Our COO, Luca Pedretti, sat down with Marion Calcine, Chief Investment Officer – Infrastructure for Ardian, to discuss the changing trends for renewable energy PPAs. Marion has been involved in infrastructure assets from transportation to utilities to renewable energy for the past 15 years and talks us through OPTA, Ardian’s new digital infrastructure project.
LP: Over the past 15 years, what were the biggest changes you saw in renewable investments? How has Ardian changed in turn?
MC: A major change over the past decade for Ardian is that we do renewable investments on our own. In 2007, when we made our initial investments into Italy, we were a minority shareholder working together with an industrial partner because we did not know the renewables business too well. Since then, we have gathered enough network intelligence and talent via our management teams to do that on our own, which we started doing in 2009.
The second big evolution for us is that we have progressively opened up to new geographies – we are now present in Italy, France, Spain, the Nordics, Germany, and the US.
When it comes to the evolution of the market, the price of technology across all the renewables has really reduced significantly. At first, we were investing in renewables which were fully subsidised for 10 to 20 years, whereas now, renewables are not subsidised because the cost of technology is highly competitive, so that renewables are now either fully merchant, or part of the production is covered by PPAs or is otherwise hedged.
I think that the most striking evolution is the contractual realisation of hedging instruments. Nowadays, investments can be hedged via fixed hourly delivery volumes, so renewable producers have the short-term risk of volume buyback on the market. As you can imagine, this was not at all the case in the past, where you had an offtaker buying all of an asset’s production.
LP: Over the past year, there has been a real acceleration of these trends through this pandemic, particularly with the price swings and remote working. How has your business had to adapt to these changes? What do you see this as the biggest risk generally for renewable investment going forward?
MC: Over the past year, we have observed in our home markets significant power price swings; however, we have not been significantly exposed as we have a renewable portfolio which is still mostly subsidised. It has reinforced our conviction that you need to put moderate leverage on this kind of assets, which is a golden rule for us. We always run a downside case to make sure that even in environments with very low power prices, you don’t have financing issues, such as breach of covenants.
I think the biggest risk today is volatility of renewable sources, as well as a mismatch in the perception of the risk which these assets carry compared to the return that people want to allocate to them.
In that respect, the COVID crisis with all these swings on the market shed light on the fact that you need tools to better analyse the short-term and the long-term merchant risk in the context of increasing price volatility. I don’t think that the pandemic drastically changed the market trends that were already in motion, but it just accelerated them. It will make the volatility on markets more acute because we still don’t have the flexibility investments (battery storage, electrolysers) which make prices more stable.
LP: Despite the changing nature of renewables as an asset class and misperception around risk, we are seeing a significant increase in the valuation of those types of investments – how can we reconcile these trends?
MC: It is true that increased awareness of climate change makes it more urgent to deploy renewable energy, which pushes up valuation of these assets, despite increased volatility.
In order to cope with this, you really have to know which risks you are taking and measure them properly. For renewable assets, the two biggest market risks are the baseload price risk and the cannibalization risk, which is the fact that more renewables buildout will decrease prices. You have to be able to measure them, assess them, and take them into account in your profitability assessment.
There are two ways to cope with that. There is the strategy adopted by many integrated utilities – increasing scale and increasing diversification in order to smooth the overall risk of their energy assets’ portfolio. When they lose out on renewables, they will win on gas and/or compensate partially through retail prices. Through this, they can ultimately balance their exposure.
On our side, we have a higher cost of capital than utilities and we do not operate on a single balance sheet – our renewable investments are made through several funds, with each its own investment and divestment pace, so that diversification is less easy. This means we cannot create scale in the same way as utilities and for that reason, we need to adapt differently.
The skillset and tools required to work with these assets are totally different now, and we’ve invested a lot in our teams and managements. Our view is that to remain competitive in the renewable space, we have to develop competitive edge in efficiency of operations, market knowledge and risk management. We are also currently setting up OPTA. OPTA integrates a number of digital tools to accompany us through this transformation.
LP: With this project you are embarking on, it seems to deal primarily with the digitisation of your business and the introduction of risk management type tools, risk reporting, valuation methodology. Could you tell us more about this project?
MC: With OPTA, we are equipping our renewable portfolio with best-in-class operating and market softwares in order to implement a future-proof, end-to-end renewable energy monitoring platform that will help us, and our management teams, to create additional value and monitor technical and market risks in tandem.
At Ardian, we are taking a “two-legged” approach to manage this with digital tools. We have brought in tools for the operational side from Greenbyte, in order to analyse the availability and performance of our assets, including the deviations of wind farms against theoretical forecasts.
On the other “leg” of our strategy, we are investing in risk management.
Our first goal was for Pexapark to accompany the management teams of our renewable assets in Europe throughout the energy transition from being fully-subsidised toward a more merchant environment. If you want to keep it as an infrastructure investment rather than a venture capital investment, it’s important to prove to investors that you can manage to control and monitor risks over the long-term.
As a fund, we do not typically internalise energy management, and as such, we want to make sure that proper risk management is being done.
There are two ways of using Pexapark –our management teams have access to information regarding various available types of PPA, and what such PPAs would imply in terms of revenues at risk on their portfolio. This enables them to decide on renewable energy sales with various criteria (maximising revenues, minimising risk of covenant breach, lowering revenue at risk).
At Ardian level, we want to have a consolidated view of the merchant risk we are taking in order to efficiently diversify away, if required, based on the risk profile of our investments. This helps us a lot in portfolio construction.
One functionality of Pexapark that is extremely important for us is the additionality – every time you add in another asset, you have the possibility to see how it impacts your overall value at risk. As discussed, we are not active on the energy markets, our portfolio companies sell their electricity to traders, which have the possibility to arbitrate on liquid markets. At our level, our investments are in companies, in projects – if you have too much exposure, you cannot sell your plant right away, so for us, it is important to have the value at risk at 10 years, rather than 5 days.
It is of paramount importance for operations and risk management to be integrated. If you can predict when prices are going to be low over a certain period of time, you can choose the best time to schedule maintenance work, or later down the line, decide whether to store energy or feed it into the grid. With the integration of tools for operational performance and projected prices, we can really construct a portfolio that supports the case for investing in renewables.
LP: What are some of the challenges you have faced when building OPTA?
MC: The prerequisite step is to be fully convinced of the project and its value across all levels of the team, from top management down.
The second step is to make sure that the CEOs of your management companies embark with you – that they perceive the fact that these tools are going to be useful for them in the first instance even prior to being useful for Ardian. We had iterative and collaborative processes with our management teams, to make sure that their comments are taken on board.
Finally, it’s about knowing that this is a very new approach for your company. It took us some time to get used to the tools from an IT perspective and define for each of our portfolio companies and teams what the brand-new reporting system can do. At Ardian, we have decided to invest in that process with a number of new hires in data science, and to gain from the outside capabilities and knowledge that we did not have internally.
LP: What would your advice be for other investors, given the changing scale of risk management? How would you expect the market to change in the next 5-10 years?
MC: I think there will be consolidation among current players. Funds that can cope with risk effectively will be the ones staying in the renewable market. It’s important not to invest at prices that are not appropriate for the level of risk. Ultimately, you have to know what utilities have and what you don’t have – such as energy management capabilities – and work to accommodate that.