Globally, are the investors becoming climate conscious?

- The change in investments of PE’s & VC’s post Paris

Climate Agreement globally vs the change in India

Submitted in partial fulfilment of the requirements of the course

Managing Energy Business

Submitted to

Instructor: Prof. Amit Garg

Associate: Ms. Manju Bhati

By

Group 2

Akshay Mehndiratta | Dhanya Vijayasarathy |

Garima Mundra | Ganesh Mahidhar | Karan Ratnam |

INDIAN INSTITUTE OF MANAGEMENT, AHMEDABAD

Introduction

With an all-time high Assets Under Management of over $6.5 trillion, the private investment
space, both in the PE and the VC sector has become a critical funding source as compared to
the traditional public market route. Having gained prominence from the start of the 21st
Century, private capital has recorded a growth which is eight-fold, outpacing public market
performance significantly. (Chart 1). This, in addition to the large AUM that these firms
control make them a key factor in deciding the flow of money across industries and firms,
thus making them a key decision maker in the operation of firms. The presence of top level
talent and managing capabilities in these firms also have led to development of significant
innovation capabilities, thus leading to improvements in the target firms, while
simultaneously creating value for the limited partners in the deal.

Cha
rt 1: PE companies value growth

With a trend of private debt, provided by these firms being on the decline (Chart 2), PEs are
become more and more involved with the corporate governance and decision making of
companies, with an increased focus on the managerial capabilities of the firm as opposed to
merely their asset performance. This increased participation in the corporate governance of
companies gains more and more prominence in deciding the methods of operations of
different companies and the industry overall. Other trends in the space, that of increasing
digital capabilities with PE firms, and the utilization of the same in making investment
decisions has also turned to be significantly positive in the last year. These digital capabilities
have also partly contributed to the rise of size of deals, with mega funds of $5billion or more
dominating buyout fundraising. This ability to digitize has also brought about a shift in
perspective, enabling PE firms to look at technology as not a vertical to invest in but as a
horizontal capability that can be established across industries. This, in combination with the
wave of digital technologies aimed at improving efficiencies makes investment flows into
energy-based businesses all the more important as a guiding force in deciding the course of
the industry. Being a high asset based industry, with growing investing power and higher deal
sizes have helped PE and VC firms globally to concentrate on making investments basis the
Environmental, Sustainability and Governance in various firms. However, using
sustainability as a measure of investability is a trend that has started only recently. Firms have
started.to diversify into energy sectors, with over 89 PE firms who have invested in
renewable energy businesses since 2015. The return on an average has been about 50% from
2015, pegging energy investments as attractive asset backed low risk investments, which gain
further importance in the midst of an economic downturn. These bludgeoning trends are a
part of a larger movement towards sustainability that has taken over the world, and the energy
sector in particular. In this context, it becomes essential to understand the impact of
regulations on the way business has been conducted post the Paris Climate Change
Agreement.

Chart 2: Private Debt Funding

Chart 3: PE/VC Investments globally
Paris Climate Agreement and Impact on Businesses

The Paris Climate Agreement is considered a milestone in the history of International climate
policies. What set it apart was its call for participation and action by governments of both
developed and underdeveloped nations on an equal level. With a clear set agenda of cutting
down carbon emissions to stop the global average temperature from rising. The agreement, a
first of its kind recognized the importance of climate finance and demanded shifting of
financial flows towards low carbon and climate friendly investments. The need for private
sector buy-in to make significant impact was recognized and clear policy signals for
businesses and investors to make low emission investments through project finances or new
technology investments were brought to the forefront. Investors were seen lined up with
billions of USD towards new financial commitments, over and beyond the promised
contributions by developed nations.

The summit also witnessed many industrial and business leaders, actively committed to the
cause of climate change and ready to pump in the required resources and money to help
mitigate the risk. CEO’s from a wide variety of sectors and industries: transportation, cement,
energy, consumer goods actively shared their commitment to reducing carbon footprints,
improving natural resources management, investing in and adapting renewable energy
resources. The business leaders were univocal in demanding a level playing field globally.
There is a need for removal of fossil fuel subsidies, introduction of carbon pricing, and other
systemic changes, incentives and regulations to motivate the companies.
At the summit over 1000 companies joined the Carbon Pricing Leadership Coalition.
Companies from diverse sectors like BP, Statoil in energy sector, Unilever and Mars in
consumer goods, emerging giants like Cemex, Braskem and Mahindra Group called for
carbon pricing. A study by We Mean Business found that companies are achieving an
average IRR of 27 percent on low-carbon investments. At the time of the summit,
institutional investors with over $3 trillions of assets had divested from fossil fuels in their
portfolios.

