Energy transition: A roadmap to successfully attracting institutional investors

By Rob Nicholson and Greg Heath
Published September 8, 2022 | 6 min read

What are the ingredients necessary to win over global financial investors and how will these same investors evaluate these opportunities?

Over the next decade and beyond, governments and companies large and small will accelerate their energy transition efforts in a collective undertaking to reach global decarbonization goals.

With natural gas, oil and coal comprising roughly 80 percent of the total energy supply in 20191, groundbreaking opportunities for radical change are still ahead. Turning innovative decarbonization and clean energy ideas into tangible, lasting, real world solutions, however, requires capital.

Energy demand over the past four decades has grown around 1.75 percent annually. While oil demand is expected to rise by 0.5 percent and natural gas by 1.3 percent annually, renewable energy consumption is forecast to lead growth with a 3.2 percent annual increase between 2020 and 20502. This global transition to net zero will be capital intensive, with one estimate projecting the journey will require US$100 trillion in capital investment, or more3. To put that amount into context, that’s more than five times the U.S. GDP in 2020.

After a slow start following the Paris Agreement in 2015, renewable energy investment has accelerated sharply in the last two years. China was by far the most active in 2021, pouring US$266 billion into the clean energy sector, but the US is escalating rapidly too, deploying US$114 billion.

Overall, global investment in energy transition reached US$920 billion in 2021 involving roughly 2,800 transactions, with renewables and electrified transport accounting for the majority of deals. More than half of the total amount invested in 2021 flowed to seed and early stage investments, highlighting the fact that technologies and decarbonization projects required for this monumental transition generally remain immature. At the same time, 2021 notably also saw a marked jump in energy transition mergers and acquisitions activity, led by traditional oil and gas producers. The past year saw approximately US$12 billion in M&A activity globally from E&Ps, a three times jump from previous levels of activity. Oil and gas producers are and continue to be some of the most active strategic investors in decarbonization technologies as they proactively position for a global need for less carbon-intensive energy.

In 2021 IPOs, SPAC, and de-SPAC transactions that took advantage of record high valuations and investor momentum dominated the landscape. 2022 is proving to be a year of moderation, with more disciplined perspectives on valuation as the market looks to corporate growth with some significant macro-economic headwinds including inflation concerns, and rising interest rates and geopolitical challenges including the war in Ukraine.

Hundreds of technology companies have emerged with innovative decarbonization and energy transition solutions, but many are not yet prepared for institutional investment. How does a new company know if the timing is right to access institutional capital? What are the ingredients necessary to win over global financial investors and how will these same investors evaluate these opportunities?

 

Ingredients for a compelling proposal

There is a checklist of half a dozen key components a company should have as they deliberate whether they are primed to seek capital from institutional investors.

The first important consideration is whether the idea has been technically proven through an in-field demonstration or has reached the pilot stage. In other words, institutional investors are, at a minimum, looking for ventures that are on the cusp of becoming commercialized.

Potential market size is the next factor that should be assessed. What is the total addressable market expected for the business opportunity? Institutional investors want to see broad applicability of a project or technology. If there is a sizable opportunity, the company should articulate clearly what the pipeline of commercial possibilities are in the coming years to demonstrate the technology’s longevity and how widely the solution can be applied.

Investors also want to see how the technology or solution in question is superior over other potential options. How can it solve a problem better or more completely? Does it offer multiple advantages while still meeting economic criteria? Is there a clear path to profitability? The more explicitly clear the benefits are, the better.

Take carbon capture. Securing 100 percent of all carbon emissions is impossible, but it is still a global problem requiring ambitious and unique ideas. In recent years much effort has been focused on point source emissions, managing a concentrated stream of carbon, but some sources are extremely difficult to treat at their origin. Airplane exhaust, for example, is spread across many different jurisdictions. Adding weight at the source would not be constructive or practical from an aeronautical design and aircraft operations perspective, therefore an alternative solution may be more appropriate.  Direct air capture (DAC) - where low concentrations of carbon but a high volume of air is processed - may be a much better methodology to address emissions in the aviation industry.

