Sustainable infrastructure

James Baldwin

Investment Consultant

The bottom line:

Infrastructure is one of the most emissions-intensive asset classes available to investors today. Rather than viewing this as a reason not to invest, I believe this presents an attractive investment opportunity.

A $1m investment in listed infrastructure generates the same emissions as around 440 flights from London to New York.

Infrastructure is one of the most emissions-intensive asset classes available to investors today. However, in a world slowly turning its mind towards decarbonisation, rather than viewing this as an investment risk I believe this presents an investment opportunity.

Infrastructure assets such as toll roads, airports, seaports and electric utilities are essential for the smooth functioning of society and I expect that they will still be integral to the economy many decades from now. However, it is imperative that we transition these assets to Net Zero carbon emissions by 2050 to avoid the worst effects of climate change.

Infrastructure investors who transition their assets to Net Zero effectively will likely earn superior long-term returns compared to those that are slower to transition, or do not transition at all. Returns will be driven by, amongst other factors, a first-mover advantage as these companies adopt technologies ahead of competitors, as well as benefitting from a reduced impact of potential carbon taxes.

Within unlisted infrastructure, investment managers tend to be majority shareholders of portfolio companies, giving them significant influence over strategic direction and Net Zero policies. The managers that will benefit the most from the Net Zero transition are those that use their influence to implement ambitious Net Zero pathways that ensure assets decarbonise successfully. Decarbonising could take a variety of forms; for example, a pipeline owner (either oil or gas) could build solar farms on unused land, or repurpose existing pipelines for 'next generation' fuels like biogas.

On the other hand, listed infrastructure investment managers are usually one shareholder amongst many, so typically have less influence than their unlisted counterparts. Therefore, a different approach is required. I favour infrastructure managers that scrutinize the Net Zero pathways of the companies in their investable universe, and only own companies with credible decarbonisation targets, such as those with Science-Based Targets.

Two ways to tackle climate risk infrastructure

Both are important for achieving net zero ecomony

However, even if you invest with an infrastructure manager – in the listed or unlisted space - with a robust approach to managing emissions, 'climate risk' cannot be eliminated and there is still a risk that assets are not transitioned successfully.

For investors with a focus on reducing climate risk, an alternative option is to invest in 'climate solutions'. These are assets that are expected to support the Net Zero transition and include renewables, battery storage and carbon capture technology. Climate solutions are also a financially attractive investment opportunity as they benefit from material tailwinds. Many governments are looking for private capital to help them meet their Net Zero ambitions which creates a fertile investment environment, similar to the wave of subsidies that UK renewables investors benefitted from in the 2010s.

Is there a downside to investing in climate solutions?

Funds which focus on climate solutions typically avoid sectors such as pipelines and airports, making them less diversified than 'traditional' infrastructure funds and more exposed to sector-specific risk.
There have been significant capital flows into climate solutions, which has led to a reduction in expected long-term returns. For example, high demand over the past decade for operational UK renewables, such as solar panels and wind farms, has reduced long-term expected returns from double digits to c5-6% pa.

Of course, there are scenarios where climate solutions may outperform, such as in 2022 when rising energy prices resulted in strong returns from renewable energy assets. It is not expected that these assets will continue to generate outsized returns now that higher energy prices have been priced in. As a result, I expect core climate solutions infrastructure to generally offer lower returns than 'traditional' infrastructure.

It is still possible for investors to access higher-returning climate solutions infrastructure, but this would require investing in less well-established technologies such as carbon capture, battery storage and EV charging. However, this approach tends to incur additional risk, such as technological obsolescence or the failure to secure widespread adoption, which is the trade-off for potentially higher expected returns.

Indicative comparison of opportunities

A spectrum of potential investments

Conclusion

For infrastructure investors, emissions present both risks and opportunities. In my opinion, there is no 'correct' way to deal with emissions. The approaches of managing down emissions from existing assets or investing in climate solutions both have their merits and drawbacks. Depending on your individual situation, one approach may be a better fit than the other. For most investors, I would advocate splitting any infrastructure allocation between the two approaches as I believe this most effectively balances exposure to both climate risks and opportunities.