In brief
- Electricity networks are essential for the energy transition. Achieving the tripling of global renewables capacity by 2030 from 2022 levels requires significant investment in electricity grids and storage.
- Most regulatory frameworks in Europe allow for near-immediate returns on incremental investments in grids and the predictable returns means regulated grids are able to support more debt than most corporates at the same rating level.
- Green bonds, and other ESG-labelled bonds, are increasingly common-place for grids, given their alignment with EU taxonomy.
Evidence that the energy transition is genuinely underway can now be clearly seen in plain sight. More electric vehicles (EVs) are on the road, more solar panels are on roofs, and more wind farms are on hills and in the sea.
The first phase of the transition has been dominated by the growth of renewable generation, driven by environmental legislation and massive cost reductions. Investments in renewables will continue to rise over the next few years before reaching peak levels globally in about 2026, according to BloombergNEF1 . However, one segment of the corporate bond universe that underpins the whole energy transition and has been enabling the change from day one is electricity networks. Global network investment is expected to expand long after we pass the peak of spending on generation.
The evolution of the energy transition
Analysts are divided about when the energy transition started. Arguably, the first nuclear plants in the 1950s paved the way for a move away from burning coal or natural gas. Wind turbines were developed in the 1980s and started to see utility-scale investment in the early 2000s. However, it was the Paris Agreement in 2015 that seeded an international commitment to reducing greenhouse gas emissions and the start of the modern energy transition.
At COP28 in December 2023, a pledge was made to triple global renewables capacity by 2030 relative to 2022 levels. This would take renewables capacity to nearly 12TW (compared with just 8.5TW for the whole system in 2022), which BloombergNEF2 estimates will require investment of over $7tn over the next seven years, in addition to the $1.2tn deployed across 2022 and 2023. On average, this would mean more than $1tn of spending per annum, up from just $623bn spent in 2023, itself the highest on record.
So how do the networks contribute to the transition? Networks move the power from where it is generated to where it is used, and significant changes to both ends of the value chain require changes to the networks as well. At the most fundamental level, the expansion of smaller, decentralised, generation sources requires many more network connections to be made. Allowing these sources to feed power into the grid, and into battery storage, as and when available also makes for a more complex system. Digitalisation allows better monitoring and automation, but accommodating the two-way flow of electricity and the need to balance a more variable generation output with increasing demand, for example the growth of EVs and data centres, requires significantly more resilience to be added to the networks.
This won’t come cheap. In order to support the tripling of renewables capacity, BloombergNEF3 estimates that investments of $4.2 trillion in grids and $1.3 trillion in storage will be needed by 2030. The bulk of this investment will be in China and the US, but even in Europe spending will have to double by 2030, from 2023 levels, and triple by 2040, in order to support net zero by 20504. In Germany, for example, spending on the grid was $13bn in 2023, which will have to rise to over $30bn in 2030 and $41bn in 2040.
The investment in the grids will be borne by far fewer companies than the generation capacity increases, and the impact of grid expansion will be felt across the supply chain too; by 2050, grids will account for 37% of global annual copper demand, up from 16% today5.
How to fund the electricity grid expansion?
Fortunately, regulatory frameworks across Europe allow for a return on incremental investment almost immediately from the point of spending. Unlike power generation projects, which involve lumpy cash outflows and are susceptible to construction risks as well as operational risks of each project, the networks are able to add investment continuously. As the size of the asset base increases so do the regulated revenues, but this is not sufficient to fund the cash investments. Additional debt, and sometimes equity, is required. The pace of network investment is therefore typically bound by companies’ own balance sheets, but also permitting restrictions and grid connection queues; these are increasingly being streamlined in order to unlock accelerated investments.
By earning a predictable return on the assets, regulated grids are able to support more debt, or leverage, than businesses that are exposed to price and volume risk, such as merchant power generators. However, balance sheet discipline is critical to maintaining the solid investment grade ratings needed to support frequent bond issuance. Too much debt-funded capital expenditure can put downward pressure on ratings, leading to companies making use of the investor demand for hybrid bonds, or even raise additional equity.
Generation capacity targets and network expansion plans are developed by companies with reference to national energy policies, so falling short of these targets is more of a problem for governments than it is for the companies involved. For this reason, it is the job of regulators and national governments to provide an environment where companies can earn an appropriate return. Some of the national development plans are so transformational that additional support is required from the government. For example, some of the municipality-owned networks in the Netherlands rely on additional equity from the state to support their capex programmes.
Green bonds, and other ESG-labelled bonds, are also increasingly common-place for grids, given their alignment with EU taxonomy. In fact, it is rare to see a network operator issuing a bond that doesn’t carry an ESG label of some sort. ESG-labelled bonds represent 26% of all euro IG deals issued year to date6. Issuance from utility companies has been 16% of the total but of this, 77% has been in ESG format (also using Nordea data).
BloombergNEF7 estimates that total global spending on the supply side of the energy system will have to reach $79tn to reach the net zero targets of the Paris Agreement by 2050. The majority of this will be directed to renewable energy and nuclear generation, storage, power networks, carbon capture and storage, and hydrogen systems. This equates to $2.9tn per annum on average but is expected to be front-loaded, at $3.6tn pa for 2024-30, before declining to $2.2tn pa in the 2040s.
In time, the changes required to the demand side of the energy transition, specifically the growth of EVs, will far outsize the spending on renewables and networks. However, achieving the 2050 net zero goals will not be possible without today’s investments in the grids. Building out the networks, and improving their flexibility to adapt to growing electricity demand and changes in behaviour, is one of the stepping stones towards a net zero world. Networks are one of the fundamental enablers of the transition that are spending heavily already, and credit investors have an opportunity to be at the forefront.