In addition, the most common and established carbon capture technologies are liquid-based capture solutions that use a substantial amount of energy and can often require significant up-front costs to retrofit and install. Innovative, next generation methods that are more cost-effective and require significantly less energy could revolutionize carbon capture and make it more easily deployable across a broader array of point source and direct air capture applications.

Next on the checklist is having the technical and commercial endorsement of a strategic partner that has invested time and financial resources into the technology. Strategic partners play an important role in de-risking technologies and providing technical endorsement, which can improve the confidence of institutional investors.

Finally, institutional investors want to see businesses that are not overly reliant on government subsidies or the development of government policy as a condition toward the success of their initiative.

Ventures that meet these criteria have the greatest chance of appealing to institutional capital. The best candidates have raised seed money, secured venture capital funding, completed both bench scale and field testing, and found a strategic partner to move from concept to commerciality. Earlier stage ventures that may have yet to achieve all of these criteria are likely to be candidates better suited for non-dilutive financing, strategic investors, or venture capital funding.

 

Thinking like an investor

Does missing one ingredient automatically disqualify a company from consideration by institutional investors? The answer is not always clearcut and will likely depend on the size or scale of the missing component. Fund managers will need to ask themselves whether it is a fatal flaw, or a risk or uncertainty that they can accept.

When fund managers explore energy transition opportunities, they do so in a very methodical, top-down manner and try to answer a number of essential questions. Ultimately, these investors want to see evidence that the venture presents a clear path to profitability.

Investors start with the big picture and the data. They want answers to questions around the rate of technology adoption and the financial incentives necessary to reach that adoption rate, for example. Do logical financial drivers exist within the industry to push decarbonization?

What is the “moat” around the technology? In other words, how will the company protect this technology? Determining the scale of the opportunity and the factors that will protect their investment are critical considerations from an investment point of view. Part of that involves ascertaining whether the technology or commercial model being considered for investment is the best solution for the market as well as examining issues including the patents involved.

On the flip side, what are the barriers for other companies to supersede the original idea being pitched? Investors want to know the strength and legitimacy of the pipeline of commercial opportunities, as well as the regulatory hurdles that may exist. Is the value compelling enough relative to the risks involved and the timeline to anticipated liquidity?

 

The opportunity

A record $920 billion was invested specifically in the global energy transition space in 2021, and tens of trillions more will be invested in the years to come as investors focus on decarbonization and growth. This is an unprecedented opportunity for businesses to stand out as problem solvers with innovative, transformative ideas. How does your company compare with what investors are seeking? For businesses armed with the ingredients needed to take the next step, global institutional investors are waiting.

RBC’s energy transition expertise and capabilities

As one of the world’s largest banks in energy and infrastructure finance, RBC Capital Markets has deep knowledge of the energy sector and is well positioned to assist companies through the many stages in the life cycle of development, from earlier stage opportunities looking for strategic partnerships to becoming a publicly traded company. RBC’s expertise is an invaluable asset for established technologies and commercial models looking to raise private capital with institutional investors. We advise clients on the rapidly evolving energy transition mergers and acquisitions market and can support clients through all their banking and financing needs, including access to public debt markets. When clients outgrow private capital markets, we also have the capacity to lead companies through the transition to public equity markets.


1 Canadian Oil & Gas ESG Scorecard

2 The New Climate Bargain: How Canada Can Manage Energy & Environmental Security

3 Global Financial Markets Association (GFMA) and Boston Consulting Group’s (BCG) report titled “Climate Finance Markets and the Real Economy”, dated December 2020


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Rob Nicholson

Rob Nicholson
Head, Renewables and Energy Transition, Canadian Power, Utilities & Infrastructure


Greg Heath

Greg Heath
Head, North American Project Advisory & Finance and Canadian Exploration & Production


Energy TransitionInstitutional Investors