In line with the Paris Agreement, each country has formed its National Climate Plans and are
formulating their policies to move towards a low carbon economy basis their economic
development, available resources, existing policies and infrastructure. There is a push across
countries to increase renewable energy for domestic consumption and investments in these
areas are extraordinary opportunities for private players. While the increase in consumption
of fossil fuels has been on the rise for a few years, the steady decline is also certain. Dabbling
between energy supply and demand to cut down emissions, transport, industry and buildings
seem to be the most important sectors across countries.

Building sector uses 1/3rd of the energy worldwide and thus is a highlight in roughly half of
the National Climate Plans. It's an attractive investment sector for incremental rise in real
estate value and energy cost savings. High efficiency standards for designs and operations
and construction codes are being implemented across nations.
Industries as a sector globally account for over 15% of the direct energy led CO2 emissions.
Change in production plans and methods, disruptive innovations, improving technologies and
research to reduce the emissions will be key change factors across industries. High emission
industries will be on the lookout for carbon capture and storage technology.
Transport sector globally accounts for 23% of energy-related CO2 emissions and thus over
70% of national climate plans include transport targets. Policy changes and plans for cleaner
fossil fuels, alternate fuels, electric vehicles, fuel efficiency etc are on the agenda.
Investments in these areas by companies are on rise and seem to be a high potential
opportunity.
In the context of these various changes, it becomes paramount to understand how Private
Funds have changed their modes of operation to reflect this paradigm shift in business.
Owing to greater public awareness and pressure on corporates, and the popularity of the triple
bottom line reporting increasingly being adopted by companies, ESG policies have emerged
as the basic criterion indicative of a company’s responsibility to the environment.
Sustainability along with transparency is the new trend, which is a response to the increasing
public scrutiny and power to take collective action. In fact, this has been taken up by private
market firms as an indicator of performance as well, with nine of the ten largest firms
reporting their records on ESG compliance. Companies have also begun creating designations
like ‘chief sustainability officers’ and ‘ESG global head’ to ensure they are prioritised and
followed. In 2013, a survey conducted by PwC, ‘Putting a price on value’ revealed that ‘62%
of portfolio companies regularly report on ESG to their board and 88% formally report on
ESG to the PE firm itself’.

ESG factors have now translated into an essential filtering mechanism employed by PE/VC
companies, as it has been observed to have a strong correlation with financial performance of
a company. Therefore, investing in companies that display a strong ESG performance
indicates that it is likely to do well in the future, making it a sound investment prospect. This
could act as a dual filter for PE/VC firms coming to making investments. The importance of
ESG affects valuation of companies, which might allow cheap acquisitions for those who rate
low on ESG compliance or do not have any evidence of ESG integration in their policies.
This presents an opportunity for PE firms to turn its focus around and improve its
performance multifold by integrating ESG principles in its end to end processes.

Impact investing has also emerged as a popular practise among investors, where spurred by
the mission of creating a positive ‘impact’, they dedicate funds towards institutions who have
ESG principles built into their core. Six of the largest PE firms have committed to relay over
$9 billion into their ‘impact’ portfolio, where before 2017 there was no such formal
announcement of the same.
Apart from investor pressure, risk management is also a key factor that comes into place
while focusing on ESG principles. Without its integration, decision-making within a
company is very unidimensional, which might lead to disasters at a later point in time, as seen
in the case of PG&E wildfires. ESG is important from a long term sustainability and
existence point of view, which is showing increased traction among investors across the
world.

In light of these reports on emerging trends, the preliminary secondary research showed a
trend towards significant shifts in investments to more sustainable businesses. However, there
is a lack of literature in the analysis of data to corroborate the same. This gap in available
literature is the one that the group intends to fill through this project.
Methodology
1. Data Extraction: Through Bloomberg, we extracted data regarding the PE/VC
investments made globally over the past six years, i.e. 2013-2019, to get a total of 85000+
deals
2. Data Sorting:
a. Country Wise: We filtered the data to get over 4000+ investments made in India
b. Category Segmentation: We sorted the deals into four categories (Full details
Excel File) i.e.
 Category 1: Carbon Emitting 
o It comprises those industries and products that cause a negative impact
on the environments. They adversely affect climate change
o E.g., Infrastructure, Engineering, Mining, Auto etc.
 Category 2: Carbon Positive
o It comprises the industries and products that help in tackling climate
change. These industries help mitigate climate change by helping to
reduce greenhouse gas emission or reduce energy consumption etc.
o E.g. Wind, Solar Energy etc
 Category 3: Carbon Neutral
o It comprises the industries that neither affect climate change nor are
much affected by it
o E.g. Service Industry, Banking, Analytics, etc
 Category 4: Indirectly Impacted by Climate change
o It comprises of those products and industries which are vulnerable to
climate change, and they themselves can be an indirect cause to
climate change
o E.g. Agriculture, Food etc

As some data points were missing in a few investments, Python was used to sort the data into
an analysable form on excel.
Analysis

Analysis 1: PE/VC Investments in India: We are not going green!

