Ageing infrastructure, lack of data, and differences in the needs of emerging and mature markets cause problems for resilience and adaption in the energy sector.
The steps needed to achieve proper resilience and adaption against climate-related risks to physical infrastructure were highlighted by resolutions and initiatives at COP26 last week.
One area, energy infrastructure, will be particularly slow and expensive to shift. Energy infrastructure consists of power lines, power plants, pylons, substations, as well as the less visible components such as underground cables, electrical metering and distribution systems, pipelines, and smart building systems. As well as transitioning away from fossil fuel energy sources, all this infrastructure will need to be made resilient against heat stress, storms, and other extreme weather.
Traditionally, all infrastructure systems were designed and built on the assumption of “climate stationarity”, says a 2018 report. However, climate change is introducing nonstationary stressors, such as rises in temperature and more frequent and intense storms, it adds. “Such stressors can affect infrastructure systems at spatial and temporal scales and require a holistic understanding.”
This change in weather patterns means adaption is urgent – but infrastructure owners and their investors are struggling to keep up. The differences between what is needed in emerging and mature markets is also stark. In mature markets, the issues stick on replacing infrastructure and working through bureaucracy. For emerging markets, the issues often revolve around asset managers and their partners developing an integrated and community-led approach to renewable power projects.
“The combination of economic growth, population growth and urbanisation is correlated to the increased demand for electricity,” says Tony Coveney, Head of Infrastructure Asset Management, at ThomasLloyd Group.
Coveney says the needs of energy infrastructure are urgent but admits to the challenges of mobilising capital and realising projects that deliver the required resilience at pace.
Asset managers spoken to by ESG Investor said investors should focus on three areas to support energy infrastructure resilience and adaption: standards for an international framework, integrated projects that work with the local community, and tackling underinvestment to replace ageing infrastructure.
The scale of the challenge requires mobilisation of both public and private finance. After COP26 concluded last week, some in the market were concerned that the new Glasgow Climate Pact does not go far enough on the issues of adaption, adaption finance, and loss and damage. For example, there is no specific date for scaling up adaption finance, though some placeholders remain throughout the text waiting for ministerial consultations.
“There is lots on the process for accelerating emissions reductions,” said Mohamed Adow, Director, Powershift Africa, on the new deal. “But on the demands of vulnerable countries, there is very little. On helping these countries adapt to climate impacts and deal with the permanent losses and damage it is very fuzzy and vague.”
COP26 did, however, prompt increased financial pledges, including to the Adaptation Fund, which promised nearly US$400 million for climate change adaptation and resilience projects and programmes.
Pooling not flowing
Seth Schultz, Executive Director of The Resilience Shift, a research coalition founded by Lloyd’s Register and Arup that focuses on futureproofing infrastructure, says capital already pledged to resilience programmes is not flowing to where it’s needed. “The money cannot find investable, bankable projects,” he says, pointing to a lack of quality, detail, and rigour, traceable to inadequate scoping and data.
Schultz says an absence of global frameworks is stopping the money flowing; a lack of global frameworks that provide data. “Codes and standards is an unsexy topic,” Schultz adds. “Most of the world’s infrastructure design in construction is heavily predicated by them. In general, it takes anywhere from three to six years to create a new code and after that, it takes another three or four years to mainstream it,” he says. These timescales can be off-putting to some investors.
According to a report from the World Energy Council, the codes can vary wildly for projects. For utilities, it is regulators that define performance requirements for operators, and these help to set resilience standards. “In other parts of the sector, companies use industry benchmarks or internal performance measures to gauge their resilience. However, these standards are often based on historical information,” it says. This lack of uniform codes can create problems for investors.
The issue affects both mature and emerging markets. In mature markets often the physical infrastructure dates back several generations. This means a lack of uniformity, which can slow down projects by several years. In emerging markets, the issue is having accurate data while also trying to build without codes and standards.
Schultz says due diligence is critical to satisfy both the needs of investors and the communities that the projects are designed to serve. “We have to be careful about this, if we don’t do it wisely, i.e. rolling out decarbonised infrastructure that is not future-proofed or more resilient,” he says, then “it will be the twenty-first century stranded assets, similar to the oil infrastructure assets of the twentieth century.”
Ursula Tonkin, Lead for Publicly Listed Companies at Australia-based asset manager Whitehelm Capital, highlights the need for more quantitative and qualitative data to help investors evaluate projects.
“An issue like lack of data is huge for an investment case. But there are solutions,” Tonkin says. “It’s predicated around how much you want to spend and then your investment returns have to compensate for that additional data costs and risk that the lack of data provides. If you don’t know exactly what is going on then you’re going to demand a much higher return.”
