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Private capital’s place in the Middle East energy transition – JD Supra

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Ambitious plans for renewable energy projects will create long-term opportunities for private funds and sovereign investors in the region, say Ben Ward and Kamar Jaffer. They explore the trends in private markets and what they could mean for the future of energy transition.

When the U.S. Inflation Reduction Act (the IRA) passed in 2022, its tax credit and subsidy provisions unleashed a wave of infrastructure fund investing and fundraising that is already writing a new chapter in the global energy transition.


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That is not only because of the impressive number and size of the solar power, electric vehicle, battery and wind projects to which investors have so far committed, it is also down to the effect the IRA has had on spurring private capital into renewable infrastructure in other parts of the world, and the Middle East in particular. That has been driven by the IRA’s effect in encouraging a greater focus on, and refinement of, energy transition policy in other regions, including the Middle East.

In a region that has long been known for its leading role in fossil fuel development, a renewables revolution is now underway as private capital is being invested into large-scale, technologically sophisticated infrastructure projects, many involving public-private partnerships, and some of them focused on digital assets.

The challenge of delivering the renewable energy solutions required for this are of course daunting but encouraging at the same time – daunting because of the sheer scale of financing required, and encouraging given the technological promise that comes with them.

Such projects are not mere add-ons to the traditional pathway for the region’s energy journey, anticipating the eventual depletion of oil and gas reserves, they represent a new, purposeful down-payment on a permanent renewable energy future for the Middle East as its governments launch landmark nation-building projects aimed at generating the growth drivers of the future.

That is because the region, while still engaged with fossil fuel development, is at the same time highly vulnerable to its own climate change challenges, including rising temperatures combined with humidity, scarcity of water resources, high levels of aridity and long coastlines threatened by rising sea levels.

Indeed, according to the International Energy Agency (IEA), “between 1980 and 2022, temperatures across the Middle East and North Africa (MENA) increased by 0.46°C per decade, well above the world average of 0.18°C”.1

The IEA pointed out that the MENA region is one of the world’s regions “most affected by climate change, imposing challenges on energy systems that are already straining to meet the demands of economic growth, energy security and social welfare”.

“Even as they expand renewables generation to meet rising electricity demand and emission reduction goals, the region’s energy systems will also have to build in more climate resilience to cope with expected increases in climate impacts,” the agency added.

Private capital’s outsized role

The extent of activity in private capital needed for the associated energy transition to help tackle this challenge is hard to overstate. Up to 70% of clean energy investment will need to be made by private developers and financiers, the IEA estimates.2

Much of this is already flowing into the Middle East, as sovereign wealth funds seek partnerships to grow exposure to the energy transition. They are teaming up with government-related entities and, crucially, global private sector funds to boost local and cross-border investment in support of domestic and regional development agendas.

Such global funds have started to arrive in the Middle East in force, bringing a shared interest in energy transition and digitalisation, looking to raise infrastructure funds that often involve “anchor” commitments from sovereign investors.

A big part of this involves increased allocations of big-ticket funding to renewable infrastructure, such as wind, solar and carbon capture and storage.

One of the latest examples of this came in March this year when Rakiza, an infrastructure fund focused on Oman, announced that it had raised USD1 billion for its first investment vehicle.

That came four months after PIF, and U.S. asset manager BlackRock, agreed to jointly explore infrastructure projects in the region. This followed an earlier initiative under which BlackRock has partnered with the Kingdom’s National Development Fund to operate a multi-year infrastructure fund.

There has been an accompanying surge in merger and acquisition (M&A) activity, with a robust pipeline of renewable asset joint ventures and other transactions setting up the market infrastructures required for carbon trading and driving the energy transition.

Data centres and fibre optic cables

Beyond sectors such as solar and wind, one area where we have seen significant ramping up of private capital activity in the last 12-18 months is data centres, backed by regional and sovereign funds.

