Article

Nordic tailwinds

Investments in energy infrastructure promise stable long-term cash flows while contributing to a sustained transformation of the energy system. Wind farms with long-term power purchase agreements are a good example. Institutional investors can hold stakes in facilities such as these.

September 25, 2020

The energy sector across the world is undergoing a process of transition. In future, numerous countries will stop producing electricity from coal or nuclear power. This transformation of energy production entails very high investment in alternative power generation and in transmission and distribution networks, some of which are now outdated. According to estimates by the European Commission, Europe may require capital expenditure running to more than one trillion euros by 2030. As far as Switzerland is concerned, investment in the energy supply network of CHF 100 to 200 bn will likely be needed between now and 2050. On average, investments of CHF 3 to 5 bn will be required each year.

Pension funds discovering infrastructure as an asset class

Until now, the provision, operation, and funding of infrastructure facilities have mainly been the preserve of state organizations. However, the high level of expenditure required is now opening this segment up to private investors with a long-term horizon.

Investments in infrastructure can be an attractive option for pension funds, life insurers, and other institutional investors that are being hit by the ongoing low to negative interest rate environment and are seeking investments with stable cash flows over the long term. While the market in private infrastructure investments is still relatively young in continental Europe, it already has a long tradition in the UK, Australia, and Canada, for example. In these countries, infrastructure investments already account for between 4% and 11% of pension funds’ overall allocations. Globally, according to estimates by the OECD, pension funds held 2.9% of their investments in this asset class as at end-2015. The capital is primarily invested in existing facilities within the transport and energy sectors.¹

Switzerland also offers great potential. In theory, Swiss pension funds are permitted to allocate up to 15% of their investment volumes to alternative investments such as infrastructure assets. However, the actual share of alternative investments is just 6%. According to the Credit Suisse Pension Fund Index, the alternative portfolios of Swiss pension schemes largely comprise hedge funds, private equity, and commodities. In this context it is worth noting that investments in infrastructure have been explicitly listed as a subcategory within the investment guidelines since 2014. Owing to the difference in risk profile, there is a political campaign to classify infrastructure as a separate asset class outside of alternative investments with a permitted allocation of 10%, as per the “Weibel motion” submitted to the Swiss parliament.

Sustainable investment horizon

Institutional investors who invest in wind farms in Norway, Sweden, and Finland benefit from sustained, stable cash flows thanks to long-term power purchase agreements.

Investing in wind farms

Investments in infrastructure require extensive expertise and good industry contacts if suitable investment options are to be found and the attendant opportunities – and risks – are to be evaluated as a whole.

Examples include three wind farms in Norway and one each in Sweden and Finland, three of which are already up and running. Construction is currently underway in Sorfjord (Norway), while the Kalax project in Finland has reached the point where building work can begin. Construction work is overseen by general contractors with whom fixed prices have been agreed for turnkey facilities. Once all the wind farms have commenced operations, 94 turbines with a capacity of some 345 MW will be available, enough to power around 190,000 households on average.

The wind farms sell electricity at market prices and operate according to a clearly defined cost structure. The operating costs are highly predictable, as long-term maintenance contracts on fixed terms and with guaranteed availability have been concluded. The risk of electricity price volatility has been minimized by concluding long-term power purchase agreements (PPAs) with local buyers. As a result, attractive selling prices have been agreed over several years for some 70% of the power generated.

This example of Nordic wind farms illustrates how institutional investors can help to transform the energy system. A transition of this nature is only possible if the geographical, technical, contractual, and financial structure of the projects ensures stable income for equity investors and lenders over many years, while at the same time ensuring that all the relevant environmental, social, and governance criteria are met.

1 Infrastruktur. Die neu entdeckte Anlagekategorie, Credit Suisse (Switzerland) AG, 2019