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By Dr. Andreas Schlatter, Head of UBS Asset Management Switzerland
The Swiss federal government’s Energy Strategy 2050 calls for investments of over CHF 200 billion. Pension funds and life insurers are ready to invest in energy infrastructure and finance a part of the change in energy policy. A change to regulations should be considered to enable these investors to make an even greater contribution.
The Swiss federal government’s Energy Strategy 2050 is a project that will span generations. An estimated CHF 67 billion will have to be spent in Switzerland by the year 2050 on the construction and operation of new power stations. The Federal Council estimates further investments of CHF 126 billion are needed to modernize existing power stations. And an estimated additional CHF 18 billion will be required to restructure and expand power transmission and distribution grids. In total, this amounts to an investment volume of over CHF 200 billion.
New sources of financing for the change in energy policy
Until now, Swiss power companies have been able on their own to obtain the financial resources necessary to maintain their grids and power stations. However, since the pressure on these companies is mounting, and the impending investments are large, future financing of energy infrastructure will have to be broader-based. This is why many are looking to institutional investors such as pension funds and life insurers, which due to the very low interest rates are searching for long-term investments with attractive risk-return potential.
Risks in financing energy infrastructure
Where do the particular risks lie for investors who wish to invest in energy infrastructure? Investors should first make sure the regulatory environment is stable and predictable. Since such facilities generally have very long operating lives, they are thus financed on the long term. Investors must therefore be able to rest assured that promised development measures – such as the compensatory feed-in remuneration scheme (KEV) for electricity generated from renewable energies - will apply for the entire term of the project.
From an investor’s perspective, interesting projects are those which are already competitive without support. Heating projects are one example. Wood-fired heating plants burn wood and generate heat which is sold to industry, hotels or private households at competitive rates. With such projects, investors can achieve a reasonable return with low risk. In light of the persistently low interest rates in Switzerland, this can be an especially attractive opportunity for pension funds.
Return expectations of investors in energy infrastructure
Investors also focus on return, not just risk. What is an attractive return for institutional investors? The return expectations of pension funds for infrastructure investments is based on several components. For example, the risk-free interest rate in Swiss francs ranges over ten years between 2.0 and 2.5 percent. Then there is also the risk premium for regulatory and operational risks of 2.0 to 2.5 percent and an illiquidity premium of 1.0 percent. This results in a return expectation of between 5.0 and 6.0 percent. This is the minimum return energy infrastructure investments should yield to arouse the interest of Swiss pension funds in the current environment.
Energy infrastructure financing in Switzerland
As the largest asset manager in Switzerland, we see from our own experience that clients such as pension funds and life insurers are generally interested in investing in Swiss energy infrastructure. This year we created an investment solution for institutional investors allowing them to do so. We expect to achieve a return of 5.0 percent per year during the 12-year term of this collective investment. This solution has been met with great interest, and we have received commitments of around CHF 400 million thus far.
Conclusion and outlook
To attract more investors for energy infrastructure, the framework conditions must be predictable and stable in the long term, and the investment must achieve returns of at least 5.0 to 6.0 percent. If the political sphere wants a greater commitment from pension funds and life insurers in energy infrastructure financing, then the corresponding equity capital requirements and investment requirements for institutional investors must be amended accordingly.
In this regard, two measures are feasible: Infrastructure facilities should be managed in a separate investment class, such is the case with real estate. Moreover, equity backing requirements for infrastructure investments of life insurers should account for the underlying risk profile of this asset class in the Swiss environment. This would enable institutional investors to provide more capital for these long-term, low-liquidity investments and thus to make a sustainable contribution to broader-based financing of energy infrastructure in Switzerland.
UBS Asset Management offers institutional investors the opportunity to invest in the area of clean energy infrastructure.