Climate and energy transition investing:
A market in motion
As the world moves toward a low-carbon economy, private capital is increasingly financing the innovations that are providing a path toward delivering on global decarbonization goals. Climate and energy transition investing is offering investors access to a wide range of solutions spanning the risk/return spectrum, including:
• Renewable power generation and battery storage • Hydrogen, renewable natural gas, and biofuels • Transmission and smart grids • Services and technologies to improve efficiencies/reduce waste • Electric vehicle (EV) infrastructure • Carbon capture technologies
Investments in private market segments beyond traditional infrastructure sectors, including private equity, venture capital, and more value- and growth-oriented infrastructure, offer private investors distinct opportunities for long-term value creation and potential outperformance.
The energy transition landscape is expanding at a breakneck pace due in part to approaching 2030 carbon reduction goals and heightened energy supply pressures from the Russia-Ukraine conflict. We examine below the growing universe of energy-related general partners (GPs) and companies, along with current market investment opportunities and return profiles in this space. Finally, we explore the development of crucially important climate-related impact metrics and what limited partners (LPs) can expect from GPs in terms of ESG and sustainability reporting as this ecosystem enters its next phase of growth and maturity.
The Paris Agreement was adopted by 196 parties at COP 21 on December 12, 2015, and entered into force on November 4, 2016. Its goal is to limit global warming to 1.5°C compared to pre-industrial levels.
The IPCC Sixth Assessment Report on Climate Change, 2022, warns that the next few years are critical: limiting warming to around 1.5°C requires global greenhouse gas emissions to peak before 2025 at the latest and be halved by 2030.
This requires urgency and extraordinary global collaboration from governments, policymakers, investors, industries, and consumers.
Dissecting the climate and energy transition market
The global transition away from a world dependent on hydrocarbons for energy and the continuous need to reduce carbon emissions is creating a massive investment opportunity spanning all facets of the global economy, including: energy and power, industrial production and transportation, and agriculture.
The chart below shows the scale and expected growth of the market opportunity is unprecedented at $1.5 trillion annually growing to $4.5 trillion by 2030 as companies and governments work to achieve Net Zero commitments. More than 50% of the investment is projected to come from private capital sources, creating more than a $600 billion global annual investment opportunity for private markets investors.
New growth vectors are fueling the energy transition investment opportunity
- Investment capex related to the energy transition and climate will grow 3x by 2030
- Most growth will be seen in electrification, efficiency, hydrogen and carbon capture
- Expanding scope of investment opportunities beyond cleantech 1.0 and infrastructure
Source: HarbourVest analysis of IEA World Energy Outlook 2021. Based on estimated market sizing using required capex to achieve carbon reduction targets (assume Net Zero by 2050 scenario).
Energy infrastructure, which includes wind, solar, geothermal, hydroelectric and bioenergy power generation and battery storage, has been the largest area of investment. While this segment of the market will continue to be significant in terms of absolute capex required, we are seeing GPs adopting a private equity value creation model and investing in integrated renewable energy platforms - creating value not just at the asset level but at the platform level through development, M&A, and operational or efficiency improvements. GPs are developing new business models and investing in advancing areas such as battery storage, smart metering, and efficiency-as-a-service, along with repositioning legacy fossil fuel power sources and energy infrastructure companies to decarbonize their business models.
However, we anticipate the fastest growth will occur in more emerging segments of the energy transition, including:
- Hydrogen – which has investment opportunities across upstream production, midstream processing and storage, and downstream fueling
- Decarbonized transport – which includes EV infrastructure and electrified transport
- Renewable natural gas and sustainable fuels
- Carbon capture technologies
As illustrated above, these growth technologies are projected to increase sixfold by 2030 (versus a 3x increase for energy transition in aggregate). The shift may have already begun, as Q2 2022 saw the highest ever venture capital fundraising and investment in carbon capture technologies, recording $882 million across 11 different deals.¹
The GP landscape is ballooning and embracing the private equity playbook
As the market matures, we are broadly seeing a significant rise in investment activity from generalist infrastructure, private equity, growth, venture, and impact funds investing in climate technology and energy transition. At an asset level, there are simply more GPs investing in energy transition strategies and integrated renewable energy platforms looking to create value by applying a private equity playbook. It is rapidly expanding the opportunities and the range of risk/return profiles available to investors.
