The expected returns of green power investments are now much lower than they used to be. As a result, realised returns should not be used directly as a proxy of the future performance of green power investments.
In a new research publication on the realised and expected financial performance of green power infrastructure investment, entitled "The Pricing of Green Infrastructure," Noël Amenc, PhD, Associate Professor of Finance at EDHEC Business School, and Frédéric Blanc-Brude, PhD, Director of EDHEC Infrastructure Institute, examine the impact on realised performance of a permanent shift in investor preferences for low carbon energy investments, and how it relates to the expected returns of green power investments.
The authors show that while green infrastructure has outperformed the ‘Core’ infrastructure market over the past decade, this is largely the result of temporary excess demand for such assets that has pushed asset prices up and discount rates down. Controlling for a number of risk factors that are present in the returns of unlisted infrastructure equity investment, there is no persistent ‘green’ risk factor premium from which investors in green infrastructure projects might benefit over the long term, but instead a ‘green price premium’ that investors have been willing to pay to increase their holdings of such assets.
Professor Frédéric Blanc-Brude said, "In 2011, green power projects had expected returns of ~8% and brown power projects ~9%. Their 10-year annualised total returns in 2021 were 16% and 17% respectively. These two figures may seem related but correspond in fact to very different economic fundamentals. We show that the high historical performance of green power is explained by a significant compression in yields (expected returns) especially between 2012 and 2015 and the corresponding capital gains. Conversely, the performance of brown power was more driven by cash returns and less by yield compression. In effect, unlike other infrastructure investments, brown power investments have seen a slight increase in their expected returns since 2018. Hence, we find that the impact on performance of such shifts in the demand for green and brown investments cannot be equated with the appearance of a new ‘green’ asset pricing risk factor. Instead, demand shocks have led to relatively high realised performance in the green power market but also lower expected returns."
Professor Noël Amenc added, "Going forward, as excess demand for green power investments is gradually met with additional supply of green power assets and effective allocations to green power become significant, our findings suggest that both the realised and expected returns of green power investments can be expected to converge. Such a convergence, which reflects a long-term pricing equilibrium, leads us to conclude that there is no reason for superior performance by green infrastructure investments to continue. The so-called “green premium” observed in the past does not correspond to the remuneration of a superior risk factor but instead to a temporary phenomenon of excess demand, which the supply side of the market eventually satisfied."
The research publication can be accessed here:
The Pricing of Green Infrastructure, EDHECinfra Publication, September 2022.
EDHECinfra will be holding a 1-hour webinar on October 4 to discuss this research publication. To register, please click on the link below:
WEBINAR Do Greener and More Sustainable Investments Outperform? October 04, 2022, 9.00am in London.
