Rethinking the role of long-term investors in the energy transition

Even as clean energy investment rises to record levels, the world still faces a major shortfall in funding for the energy transition. Estimates by the International Energy Agency (IEA) suggest that the US$2 trillion in clean energy investment expected in 2024 represents less than half the roughly US$4.6 trillion that will be needed annually by the early 2030s to achieve net-zero emissions by 2050. 

When it comes to financing the energy transition, long-term investors could perform an important role. They can take on the short-term risks of backing early-stage technologies or projects in emerging economies—risks that other investors are often reluctant to accept. Among potential long-term investors in the energy transition, two types stand out. 

• Sovereign wealth funds (SWFs) are perhaps the highest-profile long-term investors. They have traditionally served as vehicles for investing domestic capital surpluses in international markets, aiming to generate strong financial returns.

• Public pension funds (PPFs) provide consistent returns in order to pay for pension schemes and other social security benefits in their home countries. Some PPFs—particularly the large ones—have ambitious investment strategies that seek to incorporate energy transition assets with long-term prospects, alongside more traditional investments.

Together, SWFs and PPFs command significant financial resources: some US$32.8 trillion of assets under management, as of the end of 2023. If aligned with the priorities of the energy transition, their resources could go a long way towards bridging the financing gap that exists today. These funds stand to benefit, as well; the energy transition offers multiple investment opportunities. Interested SWFs and PPFs could take any of the three approaches below to scale up their support of the transition.

The energy transition is underpinned by infrastructure that either directly produces or contributes to producing clean energy; such infrastructure includes renewable power, nuclear energy, electricity grids and low-emission fuels. To reach net-zero emissions, significant gaps must be bridged between the current energy system and the clean energy system of the future. 

The biggest infrastructure gap is renewable energy capacity, in facilities such as utility-scale and small-scale solar farms, onshore and offshore wind installations, hydroelectric dams, and other sites capable of generating carbon-free electricity. But just scaling up renewable generation is not enough; five other gaps remain. Each can offer significant potential to long-term investors.

• Mass electrification. Much of the world’s decarbonisation ambition depends on the transition to clean electricity, rather than fossil fuels, as an energy source. The uptake of electric vehicles (EVs), the wider use of electricity in residential areas and the shift to electricity-powered industrial production are all major aspects of this change. 

• Power demand for digital infrastructure. Widespread adoption of technologies such as AI and cloud computing is adding to global energy demand—particularly demand for electric power—and the trend is expected to continue.

• Power grids. Today’s electrical grids were initially developed to support large, centralised power stations and long-distance transmission rather than renewable energy sources, some of which may be decentralised. Significant expansions and upgrades of power grids are key to enabling the energy transition.

• Access to critical minerals. Demand for battery metals (e.g., lithium, cobalt) is rising sharply, fuelled by increasing competition among automakers and volatile raw material costs. Simultaneously, the electrification of energy systems is boosting demand for copper. 

• Energy storage. Renewable energy sources produce an intermittent stream of energy, owing to changing weather conditions. Batteries and other storage solutions can deliver power when generation slows.

Closing these gaps will require a major reallocation of capital, above and beyond what is already underway. Clean energy investment rose from US$1.2 trillion in 2019 to US$1.7 trillion in 2023, according to the IEA. Still greater increases will be needed to put the world on a path to net-zero emissions by 2050. To reach that target, the IEA estimates, annual clean energy investments would have to total approximately US$4.6 trillion by 2030 and then keep increasing.

In its 2022 review, the International Forum of Sovereign Wealth Funds (IFSWF) observed, ‘The environment for [renewable energy] projects may be becoming more favourable in the coming years following the passing of the US Inflation Reduction Act…and the imminent EU Net-Zero Industry Act.’ This statement proved to be prescient: SWFs’ investments in renewable energy projects rose from approximately US$3 billion in 2022 to US$5 billion in 2023. 

SWFs’ investments in other areas supporting the energy transition also increased. Financing for EVs and batteries shot up to US$2.78 billion in 2023, from negligible amounts in 2022. SWFs put another US$1.14 billion into industrial companies that produce clean energy hardware such as heat pumps and carbon capture equipment.

Looking ahead, SWFs and PPFs could play an even more significant and constructive role in financing the energy transition. This role is defined by two qualities that distinguish SWFs and PPFs from other investors. First, their long-term investment horizons can allow them to take on short-term risks that other investors are reluctant to accept. And second, they can help attract investors from the private sector. When SWFs and PPFs are involved in the financing of a project, they signal public-sector support for it, which can make it less risky in the eyes of private-sector investors. 

SWFs and PPFs can consider the following three approaches in deciding how to bolster their investments in assets and projects that enable the energy transition.

