An (over)performance that will last?

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The summer of 2022, with repeated heatwaves, fires and droughts across Europe and around the world, confirms that the effects of global warming are stronger and more rapid than even the most pessimistic projections. To be able to curb them, it is imperative to change the current mode of energy production and consumption to a more responsible model. This paradigm shift requires large investments. The European Commission has announced that between 2021 and 2030, the EU’s energy sector will focus on the development of green energy (solar, wind, etc.) and the necessary infrastructure.

But from a strictly financial perspective, are the returns worth it for investors? Would you like to provide

Our recent study examined the expected return and actual performance of green energy infrastructure compared to fossil energy infrastructure over a decade (2011-2021). This return on investment issue is critical as investments in wind and solar energy projects now account for 25% to 33% of all infrastructure investments and growth is expected to accelerate. .

Popular among investors

One of the arguments used to promote sustainable investment is that it yields better returns than conventional investments, especially fossil fuel financing. Is this actually true?

In 2011, the expected rate of return for wind and solar energy projects was 8%, compared to 9% for fossil energy projects. His 10-year total annualized returns in 2021 were 16% and 17%, respectively. These two numbers may look similar, but they correspond to two different economic realities.

Our research shows that there is evidence that investments in green infrastructure (defined as wind and solar projects) are performing well. This outperformance, defined as higher returns than traditional assets, is actually due to changing investor preferences for ‘green’ projects. In other words, there is an excess demand for this type of investment, which could be attributed to the growing public awareness of energy transition issues, and the better performance of responsible assets compared to conventional assets. is explained.

Paradigm shift?

Over the past decade, investors have increased their interest in the renewable energy sector. According to a BloombergNEF report released in August, green investment in the first half of 2022 rose 11% year-on-year to US$226 billion. In particular, investment in solar projects reached $120 billion (+33%), and investment in wind projects reached $84 billion (+16%).

In a 2022 study of approximately 350 asset portfolios, EDHECinfra found that renewable energy accounts for between 25% and 33% of investments, while fossil fuels (gas and coal) make up the majority of portfolios. It accounts for only 1-3%. North American investor.

This is because fossil fuel projects are relatively unpopular and are subject to environmental taxes such as France’s carbon tax and the European Union from 2026. Moreover, we are witnessing what could be a tipping point. In 2020, investment in renewable energy will exceed $500 billion, while oil and gas production will see him invest $400 billion. Indeed, the value of so-called ‘traditional’ assets has been affected.

Will the momentum continue?

While fossil fuel investments have been shunned by mainstream investors over the past decade, green assets have been widely integrated into investment portfolios. This was especially noticeable in his 2012-2015 period, during which green assets performed better (or as well) than traditional assets.

This performance of green assets can be explained in particular by changes in risk perception (responsible investment tends to become more normalized and more desirable). In contrast, the performance of traditional assets is still driven by risk-adjusted returns.

However, the temporary high returns of these green investments are not predictive of future performance. According to our observations, this phenomenon of strong demand, accompanied by an increase in the value of green assets, peaked in 2019. Expected returns from this type of investment are now much lower.

This means, among other things, that green energy project earnings should not be viewed as an indicator of future performance. The more the demand for green assets is met by additional investment, the lower the expected return. In fact, supply and demand can eventually converge and “fix” the outperformance of green assets.

Therefore, there is no real risk premium for green infrastructure projects, where investors may benefit over the long term. In fact, we should be talking about the “green premium” that investors are willing to pay when responsible assets become more popular. The outperformance of green assets over the past decade has been driven by excess demand, which ultimately declined.

In other words, when supply eventually caught up with demand, green assets performed relatively poorly as a result of a return to market equilibrium. It was nothing more than The last decade should therefore be viewed as a transitional period rather than as the beginning of a permanent phenomenon.

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