For years, climate change campaigners and policymakers have argued that leading energy companies must play a key role in decarbonisation if the world is to move towards net zero. Now, research suggests the industry is prepared to rise to the challenge.The proportion of energy companies that regard capital investment in energy transition as a top priority has tripled over the past two years, according to a study by law firm White & Case. Today, 42 per cent of energy businesses take this view, up from 14 per cent from 2021.

The shift reflects a growing realisation that simply investing more in greener energy while maintaining traditional production will not be enough to accelerate global decarbonisation at sufficient pace, argues Sandra Rafferty, a partner at White & Case. “Initially, when corporates, funds and banks considered energy transition, it was with a view to identifying and funding renewable energy sources such as wind and solar, as well as newer technologies,” she says. “The more forward-thinking players in the sector now recognise that full energy transition will also encompass taking fossil-based systems of energy production and consumption and decarbonising them.”<h2>The scale of the challenge</h2>Even with this shift, the figures remain daunting. The International Energy Association believes that, in order to reach net zero by 2050, clean energy investment worldwide will need to more than triple in this decade to US$4tn. Progress is being made - the first half of 2022 saw an 11 per cent increase, year-on-year, in investment in renewable energy, to US$226bn - but there is some way to go.The good news is the energy sector expects to be able to tap into a range of funding sources to bridge the gap. For example, private equity investors are growing enthused by the opportunity, with 40 per cent of energy companies in White & Case’s research study expecting to access PE funding over the next 18 months. “The investment community has really made climate action the new business imperative,” says Annette Clayton, CEO of Schneider Electric North America. “It’s a business opportunity because less carbon is less cost; it’s a time for organisations to reimagine themselves, their solutions and their stakeholders.”

How will energy companies finance their energy transition initiatives?

It’s not only cash that these investors provide. A growing number of deals in the sector have seen energy companies team up with financial sponsors that have expertise in major infrastructure projects. These joint venture partners bring funding, certainly, but also the experience of funding and managing large-scale projects. “Bringing capital into this sector is enormously important, but there is also a skill in being able to create assets,” says David Tilstone, a Managing Director at Macquarie Asset Management. “It requires expertise and experience to be able to go through that development period and to commercialise a project.”Such initiatives are also enabling the sector to explore new business models, adds Clayton, who points to two Schneider Electric joint ventures to create energy-as-a-service solutions: AlphaStruxure with The Carlyle Group, and GreenStruxure with Huck Capital and ClearGen. “This is an absolutely new way of serving the market,” she says. “The energy-as-a-service business model eliminates all the upfront customer cost for the project, as well as giving them long-term cost predictability for energy supply and insulating the customer from rising energy costs.”<h2>Investment appeal</h2>For investors, the decarbonisation story looks increasingly attractive. In 2021, private equity investors allocated US$21.5bn to the US renewable energy sector; last year, a single infrastructure fund, Brookfield Asset Management, raised US$15bn for its Global Transition Fund.Energy companies are not only looking outwards for funding, however; 32 per cent say they will turn to their existing balance sheets to finance energy transition initiatives, particularly following a period in which soaring energy prices have generated outsized revenues. Many also point to plans to raise new funding from the debt or equity markets.

Which financial instruments do capital providers expect to use for energy transition initiatives?

It helps that the sector expects to be able to raise finance through a variety of different sources and mechanisms. Alongside sources such as project finance and acquisition funding, the rapid growth of the green bond market offers an increasingly rich vein for energy companies to tap into. Green bond issuance exceeded $500bn for the first time in 2021, when fundraising increased by 73 per cent compared with 2020. According to White & Case’s research, 35 per cent of capital finance providers said they intended to make use of corporate green bonds.The evolution of such funding will reassure governments, which are under pressure to offer more support – directly or indirectly – to energy companies seeking to decarbonise. The implications for public finances, as well as the political debate, make this challenging.Energy companies that do push for such support should expect it to come with strings attached, warns White & Case’s Sandra Rafferty. “Governments need to ensure that any such support is proportionate and does not result in super profits for the recipients, particularly at the expense of the consumer,” she says. “To ensure this, it is likely that there will be greater scrutiny and regulation in the energy sector, not dissimilar to what happened to the financial services sector following the global financial crisis.”