When we analysed the trends of the 4000+ PE/VC investments made in India, the following
were our key takeaways:
 There was a slight decrease in Category 4 investments (7 to 3%), which shows some
promise.
 There was negligible change in Category 2 Investments, i.e. Carbon Positive, which is
in direct contrast with the PwC survey results (Exhibit 1), which indicates a
heightened concern about climate change by PE/VC investing in India.
 Coincidently and Surprisingly, there has been an increase in the percentage of
investment that is being made in Carbon Negative firms in 2019 vis-a-vis 2016. What
is alarming is the fact that is has been a gradual increase from 21% to 30% and a one-
off incident due to some major deal, (like Amarco's investment in Reliance)

Thus we moved forward to analyse the trends on a global landscape.

Analysis 2: PE/VC Investments Globally: Slight shift pro climate change
The analysis of the trends of global PE/VC investments over the past six years totalling over
2+ trillion dollars and 85000+ investments resulted in the following:
 Category 1 i.e. Carbon Emitting investments have seen a fall, particularly in the last
three quarters. However, we still did not see any rise in the Carbon Positive
Investments, with Carbon Neutral Investments compensating for the fall in the Carbon
Emitting Investments
 The Global Scenario contradicts the results of the Indian scenario but is evidence of
the statements made by PE/VC globally the investments are increasingly being made
in a climate-conscious manner

Analysis 3: PE/VC Investments In Energy: Sudden Shift pro climate change

As the Energy sector is the prime contributor to climate change, we narrowed down our focus
on PE/VC investments in the energy sector, globally. We divided the investments into
alternate and non-alternate sources of energy.
The results of which are as follows:
  As seen in the graph above, there is a significant rise in investments in alternate
sources of energy, which rose from 60.02% (at the time of the Paris Climate Change
Agreement) to 75.31%.
 The major shift occurring in the past three quarters, which mirrors the overall
investment trend in the global scenario

Analysis 4: Country-Specific Energy Investments: Europe is the quickest adopter of

Climate Change
We filtered the countries on the basis of those that had made at least ten deals a month, i.e. 30
deals a quarter (so that the analysis is statistically significant). The study resulted in the
following takeaways:
 USA: There has been a late shift in the adoption of the Paris Climate Agreement,
witnessed in the last 3-4 quarters, similar to the trends seen in the energy and the
global scenario
 Canada & UK: There has been an immediate shift towards investments in alternate
sources of energy post-Paris Climate Change Agreement. 
 India & France: For the past six years, most of the investments in the energy sector
in India and France have been in Alternate Sources of Energy

Hence we can safely conclude that India & France have been early proponents investments in
alternate sources of energy. Canada & UK are driving the shift in investment mindset post the
adoption of the Paris Climate Agreement and the US has been a late adopter.

Rationale for Trends

A recurring theme of a switch to being climate-conscious has been seen in the past three-four
quarters in the overall global scenario in the energy space and especially in the USA, a
country that drives a significant chunk of the deals across the globe.
Initially, we felt that there is a significant lag when it comes to the impact of the agreement
on the investments. However, delving deeper, we found out that the return to the investors
from the energy sector has reduced significantly. Combining that with the recent volatility in
price and long term supply-demand mismatch, investors are shifting away from traditional
investments in energy. The hypothesis is backed by the research by IHS Markit published on
CNBC
Research by the Global Commission on adaption indicates that $1.8 trillion in investments in
climate change could result in net benefits of over $7 trillion. With a cumulative surplus of
$1.5 trillion and more money to be raised, though risky, investments in climate change and
alternate sources of energy is a mouth-watering prospect for PE/VC, and that is the reason
why we believe there has been a recent uptick in investments in alternative resources.
On a country level, the Bloomberg NEF Report also confirms the evidence that our analysis
presents, i.e. European countries are and will decarbonise the fastest with the US playing
catchup.
Exhibit

Exhibit 1: PwC Survey Results

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