Investment approach 1: Trailblazer

Long-term investors adopting the trailblazer approach pioneer new investment theses. They use their resources to think differently about problems than other investors do, develop innovative solutions and execute those solutions. 

Energy-transition projects in emerging economies are one type of initiative that the trailblazer approach is suited to. Private investors often avoid these projects because they see them as risky. Yet some governments in emerging economies are changing regulations and policies to reduce investment risk. 

By accounting for these developments as they assess regulatory risk, country risk and market risk, long-term investors such as SWFs and PPFs might determine that emerging-market plays can provide appropriate risk-adjusted returns. And if these investors become first movers, they will achieve higher returns more quickly, thereby blazing a path for others. 

The Abu Dhabi Future Energy Company, known as Masdar, is an example of an entity following the trailblazer approach. Founded in 2006 by the government of the United Arab Emirates (UAE), Masdar is both an energy company and a long-term investor with a mandate to diversify the UAE’s economy away from fossil fuels by developing and investing in the energy transition, both at home and abroad. 

Masdar has been among the first movers for several renewable technologies, including the world’s first floating offshore wind farm in Scotland, and has invested in and developed the first wind farms in several other countries, such as Serbia, Jordan, Senegal and Uzbekistan. Other projects include the 145 megawatt Cirata Floating Photovoltaic (FPV) plant in Indonesia, which helped create a blueprint for the government to upgrade regulations and introduce new laws for more solar power plants. 

Investment approach 2: The whole-of-life

Investing in energy-transition assets can be complicated because of how their risk–return profiles vary, not only from project to project but over the course of an asset’s life cycle. Early-stage assets often present similar risks to venture capital investments, such as technology risks (in green hydrogen projects, for example) or financing risks (which can occur in solar projects, as developers spend money to acquire land). As these assets mature, their risk–return profile becomes more attractive to infrastructure investors and others. However, the challenge for asset managers is that assets can be difficult to move from one type of fund, such as venture capital, to another type, such as infrastructure.

Long-term investors, though, are generally less constrained than other asset managers by specific investment mandates (beyond a mandate to generate strong long-term returns) or by restrictions on which investments are suitable. The freedom permits many long-term investors such as SWFs and PPFs to hold an energy-transition asset for its entire life cycle, in what we call a whole-of-life approach.

This approach involves planning for how an asset’s risk-adjusted returns will change over time and capitalising on its potential for long-term revenue growth. It enables SWFs and PPFs to finance clean energy projects spanning the entire maturity spectrum, from early-stage development through operations. 

GIC, a Singapore-based SWF, espouses the whole-of-life approach. Founded in 1981, GIC has a broad investment scope in terms of asset classes and geographies. In recent years, it has made several energy transition–related investments in both developed and developing countries. These investments include a majority stake in a renewable energy company in India, a minority stake in a renewable energy platform serving Southeast Asia, and a share of an Iceland-based firm focused on decarbonising the building sector through geothermal energy. 

Investment approach 3: Blended finance

Blended finance structures allow long-term investors such as SWFs and PPFs to collaborate with multilateral development banks (MDBs), development finance institutions (DFIs) and private investors to finance energy-transition projects that generate solid financial returns and socioeconomic benefits. For instance, in a blended finance debt fund, MDBs and DFIs would provide concessional financing, below the market rate, to help de-risk the project. Other investors would then supply additional funding, at a lower level of risk.

To date, long-term investors such as SWFs and PPFs have not made much use of blended finance. But certain long-term investors could absorb initial losses through subordinated tranches in investment structures, thereby enhancing a project’s risk-adjusted returns to a level at which other investors will take part.

As our PwC colleagues have observed, blended finance can help align the interests of the public and private sectors and distribute risks among parties according to their ability to manage them. This creates a multiplier effect whereby public-sector financing is used to attract private-sector financing. And in emerging economies, the de-risking achieved with blended finance could be crucial to addressing the investment gap.

One entity using blended finance is Temasek, a single-asset-class (equity only) long-term investor established by the government of Singapore in 1974. Temasek strongly advocates using blended finance structures to fund the energy transition and attract private investors. It has several investment platforms aimed at providing such solutions for the energy transition. One of these, Pentagreen Capital, is a debt financing platform for sustainable infrastructure, jointly established by Temasek and HSBC to de-risk projects in Asia.

As the impact of climate change becomes increasingly apparent, the urgency of the global energy transition grows. For long-term investors, this urgency creates an opportunity to generate returns and to help address one of society’s greatest challenges. SWFs and PPFs have the financial resources to accelerate the energy transition, along with unique capabilities that can help them mobilise capital in ways that other investors cannot. The long-term investors that move first can capitalise on today’s opportunities while forging a path for others to follow.