Data and digitisation are seen as increasingly critical throughout the lifecycle of energy infrastructure. A recent Allianz Research report says that the merging and integration of electricity markets would enable data to flow and could increase supply security. “Investment must be made to make grids smarter, increase the transmission capacity and strengthen network infrastructure,” it adds.
Showing its age
Tonkin says new resilient renewable energy generation technology can only go so far unless all infrastructure systems – such as power grids, powerlines, power plants, pylons, substations, and other physical infrastructure are upgraded, integrated, and connected. Literally, the nuts and bolts of a project are often overlooked.
“When people think about energy transition electrification, they think electric vehicles, offshore wind projects, solar panels, but you need something to connect that all together. Particularly as renewables penetration increases,” she says.
“The way that that energy connects together within a grid and particularly across grids will become more important. Not only do you need the extension cords to plug in to every new renewable power project, but you also need to connect grids to one another so that they are balanced.”
In many mature markets, these systems were built post World War Two, if not before. “They were built to take power from a central point and send that out. They weren’t necessarily built to flow both ways. That adaption is required,” Tonkin adds.
However, adaption and resilience cannot be seen in isolation. “Electrification is the key to decarbonisation in the EU,” said the Allianz report. “The utilities sector is a key focus area if climate neutrality is to be reached by 2050: electricity demand is increasing and will reach record highs, driven by transportation and industries where the electrification rate is projected to rise from 30% to 60% by 2030.”
Dr Markus Zimmer, ESG Economist at Allianz Research, and a co-author of the report, says that a critical problem in Europe for investment in energy infrastructure projects is a non-cohesive decision-making framework. “[The hindrance] is the legislative progress of getting projects up and running.”
Allianz’s report says that if established technologies are implemented, the electrification rate could reach as high as 76% by 2050 and as a consequence, growth for wind and solar photovoltaics must triple. However, this isn’t happening fast enough to meet rising electricity demand. “While 2020 was a landmark year, with renewables overtaking fossil fuels to become the main source of electricity in the EU hydropower and bioenergy have stalled,” it said.
The EU’s power generation is now 38% renewables, but 2020 also saw the largest decrease in nuclear generation since 1990, a trend that is expected to continue as countries set national phase-out targets.
If these electrification numbers are to be matched in other markets, Tonkin says, the ‘nuts and bolts’ of the projects are going to have to be understood by investors.
Communities in focus
Not only do tomorrow’s energy infrastructures need to be resilient, renewable, and fully integrated, they must also take full account of local needs.
Part of this is due diligence. ThomasLloyd’s Coveney says asset managers must work with local partners and invest with a clear end goal in mind which is “directly aligned with the community”. He says projects should be built within the community that it’s going to operate in and be integrated fully to provide better returns and results. “In order to do that, we have got to have a more nuanced approach to risk management,” he says.
“Renewable energy is in your backyard. And there’s no point putting some infrastructure in somebody’s backyard if they don’t want it.”
This means it is important to work in the local community to ensure both the need for the investment and the need for the infrastructure that is created. Further, the project must demonstrate benefits to the community rather than undermining or weakening it.
“The perfect opportunity is a team comes to us and says: ‘We have roots in this community, and it would benefit from a change in its infrastructure. And we believe we’re able to originate a number of projects for you,’” says Coveney.
Tackling the issue of energy infrastructure resilience requires nuance and commitment.
“Infrastructure as a percentage of the GDP is actually declining over the last thirty to forty years,” says Colm O’Connor, Portfolio Manager at KBI Global Investors Ltd, which he says highlights that even though resilience is being pushed in infrastructure, less money is actually going into it than in previous decades in mature economies.
This trend is likely to reverse. Policymakers are acutely aware of the impact of climate change now, which they weren’t even ten years ago, O’Connor adds. “We are in a low interest rate environment where there’s a recognition from governments – whether it’s Joe Biden’s US$1.2 trillion infrastructure plan or it’s the EU pandemic recovery fund – that the global economic recovery needs to see more infrastructure spend, but crucially, where CO2 objectives are not jeopardised.”
Political will, private finance and technology solutions are aligned. “Most infrastructure assets are capable of transitioning into green infrastructure. Electricity grids, transmission lines, energy storage, 2040 and again by 2050,” Tonkin adds.
It is also clear that resilience and adaption in energy infrastructure is sorely needed. But questions still remain on how best to deliver it, with an increasing risk to laggards of losing their social license to operate.