Funds taking on market risk to boost returns

Alternative infrastructure and private equity funds are increasingly targeting European energy assets with merchant risk as a way of boosting returns.

November 27, 2017

Investment funds have made a big push into European energy infrastructure this decade. This has been fuelled by a search for yield in a record low interest rate environment. But yields on regulated infrastructure assets are now also being driven down to historically low levels.

A key issue is that energy infrastructure investors are competing with utilities for the same sort of assets and development projects. In both cases capital preservation is key. And this has meant a focus on regulated or long term contracted assets, for example ‘feed in tariff’ or CfD protected renewable assets and regulated or contracted pipes and wires.

However as regulated asset yields compress further into single digits, infrastructure investors are being forced out along the risk curve. Alternative pools of capital are also being formed with a more open investment mandate than that of classic infrastructure funds.

The search for yield is driving a greater tolerance for market risk exposure. And this is becoming evident in the types of assets that fund investors are targeting (e.g. conventional power assets, gas & electricity storage, pipelines & regas).

Investment funds targeting European energy assets

In Table 1 we have grouped funds that are active in European energy infrastructure into 3 categories based on capital type, target returns and risk appetite. We have also provided some examples of specific funds and transaction case studies.

Table 1: Summary of investor categories

Investment drivers Fund examples Transaction examples
Infrastructure & pension funds Focus on capital preservation. Regulated or contracted cashflows. Low market risk tolerance. JP Morgan, Ardian, iCON Infrastructure, Allianz Capital Partners Denmark PKA pension fund wind investments. Allianz Capital Partners acquisition of Gas Connect Austria.
Alternative infrastructure & Sovereign Wealth Requirement for a base level of secure cashflows (e.g. from capacity payments). Some market risk tolerance to increase returns. Macquarie, Blackrock, Brookfield, ADIA, CKI Macquarie UK CCGT acquisitions. Fund investment in UK peakers (e.g. Infrared, AMP). Brookfield acquisition of Mitsui stake in First Hydro pump storage.
Private equity Comfortable with market risk. Need clear value growth & exit strategy. Business model efficiencies also important. KKR, Riverstone, ECP, Blackstone, Warburg Pincus ECP acquisition of UK CCGTs. KKR acquisition of French CCGTs. Star Capital development of Eleclink interconnector.

Source: Timera Energy

Infra & pension funds

The investment mandates of infrastructure & pension funds drive a focus on protected cashflow. Risk tolerance of these funds is steadily rising, for example taking on greater development or regulatory risk. But any assets with significant exposure to market risk struggle to make it past the investment committee approval stage.

Alternative infra & sovereign wealth

A recognition of this challenge by some of the larger infrastructure fund managers has seen new pools of capital emerging. This can be in the form of ‘special situations’ funds, or alternatively via raising specific capital to pursue a target asset or portfolio.

Behind this transition are institutions, sovereign wealth funds and individual investors who are also being pushed into riskier asset classes to boost returns. As long as the low interest rate environment persists, energy asset acquisitions from this category of alternative infrastructure capital is set to grow. But the key challenge these funds face is how they manage market access, hedging and optimisation of assets post acquisition.

Private equity

Private equity funds are already big owners of energy infrastructure in the US. Step forward five years and it may be the same in Europe. Value growth and a clear exit strategy are key. But these funds have a strong tolerance for market risk, which can either be managed via in-house trading functions or outsourced via market access contracts.

Private equity backed acquisitions of European energy assets have been more opportunistic to date. These have included for example KKR, ECP and Castelton’s acquisition of CCGT assets. PE funds have also been active with oil & gas assets e.g. upstream and midstream acquisitions from Blackstone, Riverstone, Hitec Vision & Warburg Pincus.

As utilities and producers continue to offload energy assets, we are set to see a shift from opportunistic purchases to structural growth in private equity asset ownership in Europe.

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