Energy companies face a dilemma. They recognise the imperative to decarbonise – and therefore to invest in renewable energy technologies and green solutions that reduce emissions. But the race to net zero is fraught with difficulty: move too aggressively and they may undermine their competitiveness today; move too slowly and they may face criticism – and even confrontation with groups such as regulators and activists – as well as other dangers.New research from law firm White & Case underlines the delicate nature of this balancing act. While 59 per cent of energy companies regard the need to remain competitive during transition as one of the biggest risks they face in relation to decarbonisation, 44 per cent are anxious about the potential for challenges from activist shareholders.

<h2>Imagination required</h2>It does not help that the pathway to decarbonisation remains unclear. Large parts of the energy sector are still trying to work out how financial and environmental sustainability can go hand in hand, says John Moon, Head of Morgan Stanley Energy Partners. “There are lots of things we can do to decarbonise without putting our shareholders’ financial welfare at risk,” he says. “But it takes real creativity and differentiation.”Some investments will be targeted, Moon suggests. For example, he points to the case for investing in battery storage and microgrids, particularly given high levels of competition in the solar and wind sector. Others will be incremental: shifting from coal and diesel to cleaner natural gas might not represent complete decarbonisation, for example, but will still reduce emissions while generating financial returns.Certainly, the risk of waiting until a fully plotted roadmap to net zero is clear is highly significant. Energy companies have already faced a series of activist investor campaigns, with high-profile confrontations at businesses including AGL, ExxonMobil, Royal Dutch Shell, Glencore and SSE. These shareholders are not demanding that companies turn their back on profitability and competitiveness, but they are pushing for more radical action on climate change.

In some cases, these disputes may evolve into full-blown litigation, warns Seth Kerschner, partner at White & Case. He points to the example of ClientEarth, an environmental advocacy organisation that, in February 2023, filed a derivative action against Shell’s board of directors, in which it holds shares, alleging that they failed to properly prepare the company for transition to net zero and mismanaged material and foreseeable climate risk. “It remains unclear whether ClientEarth will succeed with this type of claim” says Kerschner, but that, he adds, may be beside the point. “The main aim may be more the publicity surrounding the claim itself than any ultimate remedies.”<h2>Inconsistent regulation</h2>A related problem is the ongoing interventions from regulators and policymakers in the sector. Governments are offering incentives such as subsidies for those decarbonising quickly and penalties such as higher taxes for those moving more slowly. But while that increases the pressure on energy companies to step up the pace, consistency is in short supply. “Across the market, you can point to instances where instability in the regulatory regime is creating uncertainty, and uncertainty is bad for investment,” says Morgan Stanley’s John Moon. “As regulatory regimes go back and forth, it is very difficult to plan.”

Which deal-making challenges do capital providers and companies expect over the next 18 months?

The M&A arena provides one good example of where this issue is playing out in practice. While dealmaking in the energy sector has bounced back strongly from the Covid-19 lull – with many businesses seeing M&A as a potential route towards decarbonisation – some 40 per cent of firms in White & Case’s research study complain that regulatory uncertainty makes this a challenging strategy.Technology investment is another tricky area. New technology may enable energy companies to explore greener solutions – both in the shift into renewable power and in mitigation of carbon-intensive activities through processes such as carbon capture – but innovation always brings risk. In White & Case’s research, 47 per cent of companies describe new technology risk as very challenging.

Very challenging

Somewhat challenging

Not challenging

How challenging is new technology risk?

Investors are pushing the sector to be less risk-averse, says White & Case partner Carina Radford. “Most investors and financiers understand that the first-mover advantage could be significant, and they may just have to take a leap into the less-proven to capture real opportunity as the pace of change is so fast.”One possibility is to share risk by pursuing more joint ventures. In Italy, for example, Enel Green Power is developing green hydrogen projects by working with partners such as ENI, Saras and AME. In the UK, the HyNet North West project is attempting to decarbonise an entire region’s industrial activity; a consortium of eight partners are developing the principal infrastructure, with support from businesses in the chemicals, glass and oil refining, food, paper and automotive sectors.The bottom line, however, is that any transformation carries significant risk – and the decarbonisation of the energy sector is about as large a transformation as it is possible to imagine. Still, the biggest risk of all may be doing nothing. “Decarbonisation is a form of risk management in itself, given the transition risks associated with climate change and the increase in regulation that impacts our businesses globally,” says Mary Nicholson, Head of Responsible Investment at Macquarie Asset Management. “If we don’t work with our businesses to help them navigate that transition, we are at risk of having detrimental impacts on their valuations or finding it harder to sell them in the future.”

