Why energy efficiency is both a risk and a win-win opportunity for private equity

Rarely in the investment industry do the stars align behind a value creation concept that has clear economic, environmental and business security benefits, writes Triton Partners' Ashim Paun.

Europe’s energy ‘supply shock’ of 2022 and the subsequent surge in costs for consumers and corporates has highlighted energy supply as a key business risk. Ensuring energy security is more critical than ever. Yet, fossil fuels still account for 68 percent of primary energy in Europe, much of it imported, and 80 percent globally. Fossil fuels remain relatively expensive and experience ongoing price volatility, plus they are difficult to store in large quantities. Reducing energy consumption – ie, achieving greater efficiency – is therefore of paramount importance.

More recent, geopolitically-driven challenges have been intersecting with long-term drivers arising from the climate crisis and the need to decarbonise – creating the conditions for energy efficiency to become both an integral means of value creation and an investable theme for private equity investors and their portfolio companies.

For private equity managers, investing in energy efficiency across their portfolio represents a rare ‘win-win’ – cutting energy use without compromising economic performance has both financial and environmental benefits. However, there is an additional opportunity for GPs – investing in companies that offer energy-efficient products and services themselves. Energy efficiency is then an investable theme; a means of creating value from the top to the bottom lines, which agile private equity firms are navigating simultaneously.

While some energy-intensive sectors are clearly more exposed than others, rising energy prices in recent quarters, especially for natural gas and electricity, have almost universally increased the cost base of private equity portfolios.

However, by embracing more efficient technologies, companies are protecting themselves from both short-term volatility and long-term climate-related risk. Even for the most cost-of-capital-focused investment teams, the economics of investing in energy efficiency have rarely offered such rapid payback times, while regulatory catalysts continue to accelerate.

How does this all manifest in practice? Our focus at Triton has largely been on the buildings and commercial premises of our portfolio companies, which are major consumers. A manufacturing business, which we exited last month, was able to reduce its electricity consumption by 73 percent and heating fuel consumption by 65 percent per square metre by moving to a new headquarters and production facility with more efficient features. These included efficient insulation in the building, double glazing, centrally controlled air conditioning in all offices, production that utilises heat recovery and energy-saving lamps.

Transport and mobility are also a key focus area for energy efficiency and decarbonisation ambitions – for example, transitioning to electric and hybrid fleets of vehicles and ships. Another Triton portfolio company, operating in ocean services, has started to install battery-powered hybrid systems in its vessels in 2020 – one-third of the fleet now operate a hybrid battery pack, reducing CO2 emissions by 16 percent. Overall earnings at the company, which have potential upside exposure to energy prices, are up more than 30 percent for the year. Economic gains and environmental benefits need not compete against one another.

In addition to seeing energy efficiency as a win-win means of value creation, some private equity firms are also investing behind such solutions, backing innovative businesses that offer technologies and products that help their customers become more energy efficient. Sustainability trends are now well embedded, and we believe businesses in industrial technologies, installation and maintenance services, and consumer choices for the homes of the future, will grow even more attractive as corporates increasingly prioritise energy efficiency and security.

Providers of energy efficient technologies can take many forms. Lighting, which contributes to 15-20 percent of the world’s total electricity consumption, can present an easy win. We invested in a Norwegian lighting manufacturer and supplier in 2017, growing revenues 30 percent since this date. The business provides smart luminaries and lighting control systems to customers across land and sea, from commercial and industrial buildings to cruise ships and offshore wind farms. Smart sensors and monitoring features offered by the company create automated, artificial light only when needed, typically reducing light energy consumption by up to 90 percent.

Rarely in the investment industry do the stars align behind a value creation concept that has clear economic, environmental and business security benefits. With sustainability trends further backed by regulatory headwinds – there have been more than 170 mandatory regulations regarding energy efficiency passed in the last decade across the EU alone – there seems little doubt that energy efficiency will become an even greater consideration for investors, across private and public markets alike, in the years ahead.

Ashim Paun is head of sustainable investing at European investment firm Triton Partners. He was previously global co-head of ESG Research at HSBC