There is also unprecedented growth happening among specialist energy transition GPs. The number of specialist managers has grown from just a couple dozen five years ago to become the largest segment within infrastructure and real assets with nearly 100 distinct fund strategies actively raising or investing in funds with a total capitalization of $100 billion – and this number is increasing rapidly with new fund launches.² The growth has largely been driven by three main groups of GP profiles, including:
- Spin-out managers coming out of the energy and power industry
- Power and energy managers pivoting their strategies to focus on the energy transition, and
- Multi-strategy private equity and infrastructure platforms sponsoring dedicated energy transition strategies
The many roads leading to today’s energy transition investing
As we consider the development of this market during the period of the mid-2000s to early 2010s, the investments and innovation in what we call Cleantech 1.0 represented Phase 1 of the energy transition. Phase 1 was generally characterized by venture capital investors primarily backing companies that were de-risking and commercializing technologies related to renewable energy and battery storage.
Phase 2 of the energy transition focused on developing renewable generation assets (as opposed to platform companies) and was primarily supported by investments from specialist and generalist infrastructure GPs. Much of this investment activity is transitioning to lower cost of capital owners and operators as yields and the risks associated with the underlying assets decrease.
The current phase – Phase 3 – is where investors are applying the private equity value creation playbook to the energy transition. The universe of dedicated, specialist GPs has grown from a niche market segment to one that is approaching being an asset class of its own, and the growth is shifting from developing core renewable assets to optimizing integrated power operating companies -- creating value with operational improvements, development, and M&A. Value-add infrastructure, buyout, and growth GPs are also investing in the market by leveraging new business models to decarbonize legacy assets and investing in areas such as battery storage, smart metering, and efficiency-as-a-service.
Phase 3 is also seeing some of its largest growth and greatest amount of new capital directed toward emerging technologies, such as EV infrastructure, hydrogen and carbon capture – and there is much greater government, consumer, and capital markets support for these technologies as compared to earlier venture capital strategies associated with Phase 1. For example, the recently approved Inflation Reduction Act in the United States is expected to increase activity and growth related to renewable energy generation, battery storage, hydrogen, and EVs.
Breaking down the current Phase 3 opportunity set
Unprecedented market opportunity - $50T+ of investment required by 2035
Source: HarbourVest proprietary information and Preqin datasets, 2021.
*For illustrative purposes only. The approximate bubble size and market size statistics are based on HarbourVest estimates and meant to represent approximate expectations for the scale of the private investment opportunity through 2030.
The linchpin of progress: Capturing and reporting emissions data
Metrics related to climate and energy transition are pivotal to measuring real progress in achieving Net Zero and global climate goals. The current state of play shows a small but growing set of advanced GP outliers when it comes to climate and emissions KPIs and reporting. But there is much work still to do, particularly with respect to climate risk analysis, emissions data collection, and industry benchmarking. More robust data will enable investors to commit to a broader range of opportunities tied to emissions or climate objectives, including in more carbon-intensive sectors where there is the greatest potential for impact through reduction and substitution strategies.
To date, funds with the most success fundraising in the energy transition market generally have robust ESG practices and delineation of climate-related metrics, including the ability to track and report on those KPIs – notably Scope 1 and 2 emissions, Scope 3 emissions (typically estimated) and calculations on avoided emissions.³ As ESG approaches evolve quickly, the most sophisticated investors will adopt a range of approaches to the energy transition according to their investment strategy; phasing out or decarbonizing high-emitting assets, addressing physical climate risk factors, setting targets for carbon reduction to Net Zero alignment, and investing in the opportunities associated with the transition.
From a portfolio perspective, the reporting of tangible KPIs remain in the early stages for private markets, with metrics largely focusing on CO2/greenhouse gases (GHG) avoided, reduced, or captured. We expect this practice to ramp up relatively quickly amongst top managers, with metrics expanding to include emissions intensity and portfolio alignment with science-based targets in due course.
The Initiative Climat International (iCI) is a global GP-led practitioner forum building capacity, consensus, and resources on climate change risk analysis, emerging regulation, emissions disclosure, and target-setting.
In 2022, the iCI issued the private equity standard on Greenhouse Gas Accounting and Reporting for Private Equity, which supports capacity-building and understanding amongst GPs, as well as a consistent approach within private equity to calculating and disclosing on financed emissions. HarbourVest is proud to have co-led the working group that delivered this guidance for the private equity sector.