At a time when fossil-fuel-focused energy businesses are under huge pressure to decarbonise, investors might be expected to be running scared. However, new research from law firm White & Case suggests many investors in the industry are focusing on the opportunities of decarbonisation, rather than planning an exit.Indeed, capital providers determined to work with the energy sector to help it decarbonise comfortably out-number those who want to sell up. In White & Case’s research, 45 per cent say they engage with emissions-intensive portfolio companies with the aim of lowering emissions, against 34 per cent who say they divest. This mirrors the view taken by energy businesses themselves: 42 per cent want to decarbonise their emissions-intensive operations rather than sell them off.

Agree

Disagree

Neutral

We engage with emissions-intensive portfolio companies to lower their emissions, rather than divest them

Divestment of emissions-intensive lines of business will be a last resort for my organisation

<h2>Carrot, not stick</h2>For John Moon, Head of Morgan Stanley Energy Partners, this view represents the best way to make progress towards climate change targets such as net zero. “We should work to decarbonise carbon-emitting industries, rather than vilify them,” he says. “Good engagement means accountability, and this requires good measurement – holding [companies] accountable for specific decarbonisation goals is part of the trick.”Certainly, there are financial risks in staying invested. Among those who do plan to divest from White & Case’s research, 49 per cent of capital providers cite their fear of stranded assets – getting stuck with investments rendered increasingly worthless by efforts to mitigate climate change – while 26 per cent fear such holdings could expose them to reputational damage.

Still, many investors worry that divestment means giving up a seat at the table from which they can influence the pace of decarbonisation. They also recognise the significant opportunities that the energy sector’s transition will bring, and are reluctant to miss out.Not least, investors are looking at potential returns from investing in solutions reflecting the reality that the use of fossil fuels is likely to continue for some time. In White & Case’s research, 42 per cent of capital providers say they now want to invest in low-carbon technologies that will help to reduce emissions and speed up the decarbonisation process; 33 per cent want to invest in portfolio companies that are reducing their carbon emissions.These are also priorities for energy businesses themselves, with 41 per cent planning investment in carbon-reduction technologies. Carbon capture and storage projects, which extract carbon dioxide from major industrial emitters, or directly from the atmosphere, are one focus, says Jay Cuclis, a partner at White & Case. “We are seeing significant and increasing activity in the CCS space, both in the US and globally, as this is viewed as one of the most effective ways of reducing the environmental impacts of continued use of fossil fuels and achieving the world’s net-zero goals for 2050,” he says.<h2>Targeting clean energy</h2>Equally, both investors and energy providers are also determined to identify fully fledged clean energy investment opportunities, which can run in parallel to mitigation initiatives. Among providers, for example, 45 per cent are exploring the potential of new greenfield renewable projects.

Which energy transition-related opportunities are companies planning to pursue over the next 18 months

Which energy transition-related opportunities are companies in each region planning to pursue over the next 18 months?

Interest in such projects is particularly heightened in the Americas, says Annette Clayton, CEO of Schneider Electric North America. “The US hasn’t really invested in infrastructure in decades,” she says. “So we’re now seeing and embarking on this unprecedented investment in US infrastructure to modernise and digitise it, to make it more resilient to climate impacts and to make it more sustainable.”In Europe, meanwhile, the energy company Enel points to an initiative to give a second life to 23 thermoelectric power plants and a former mining area that would have been shut down to achieve carbon neutrality by 2040. “The goal of the Futur-e initiative is to valorise the energy potential of the sites with renewable, storage and, when necessary for the grid’s needs, gas technologies,” explains Salvatore Bernabei, CEO of Enel Green Power.

Where do capital providers intend to invest?

As for investors, 39 per cent have plans to acquire renewable energy assets, and 35 per cent intend to acquire emissions-intensive assets with the intention of greening them. “As the need for renewables increases, there is tremendous opportunity in that asset class,” says Mary Nicholson, Head of Responsible Investment at Macquarie Asset Management. “But we’re also looking beyond renewable energy generation to the technology that will enable the transition. That could be clean grids, battery storage, electric vehicles and more – they will all be as equally important as clean energy generation in the future.”Nicholson, like other investors who are still committed to the energy sector, is determined to play a role across a broad range of areas where transition is necessary. And while some capital providers will inevitably feel uncomfortable with retaining exposure to the industry – fearing either financial or reputational risk – the pace of change for those who remain invested now appears to be accelerating.