The explosive growth of applications such as artificial intelligence, combined with countries’ digital ambitions generally, require a corresponding increase in the supply of processing capacity. The region’s policymakers recognise that the region must catch up on data capacity with the U.S., Europe and Asia so that start-ups and larger businesses are able to develop innovative solutions to grow.

Data centre capacity in Egypt, Saudi Arabia and the UAE is forecast to more than double over the next two years, with improved data protection laws and subsea cable connectivity driving activity. Analysts at real estate company CBRE say the data centre capacity of these three markets is estimated to total around 336MW but is expected to grow to 707MW by 2025. Saudi Arabia and the UAE are expected to add the bulk of the additional capacity.

Much of this is being driven by the development of so called smart and sustainable cities, where technology — such as digital solutions to make older buildings greener or electric bus charging infrastructure — is helping the decarbonisation journey.

In Dubai, for example, smart city initiatives have been underway since 2021, with the city ranked, along with Abu Dhabi, among the top 20 in the latest global Smart Cities Index published by IMD, the Swiss-based executive business school.

Yet there is legitimate ongoing debate about the balance between the utility of data centres in providing computing power and the impact they may have on countries’ Net Zero targets given that they are highly energy intensive.

A report by Arizton predicts that the market for green data centres, which use less energy and emit less carbon, will expand by 15% annually in the Middle East and Africa from 2021 to 2027. Industry players in the region have found ways to make their data centres more eco-friendly. For example, Khazna teamed up with Emerge, a joint venture of Masdar and EDF, to build a solar power plant that will supply renewable energy for Khazna’s data centre expansion in Masdar City. Khazna also uses pre-cooling and free cooling techniques to reduce its dependence on conventional cooling systems and cut down its carbon footprint.

As a result, investment and interest are both growing from a mix of international technology, infrastructure and real estate fund investors looking to capitalise on the region’s increasing need for data processing, storage and cloud computing whilst providing access to greener digital solutions.

The next frontier beyond data centres may be fibre optic cables, based on our conversations with funds and industry players. One of the main sustainability advantages of fibre optics is its low energy consumption levels. A number of funds in Europe and the U.S. are already investing in fibre optics amid a focus on building out cable connectivity across continents in order to be able to handle burgeoning data traffic. The Middle East looks set to be next, as the region ramps up fibre transformation as 5G networks proliferate amid the smart city trend and this also has wider sustainability benefits.

Funding formulas and structures look set for evolution as the landscape shifts.

Environmental, social and governance

ESG factors remain at the top of the agenda and a key area of concern in the Middle East. Many investors have made ESG part of their investment policies, with specific ESG policies relating to private market allocations. We are seeing increasing demand and opportunities for investing in climate change, renewable energy/energy efficiency and clean technology.

Early-stage investments

With competition for assets intensifying and with most targeted projects developed to some extent, there are early signs of discussions among some funds of going after energy transition opportunities at an earlier stage in the development cycle and setting up funds to invest in early-stage assets. This could include setting up a single asset funded around one renewable or green project, and maybe at a future date transferring that asset, once it is developed, into an infrastructure fund.

Rise of debt financing

Private debt has taken off since the 2008 financial crisis, although private debt fundraising slowed down in 2022. Most of the transaction activity in energy transition in the Middle East tends to be equity co-financed, involving sovereigns and private funds. Our sense of the market is that we could see interest in infrastructure debt funds that provide financing for renewable energy projects, as has happened in the U.S. and Europe.

Changing behaviours by sovereign investors

We see the potential for increased allocation into infrastructure joint ventures directly, and possibly alongside other co-investors that may not be funds, so that participation is across the whole lifecycle of an asset. This means sovereigns would have exposure to specific assets in addition to the fund exposure they have.

Footnotes

1. https://www.iea.org/commentaries/climate-resilience-is-key-to-energy-transitions-in-the-middle-east-and-north-africa
2. IEA, The cost of capital in clean energy transitions, 17 December 2021. Available here.

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