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IEEFA: Private equity, part of the fossil fuel problem, can play a role in its solution

December 08, 2021
Tom Sanzillo and Suzanne Mattei

How can private equity financing be utilized as a tool for climate solutions?

Over the last few weeks, the problem of how private equity (PE) financiers are contributing to some of the worst aspects of climate-destroying investments has become clear at the macro level, with a Private Equity Stakeholder Project report on investments by 10 of the world’s largest asset managers, and at the micro level, with IEEFA’s analysis of the Gavin coal-fired power plant in Ohio. Most of the prestigious names in the private equity industry—KKR, Blackstone, Warburg Pincus and TPG Capital—continue to cultivate a portfolio of oil, gas and coal assets that plainly contradict the emerging consensus in global capital markets of the need to move away from fossil fuels and toward sustainable investments. 

Why are these firms still interested in coal, oil and gas assets? Most market watchers know that oil and gas stocks have fallen from investor confidence for decades. But PE funds often follow the losers and squeeze whatever is left of value. They pay little attention to the consequences beyond the investment envelope and timing of the exit strategy, planet be damned. To date, none of the major private equity funds—KKR, Apollo, Blackstone, TPG and Carlyle—have signed on to the UN-sponsored Global Finance Alliance for Net Zero, which now accounts for a staggering $130 trillion of collective assets.

PE funds often follow the losers and squeeze whatever is left of value

From a strictly financial perspective, this approach toward fossil fuels and toward the rest of the economy has proven successful enough to keep PE managers on the “stay in touch” list of most institutional fund managers. No fund manager is in a position to ignore an investment strategy with meaningful returns. For institutional managers, private equity makes significant contributions to the bottom lines of foundations, pension funds and other trusts. For public pension funds, that means keeping taxes down, public workers employed and critically important payments to retirees flowing into local and state economies that depend on retiree populations. 

To workers who rely on power plants that could close next month, the PE investments are the difference between employment and unemployment. In Ohio, the PE investors are keeping Gavin, one of the last remaining coal-fired power plants in the state, open—despite the fact that it should be closed for both financial and environmental reasons. They’re also keeping mine employees and utility workers who keep the plant running on the job, which is important since there’s no new energy investment in that part of Ohio (or much investment at all). 

To understand the extent of the contradictions of the energy transition, consider the case of Apollo Global Management. The company made headlines in November for two very different reasons: It was cited as one of the many PE firms refusing to join the Glasgow Financial Alliance for Net Zero (GFANZ), a coalition of leading financial firms.  At the same time, Apollo also agreed to invest as much as $400 million in Broad Reach Power, one of a growing number of battery storage providers in the U.S. that will play a key role in the transition away from fossil fuels. 

The example underscores the point that not everything the private equity sector does is destructive to the climate. And the sector’s ability to take risks beyond what would be palatable for the stock market means it can play an important role in spurring new projects and technologies.

Many PE funds invested in renewable energy when such investments were far too risky for the stock market. Brookfield Renewable Partners, for example, has two decades of very successful involvement in the renewables market. But we also need to watch that PE exit strategies do not eviscerate the initial progress they made. Poorly designed asset transactions can crush a strong operating system under a mountain of debt for new owners. 

Not everything the private equity sector does is destructive to the climate

A more complex use of PE money—and one that is tougher to analyze from a climate perspective—involves investing in oil and gas drilling while promising to invest profits into forward-looking energy projects. This will mean shutting down depleted coal, oil and gas assets responsibly. Do these investments make a constructive contribution to emissions reduction? The jury is out. 

Two energy economies—one based on fossil fuels and one based on renewables and sustainability—are now in competition worldwide for market share, political benefits and the hearts and minds of the public. At a systemic level, however, the two economies are still working together to supply electricity, transportation, materials and power for communities and industry. 

The interplay of the two economies will be the stuff to watch in the coming decades.  

Even the PE funds spin doctors are running into themselves when trying to make the contradictions coherent. New Private Markets, an industry trade publication, recently interviewed 10 PE companies that had invested in fossil fuels. Most said they were on their way out of fossil fuels and some explained that they had renewable energy funds (while failing to mention or not admitting the publicly known fact that they were wedded to fossil fuels).  Some told the truth; others offered spin.  

What should investors and private equity funds do now?

Pension funds, institutional funds and others must make it clear to private equity funds that they want to know what fossil fuel investments the PE funds currently hold. Right now, there is little transparency for the public, and many institutional funds (customers of the PE industry) are left exposed.  A clear path forward for the private equity industry would include:

  •  No new investments for fossil fuels;
  • A detailed disclosure of current fossil fuel holdings; and
  •  A plan that specifies how they aim to exit from these positions, including scope, benchmarks, timing and plans for doing so while continuing to meet  financial targets; 

The PE industry has historically been secretive, a  tendency that will redound to its detriment in addressing the climate issue. Although we recognize that institutional funds must press PE managers to act responsibly, the wise PE fund would do well to be forward-looking without prompting from clients.  The PE companies that take the lead can expect benefits as others look to replicate their success. An upward spiral of progress can be attained, offsetting the negative repercussions of fossil fuel investments. The two energy economies really is a story of one being born and one dying.  The PE industry can play a critically important role in hastening the transition.

 

Tom Sanzillo (tsanzillo@ieefa.org) is IEEFA director of financial analysis.

Suzanne Mattei (smattei@ieefa.org) is an IEEFA energy policy analyst.

 

Related items:

IEEFA. BlackRock has moved rapidly on climate—but Adani exposures remain a major obstacle

IEEFA India. Renewable energy sector could attract a flood of global capital to meet climate targets

IEEFA. Pension Funds Investing Indirectly in Ohio’s Gavin Coal Plant Are at Risk as Financial Environmental Disadvantages Mount

Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures. He also examines such areas as community and shareholder activism, institutional investment, public subsidies and Puerto Rico’s energy economics.

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Suzanne Mattei

Suzanne Mattei is an attorney with over 30 years of experience in public interest law and policy. She has analyzed the Federal Energy Regulatory Commission’s policies related to interstate pipeline approval. She has also conducted research on blue hydrogen, petrochemical projects, gas flaring and fossil fuel extraction on public lands.

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