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PORTFOLIO PERSPECTIVES | WHITE PAPER – 6 Min

Infrastructure debt – Financing a sustainable future

In this article:

    Private capital can be vital in meeting net zero emissions goals. This includes infrastructure debt which can be an attractive way for investors to achieve their long-term return and income objectives and at the same time help finance the assets needed urgently to support the transition to a low-carbon economy.  

    An essential asset class for an urgent challenge

    Rising temperatures are having a tangible impact on the global economy, on ecosystems and on society as a whole. The International Energy Agency estimates that investment in clean energy alone must reach USD 4 trillion annually by 2030 if we are to achieve net zero by 2050 and prevent catastrophic changes to health, livelihoods, water supply, food security, human security and economies.

    Public funding alone cannot meet these investment needs: private capital has a huge role to play. One urgent challenge is to build the infrastructure that will be fundamental to the transition to a low-carbon economy – from clean energy production and storage capabilities to electric vehicle charging stations. Infrastructure debt can be seen as an asset class at the forefront of the energy transition.

    Proven resilience

    Infrastructure debt helps finance essential assets and services that benefit from high barriers to entry, have predictable cash flows, enjoy a supportive regulatory framework, and have strong contractual frameworks.

    These characteristics have given the asset class resilience across economic cycles and offer an attractive risk-return profile with inflation-linked features. For investors with the ability to lock money away for longer periods, it can be a useful portfolio diversifier: 

    • Volatility is typically low
    • There is a low correlation with public markets
    • Income is stable
    • Investors can access an illiquidity premium. 

    After rapid growth in recent years, the European infrastructure debt market totalled USD 185.1 billion as of Q3 2023 (Inframation News, September 2023). The increasing maturity of the asset class means investors can build portfolios that are diversified across sectors, themes, geographies and currencies, and access opportunities in junior as well as senior debt, depending on their risk appetite.

    From utilities to mobility, many major infrastructure debt sectors are closely related to the energy transition. Social infrastructure assets such as healthcare and education facilities have also been a core element of the opportunity set for many years, providing essential services that directly benefit local communities. As a result, the asset class is closely aligned with investors’ environmental, social and governance (ESG) preferences. This gives it strong impact potential.

    Opportunities aligned with investor goals

    Infrastructure debt investors in Europe and, increasingly, around the world are transitioning to low-carbon assets as recognition grows that private capital is needed to help achieve net zero. Alongside financial performance, sustainability and climate change mitigation are becoming increasingly important criteria for investment. As a result, there is a strong and growing appetite for assets that can easily be identified as ‘green’ such as solar plants and wind farms.

    The net zero transition is also creating a wealth of less immediately apparent opportunities for sustainable investors. 

    • All infrastructure assets need to be decarbonised, from transportation to the phase-out of fossil fuels in the utility mix.
    • New technologies such as gigafactories producing batteries for electric vehicles and energy storage are creating significant infrastructure needs.
    • Significant capital expenditure is required to harness the potential of emerging technologies such as green hydrogen and carbon capture and storage (CCS).
    • Natural carbon sinks such as forests are another new and developing frontier for real asset investment.
    • Beyond climate, the preservation of biodiversity and natural capital is becoming increasingly important in the analysis of new projects.
    • Emphasis is growing on the circular economy and recycling, both in project design, which seeks to minimise the use of raw materials and optimise reuse of materials at the end of the asset’s life, and as a source of investment opportunity. 

    More development related to the social aspect of ESG is expected too, particularly if the plan for an EU social taxonomy is revived.

    Exhibit 1

    A wide range of climate change-related opportunities

    Source: BNP Paribas Asset Management; January 2024

    New value chains are emerging

    Innovation to address climate change is driving the emergence not only of new asset types, but also of new ecosystems that span sectors. We look at two examples.

    Battery technology: An essential element enabling green mobility and clean energy storage

    Battery technology is an important tool for the stability of the renewable energy supply and the power source for electric vehicles. The market for battery cells is expected to grow by more than 20% a year on average until 2030, with further acceleration possible as costs fall.

    Demand for batteries is creating a complete ecosystem, from the sourcing and transportation of critical metals and minerals to battery production, grid enhancement and gigafactories for electrical vehicles.