Developing and tracking climate metrics
It is important for investors to define, measure, and report on their climate objectives. As we participate with GPs and portfolio companies to develop best practices and relevant KPIs, below are some considerations for investors as they look to implement a more formal framework for their energy and climate investing: 1- Clearly define objectives: Examples of climate-related objectives could include investments in companies aligned to Net Zero; investments with significant decarbonization potential; renewable and circular economy investments; and/or companies with best-in-class emissions management practices. However, it should be noted that GP objectives can have varying degrees of discipline and there can be varying levels of accountability across GPs, making clearly defined objectives a crucial step. 2- Determine the appropriate targets and/or benchmarks: GPs, portfolios, and portfolio companies should be benchmarked by industry, geography, stage, etc., and targets set for near and long-term objectives to ensure accountability.
Investment dislocations in a fragmented climate market
While an “orderly” energy transition is considered the best-case scenario by global financial institutions and society alike, 2022 made it increasingly apparent that a nonlinear path will be followed to a low-carbon economy. World leaders have been quick to acknowledge the need to act on transition; in its 2021/2022 Global Risks Perception Survey, the World Economic Forum reports climate inaction as the top concern over the next decade for over 1,000 global leaders and experts who responded.⁴ However, when it comes to leaders and financial institutions acting on these risks, there is less clarity. For example, COP27 saw the announcement of a new Loss and Damage Fund, but very few details about the structure, size, contributors and beneficiaries of the fund were agreed.
In the US, a fragmented market is emerging; the Inflation Reduction Act provided a climate-related tailwind, the SEC coalesced around an “all-agency” approach to climate risks and opportunities, and the federal government took steps toward developing a centralized carbon market through public-private partnerships. In turn, this has prompted some investors to question whether climate-related policies are consistent with fiduciary duty. Globally, the Russia-Ukraine conflict has resulted in volatile energy prices, in some instances causing internal combustion engine vehicles to again be less expensive to power than EV charging, and more broadly has led to substantive debates around energy security and interdependence.
These examples shed light on the reality of a transition – often sparking disagreement and requiring compromise. However, from an investor’s perspective, the energy transition and climate market has already planted its roots and will continue to grow. This may lead to investment dislocations, and GPs that are early to understand this market may benefit from unique market coverage and underwriting capabilities to evaluate unrealized portfolios. Given the wide range of themes involved in the broader transition, we believe that a sophisticated transaction approach that spans co-investments, bespoke GP-led secondary transactions, and primary fund commitments is a competitive advantage because it offers a flexible approach to this market.
As the energy transition matures, innovation expands, and greater capital is deployed, it is likely that climate market participants may coalesce around common themes and approaches. Until then, there is a significant amount of upside to be captured in this nascent market.
From our experience in assessing GPs’ climate strategies, we know that there is a wide range of progress being made toward climate strategy development. At HarbourVest, our current focus is building out our data infrastructure for climate change analysis and disclosure. Our most recent ESG Report provides a summary of GP progress on climate as well as our own TCFD report.
1 PitchBook, Post combustion carbon removal, 9/15/2022.
2 HarbourVest, data as of 9/30/2022.
3 Source: HarbourVest. Scope 1 emissions are direct emissions from the company/asset’s owned or controlled sources. Scope 2 emissions are indirect emissions from purchased energy (i.e., heat or cooling). Scope 3 emissions are all indirect emissions that occur in the value chain of a reporting company / asset. Scope 3 emissions are largely reported on a voluntary basis and may be calculated using estimate data with a wide degree of quality/conservatism, depending on the assumptions used. However, Scope 3 emissions are important to consider in the context of overall impact a company may have on the energy transition and typically represent the largest share of total emissions.
4 World Economic Forum, The Global Risks Report 2022, 17th Edition.
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HarbourVest is an independent, global private markets firm with 40 years of experience and more than $103 billion of assets under management as of September 30, 2022. Our interwoven platform provides clients access to global primary funds, secondary transactions, direct co-investments, real assets and infrastructure, and private credit. Our strengths extend across strategies, enabled by our team of more than 1,000 employees, including more than 200 investment professionals across Asia, Europe, and the Americas. Across our private markets platform, our team has committed more than $53 billion to newly-formed funds, completed over $44 billion in secondary purchases, and invested over $32 billion in directly operating companies. We partner strategically and plan our offerings innovatively to provide our clients with access, insight, and global opportunities.
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