Technology and big data will change how electric grids are organized and water is transported, creating upside for sustainable investors that may not be priced in today, says Lara Banks, a managing director at Makena Capital Management, which oversees about $19 billion.
Banks, who oversees portfolio management and manager selection for natural resources at the Menlo Park, California-based firm spoke to Emily Chasan on Nov. 6. Comments have been edited and condensed.
Q: How are you looking at natural resources opportunities now?
A: The investors in the portfolio are often endowments and foundations, so that gives us the flexibility to look at opportunities that will generate returns over the next 10 to 15 years. We still think there’s opportunity in traditional energy, but we have some investors who would rather not invest in the oil-and-gas space, so we’ve bifurcated the portfolio into traditional and sustainable natural resources. We expect the sustainable allocation to grow over time.
Nobody really knows how this energy transition is all going to play out. There are so many pieces, some people are waiting a little to see how they fall. But we already see a big shift in what’s happening with oil, coal hasn’t been a good place for returns, and renewables are going to be a key growth driver. Our portfolio is more focused on the U.S., but we invest across the world, and China and India are going to be really important also.
Q: As costs come down how are margins in renewables affected?
A: We haven’t been investing in manufacturers of solar panels, which are facing a lot of pressure. We look more at the renewable power development side. Even there, returns have come down because a lot of capital is looking for renewables. But since we’re looking at energy infrastructure and the value of these assets over the long term, you can look past the day-to-day of what happens at SunEdison or the issues with yieldcos.
For example, we can think about what happens if you add a battery to a solar plant, even if you can’t add it yet. Right now, there are some corporate buyers that are willing to pay more to access solar power with batteries during the evening, so you can see the value they bring. You don’t pay for that today, but that technology gives you upside you wouldn’t be able to have if you were just holding assets for a two-year period.
Q: Are there other renewables where you see tech playing a role?
A: The upside to having technology improve over time isn’t fully priced into the market yet. There is further cost compression ahead that will drive returns. Tech upside is stronger in solar right now than in wind, given where we are in the cycle with batteries. It’s not clear yet which type of battery will be the winner, and it’s not clear there will even be one winner. But when there’s change there is usually opportunity.
There are also a lot of questions about how electric vehicles will affect the power grid, or how EVs can improve and balance the power grid with their batteries. Those intricacies are really a big data problem that require grid upgrades. We’re going to have to know how many EVs are charging and at what point in time that’s happening. Grid communication goes just one way now, but power and system operators will have to learn to talk to each other.
Q: What’s the demand for these strategies from long-term investors
A: People are interested but investors are still mostly dipping their toes in the water. Still, some endowments and foundations are very focused on renewables. Some pensions see this as part of their ESG mandate, but also as assets that have nice long-term cash flows they can match against their liabilities.
The challenge we face is that the return profile is still rather low for the risk you’re taking. Solar assets are not completely riskless but they are being priced very close to risk-free bonds. It’s not always clear this is a better return versus a more liquid alternative, like the S&P 500. But there’s also scarcity value to some renewable assets and a risk that these are the only power assets that will be valuable in the future if there are more carbon taxes.
Q: What’s another natural resource you’re excited about?
A: We really like the water space. There’s huge demand for that and there’s been underinvestment in water infrastructure and sustainability. Again, there’s a lot of opportunity there for human ingenuity and technological improvements. We’re seeing new ways to store more water, use storm water, and create efficiencies to do more with less. The ownership rights surrounding water are really complex so that also creates opportunity.