Opportunities abound, but planning is essential 5 min read
Investing in energy transition-related projects is a smart way to deploy capital in the current market, and can be done in an ESG-compliant way. Here are some proven ways dealmakers can close energy deals efficiently, while maximising value creation and managing ESG risks.
Key takeaways
- There are currently unprecedented opportunities to invest in energy transition—plus, reallocating capital to green power projects helps meet ESG-related legal and stakeholder requirements.
- Specialist ESG-focused due diligence is essential to both identify opportunity and identify, minimise and mitigate risk, in energy deals.
- There are several hallmarks of best practice ESG due diligence, which apply to almost all energy deals.
Why invest in clean energy?
Clean energy investment has never been more necessary. Bloomberg found global investment in the renewable energy transition hit a record-high last year, totalling US$755 billion. But estimates from the Intergovernmental Panel on Climate Change found that worldwide annual investment needs to reach US$3.5 trillion to avoid damage from climate change. Evidently, large amounts of investment—including private capital—are needed to fund the transition to a net-zero economy.
Investment in clean energy projects is a win-win for investors. On one hand, there are unprecedented opportunities for investing in energy transition right now. On the other, reallocating capital towards green power projects meets the needs of ESG-minded stakeholders and regulatory requirements.
Putting ESG at the heart of your investment strategy
Make no mistake, the energy transition is being driven by market forces. Though government policy is providing impetus, the biggest push for decarbonisation is coming from investors and consumers alike, who are ready to spend on the energy transition. ESG considerations are now the core of any strategy to reallocate capital in the energy sector.
Investing in the energy transition, however, often means investing in new infrastructure. In today’s market, any project involving construction must be assessed for its ESG impacts, and this applies to ones as diverse as electric vehicle charging stations and renewable energy zones, through to pumped-hydro projects and hydrogen assets.
In short, all dealmakers—whether you represent a super fund or a private equity firm—need to understand how investees integrate and evaluate their ESG commitments. For instance, when acquiring an entity, consider how the acquisition will affect your existing ESG strategy and commitments. Does the entity's ESG profile align with yours, and if not, what uplift is required to ensure alignment? Conversely, consider how ESG risk has been allocated in the transaction agreement. And how will it be integrated going forward? Considering ESG commitments, though, is not only an exercise about risk. Controllers of private capital are in a unique position to leverage ESG as key drivers of value and upside potential in their investments. Specialist ESG-focused due diligence is a must to identify opportunity, and to identify, minimise and mitigate risk, in energy deals.
So, in practical terms, what does this look like?
Best practice ESG due diligence for energy investments
It’s vital to establish a clear understanding of your legal and regulatory obligations—not to mention stakeholder expectations of the asset—before you commit any funds. Also, identify to what extent the asset is meeting (or is capable of meeting) those obligations and expectations.
Specialised ESG due diligence depends on the asset class in question, and ESG issues vary between sectors, industries, and jurisdictions. There’s no one-size-fits-all approach. There are, however, several hallmarks of best practice ESG due diligence, and these apply to almost all energy deals.
1. Take a 360-degree ESG lens
Environmental issues are often the first to spring to mind when we talk about ESG, but due diligence must also address ‘S’ (social) and ‘G’ (governance) factors. During the purchase of a renewable asset, for instance, you need to be able to quantifiably measure your target company’s engagement with Indigenous peoples on the land they’re seeking to develop. Further, you'll need to assess whether the target company's supply chain poses any human rights risk, including in relation to compliance with modern slavery laws. Similarly, are there any historical community complaints or judicial findings to factor in?
2. Understand regulatory obligations: present and future
The energy sector is shifting. Where previously it was mostly characterised by voluntary ESG standards and 'soft laws', these are increasingly being 'hardened' by domestic laws. The Federal Government's commitments around disclosure of climate risks and opportunities—to ensure Australia catches up, and keeps up, with global regulations—will, in this financial year, see new developments enabling transparency and comparability between investment opportunities. Dealmakers need to be across these changing obligations. To ensure you are prepared, it would be wise to look to the future and consider what regulatory obligations might be introduced within the lifetime of an asset.
Dealmakers also need to understand any risk exposure due to misalignment between the target asset and public obligations. At Allens, for instance, we provide our clients with an ESG obligations matrix for energy assets. This allows dealmakers to fully comprehend their risk exposure to domestic and international obligations, as well as any voluntary commitments (ie soft law).
3. Map related impacts
Understanding the impact of any new energy acquisition means understanding its related impacts too. Best practice ESG due diligence goes beyond the direct footprint of a company, and asks eg what are the scope 2 and 3 (indirect) greenhouse gas emissions of the asset? Also, do you have visibility over what’s happening upstream and downstream along supply chains, even in relatively opaque regions? This is a crucial step, especially in light of increased regulatory scrutiny of greenwashing, both internationally and in Australia. Therefore, it is important to map out all value chains before taking the plunge.
4. Reporting and assurance
Finally, any responsible investor will spend time considering the reporting and assurance practices of the target asset. Some questions to consider are:
- Does the investee have appropriate disclosure of its ESG targets and outcomes? Is this transparent?
- Does the investee simply meet mandatory reporting requirements, or is it going the extra mile with voluntary disclosures?
- Have these disclosures been independently assured or verified to ensure all reporting is accurate?
- Does the investee have a plan in place to support and describe how it intends to achieve its ESG targets and outcomes?
Finally...
Don’t get caught out, post transaction, trying to retrospectively resolve ESG policy misalignments or conduct risk assessments. Instead, do an implementation assessment and identify any gaps up front. Consider the drafting of activities to remediate poor ESG alignment into transaction agreements as a post-closing obligation. To mitigate risks of any gaps, or potential regulatory misalignment, ask that the sellers provide warranties. Involve your external lawyers from the get-go when making major decisions or discussing strategy, so that everyone is on the same page.
When they’re brought in early, specialists can also help map stakeholders, which is a vital part of the ESG due diligence process.
If you would like to discuss the issues raised in this Insight, please contact our team below.