The key private equity challenges as energy security moves front and centre

By Helge Tveit, Managing Partner

All investors are familiar with the caveat that “past performance is no guarantee of future results”. But most of us would agree that an understanding of previous trends, momentum and track record can greatly influence future outcomes.

That holds true in the private equity world just as it does in the arenas of public investment, global economics, geo-politics, climate and the environment. The Russian invasion of Ukraine represents a watershed moment in terms of global energy supply and security. It has the potential to accelerate investment in clean and renewable energy alternatives. In the short term we will also expect traditional energy to benefit from increased investment in Europe and the US.

So, given the significance of this inflection point in global energy markets, it makes sense for us to take stock. That means looking back at the key investment themes from before the invasion and considering how we might effectively apply our insights to the new reality.

Naturally, at EV Private Equity, we view the world from a distinctive perspective – through our lens as a technology-enabled impact investor focused on reducing greenhouse gas emissions and combating global warming.

From this vantage point, at a macro level, the balance sheet over the last year had some strong credits and some worrying debits.

On the plus side, the US re-joined the Paris Climate Accord; COP26 took place in Glasgow; a record-breaking 290 GW of new renewable generation capacity was added around the world (source: IEA); a battery electric vehicle, the Tesla Model 3, became the best-selling car in Europe for the first time; and in Norway, our $1.4 trillion sovereign wealth fund, the world’s largest, was given a strong mandate to commit to net-zero carbon emissions by 2050.

But, even before the Russian invasion of Ukraine, it was not all positive. The summer of 2021 was the hottest on record causing deadly heatwaves, raging wildfires and severe flooding from the Pacific Northwest to the Siberian Arctic; global energy-related CO2 emissions jumped by an estimated 1.5 billion tonnes; and at COP26, commitments to ‘phase out coal’ became considerations to ‘phase down’ coal.

Against that background, our dominant investment themes of climate change mitigation, decarbonisation and digital transformation are more relevant, and indeed more necessary, than ever.

A banner carried by a young activist at the COP26 event summed up our position perfectly. It read simply: ‘Be part of the solution, not the pollution’.

Over the last 18 months we have demonstrated precisely how we are becoming part of the solution. Our portfolio continued to transition, rapidly and successfully, from our oil and gas heritage to our sustainable energy future.

Our latest fund invests in technologies that eliminate hydrocarbons and reduce GHG emissions with a focus on software, particularly SAAS (software-as-a-service) and capital light opportunities that are scalable globally.

Electrification, energy efficiency and renewable energy have been our key themes but, as we look forward to a rapidly changing global energy environment, we are increasingly targeting innovative technologies that support the emerging themes of circular economies, hydrogen and CCUS, such as process efficiency services, sensor technologies and decision support software.

Smart grid is a sweet spot for us: we believe technologies that manage grid assets to reduce cost and increase efficiency are going to become prevalent in the near future. These balancing technologies will optimise the whole grid operation and smooth consumption by minimising peak loads to take advantage of off-peak tariffs.

There are several emerging trends that we believe must be accelerated: international commitment to carbon tax; standardisation of ESG frameworks and corporate climate disclosure metrics; and tackling methane as a matter of urgency. All of these have significant bearing on opportunities and returns in the private equity market.

November’s COP26 in Glasgow produced a lot of bold statements and impressive pledges, but we still need evidence that these are backed by a will to deliver. Big words need to be followed by big actions to translate ambition into action. That is especially true of the need for significant international agreement on carbon tax. The renewed focus on energy security should not be used as an excuse to delay and undermine moves in this direction.

We need to put a price on carbon pollution as a way of cutting emissions and driving investment into cleaner options, green energy and the technologies that enable them. Such carbon taxes already exist at national and regional level in areas like British Columbia, Germany, South Africa as well as on the Norwegian continental shelf, but we need to see this at a global level.