    To date, the infrastructure debt opportunities in Europe have been limited, but the technology is an increasing focus in the region, with governments keen to secure local supply and production.

    Green hydrogen: Early-stage technology with the potential to address decarbonisation challenges

    Hydrogen fuel cells are an alternative power source with potential uses in freight haulage, shipping and aviation. It is widely used in heavy industrial processes that are hard to decarbonise such as steel production.

    More than 80% of hydrogen produced today comes from fossil fuels using steam reforming of natural gas and coal gasification. However, water electrolysis can be used to produce ‘green’ hydrogen.

    Early-stage operational assets in Europe to date are small pilots and projects related to sustainable mobility. However, we expect the first utility-scale green hydrogen projects to come to market for infrastructure debt financing early in 2024.

    Parts of Europe offer rich potential to produce green hydrogen using low-cost, abundant renewable energy.

    We see infrastructure debt opportunities further along the value chain, for example, in green steel and transportation.

    AI as a facilitator of green infrastructure

    Digitalisation has long been a driver of the development of infrastructure assets. Artificial intelligence (AI) represents a significant step forward given its ability to act as an enabler for new solutions, optimising the design and use of infrastructure assets and the management of data.

    There are many applications. In electricity networks: AI can optimise power supply based on consumption, realise economies of scale and identify efficiencies in the management of production of the grid.

    In green transportation, AI can be used to optimise electric vehicle charging networks.

    Across the infrastructure asset class, AI is helping to build better, more efficient and greener assets as well as optimise their use.

    Capturing the opportunities

    With so many projects and business models relating to early-stage assets and ecosystems, capturing the infrastructure debt opportunities resulting from the net-zero transition while maintaining an adequate risk profile requires resources and specialist expertise to analyse complex projects.

    Lenders such as BNP Paribas Group with the ability to assess the full value chain, from technology to market research to income generation and to offer bespoke financing solutions that align with emerging business models, have a greater capacity to invest proactively and take advantage of early-stage opportunities to capture assets with the best risk-return.

    The backdrop of higher capital costs means caution is required on the profitability of projects. For example, though now normalising, the cost of producing a wind turbine or a solar photovoltaic (PV) array had risen steeply. Lenders need to be highly selective and ensure projects can generate sufficient income and stable cash flows to mitigate the higher costs. A rich project pipeline makes such selectivity possible.

    The rapid evolution of the opportunity set is accompanied by equally fast-paced regulatory developments. In-house sustainability expertise, legal capabilities and a robust ESG framework are vital when structuring long-term sustainable products, as is a constant dialogue with regulators.

    Conclusion

    We believe the opportunities are broad for investors in infrastructure debt to drive impact while meeting their return, income and diversification goals. We expect the asset class to continue to expand as decarbonisation and the energy transition progress, alongside megatrends such as digitalisation.

    As investors align behind net zero goals, more asset managers are launching thematic funds that seek to address climate change by investing in sustainable assets related to renewable energy, clean mobility and other areas of innovation. Expertise and track record are key in an asset class in which depth of research and access to a strong pipeline of deals are important differentiators.

    Disclaimer

    Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.
    Environmental, social and governance (ESG) investment risk: The lack of common or harmonised definitions and labels integrating ESG and sustainability criteria at EU level may result in different approaches by managers when setting ESG objectives. This also means that it may be difficult to compare strategies integrating ESG and sustainability criteria to the extent that the selection and weightings applied to select investments may be based on metrics that may share the same name but have different underlying meanings. In evaluating a security based on the ESG and sustainability criteria, the Investment Manager may also use data sources provided by external ESG research providers. Given the evolving nature of ESG, these data sources may for the time being be incomplete, inaccurate or unavailable. Applying responsible business conduct standards in the investment process may lead to the exclusion of securities of certain issuers. Consequently, (the Sub-Fund's) performance may at times be better or worse than the performance of relatable funds that do not apply such standards.
    Private assets are investment opportunities that are unavailable through public markets such as stock exchanges. They enable investors to directly profit from long-term investment themes and can provide access to specialist sectors or industries, such as infrastructure, real estate, private equity and other alternatives that are difficult to access through traditional means. Private assets do, however, require careful consideration, as they tend to have high minimum investment levels and may be complex and illiquid.

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