management buyouts (MBOs).

Outside of this dynamic, companies that have learnt the lessons and built up capabilities from their oil and gas years can and will be big players in the future energy services market. The current offshore wind market is focused on development; contractors are the same as those who built and maintained the offshore oil and gas infrastructure. They are the ones who have the experience and the ‘enabler’ assets to make construction possible. Those companies that subcontract to and supply these companies do not need to adjust their business model to a whole new client base or invest in a new asset base. It does not stretch the imagination to see these companies as the leaders in maintaining this offshore wind infrastructure as it becomes established and ages.

The desire for more integrated holistic offering in the offshore renewables space should give rise to successful buy-and-build strategies for investors. However, given the scale of growth anticipated, there are bound to be supply-chain challenges and a risk of price inflation as access to the right equipment and locations becomes more competitive. Given cost deflation in offshore oil and gas development, we will continue to see both sectors compete for the same asset pool for some considerable time.

In terms of infrastructure investing, there is a well-trodden path to solar and wind investing. However, for those looking for higher yield core-plus infrastructure investing, there will be opportunities to invest in broad energy infrastructure service providers that enjoy a base level of activity serving a marketplace that operates more like the current aircraft market as opposed to the energy market.

This is a time of uncertainty and change, but it has provided significant opportunity. For investors looking to support and benefit from this transition, there is no better time to do the homework and make a considered move based on basic principles.

Barry Wingate is senior adviser at Gneiss Energy. He can be contacted on +44 (0)7724 989 784 or by email: barry.wingate@gneissenergy.com.

Barry Wingate

Gneiss Energy