The whole ESG (environmental, social and governance) arena also needs to develop at pace and establish more rigour. In one sense, ESG has already gone mainstream in the private equity world. LPs are simply no longer going to engage with GPs that don’t integrate ESG criteria in their investment models. That’s a good thing but it doesn’t go far enough.

The ESG schemes that are out there for public companies have a lack of correlation and that is a massive concern. There are currently upwards of 300 rating schemes with 4,000 KPIs.

A mutual fund that has a high ESG rating with one scheme might achieve a completely different score against a scheme with a different benchmarking methodology.

However, in the private equity world, we’ve now reached a place where ESG is just good operating practice. It’s sound common sense. In the coming year we can expect to see a much starker distinction emerge between impact investing and so-called ESG investing.

A portfolio company with a low ESG score can be fixed. A company that does not deliver impact has little prospect of delivering impact. If it is fundamentally a polluting business, it will require a huge effort to turn it around. At EV, we are focusing on businesses that help society enable a transition by investing in companies that facilitate emission avoidance.

As impact investors we seek intentionality. Our investment strategies actively prioritise positive environmental impact as a specific objective alongside superior returns. This differs from the negative screening approach which seeks only to minimise harm. We actively seek to do good as our impact pledge of targeting a net reduction of one million tonnes of CO2 demonstrates.

Rapid progress towards a transparent, accountable, robust and measurable ESG and impact framework will therefore be one of the key aims as the world adjusts to the new geo-political and economic reality. All metrics that have to do with sustainability and climate-related risk should be subjected to the same scrutiny as audited financial statements.

The accountancy profession needs to step up to the plate in the coming year and take ownership of providing verification of the numbers on carbon accounting, because otherwise such disclosures will be meaningless.

At EV Private Equity, we’re innovating in our own right in this respect. We’re partners in the development and launch of xIQ, a software platform that allows investors to assess, measure and report on the net total impact of a company’s GHG emissions. It’s Europe’s first measurement platform that covers Scope 1- 4 emissions.

In the short term, we absolutely need to invest in fixing global methane emissions which account for a third of global heating. Many regions worldwide, including the USA and Russia – are experiencing huge problems with this.

A 2021 UN report points out that methane emissions could be almost halved by 2030 using existing technologies at reasonable cost. Leaks from hydrocarbon drilling sites, coalmines and pipelines produce more than a third of the world’s total emissions of methane, a much more powerful greenhouse gas than carbon dioxide. Indeed, new and existing technologies that capture methane gas leaks at fossil fuel sites could actually generate profit.

In the long term, however, if we are to achieve the twin goals of net zero and energy security, we need more transformative technologies. On a time horizon of up to 25 years, we require more radical approaches to generating energy. There is a limit to how far renewable capacity can provide our base load requirements.

Wind and solar can probably account for a maximum of 60% but these are intermittent sources and battery storage capacity has its limits. We have to ask what will make up the base load when the wind isn’t blowing and the sun isn’t shining. Right now, in the US, that fall-back baseload comprises a lot of gas supplemented by some coal and nuclear. High carbon sources of energy must be phased out, while the jury is still out on nuclear with the new geopolitical reality.

Low-risk nuclear power from fusion is one such solution although currently there is much negativity towards nuclear, from ‘not-in-my-back-yard’ arguments to resource issues around the current shortage of nuclear scientists and engineers.

However, these obstacles are not insurmountable and the renewed focus on energy security has increased the desire to solve these issues. Investing in fundamental technological innovation in that domain can reduce the cost and the hazard. That strategy applies to nuclear just as much as it does to our themes for 2022 in the domains of the circular economy, hydrogen, and carbon capture.

Past performance may not be a guarantee of future results, but our advantage in the private equity space is that we have two decades of investment experience in sustainable, high growth, differentiated technology. That gives us an edge in energy transition – in transforming opportunity into superior returns while offering the solutions to pollution.

Learn how we’re leading positive change through sustainable energy technology investment here.