The term “ESG” may now be fraught with controversy, but just three or four years ago, environmental, social, and governance investing was all the rage. BlackRock CEO Larry Fink’s impassioned support of ESG standards for the business community had elevated him to near-sainthood. An unknown activist fund, little Engine No. 1, was preparing to force mighty Exxon Mobil Corp. to accept board members advocating a climate-friendly strategy. And companies were vying for the highest ESG ratings with promises to divest their fossil-fuel holdings.
It was the worst moment for a contrarian to dive into the fray. But in 2019, Carlyle Group, a leading alternative asset manager, announced that it was investing billions for a large stake in Cepsa, a Spanish multinational oil and gas company. Amid widespread skepticism, Carlyle promised to reinvest a hefty portion of its Cepsa profits to sharply reduce the company’s carbon footprint.
“We think that investing in the energy markets is an important part of any investor’s portfolio,” says Pooja Goyal, chief investment officer of Carlyle Global Infrastructure, whose purview includes energy. “Our philosophy has always been to invest, not divest.”
That philosophy has become the mantra of large alternative asset managers, who have emerged as unlikely leaders of the clean-energy movement. The big alts firms have convinced investors that the transition to a low-carbon era depends on a willingness to plow money into the fossil-fuel companies with some of the worst ESG ratings — and then use part of the profits to transform those polluters into founts of green energy.
“The right way to decarbonize the global economy is not to stop using fossil fuels tomorrow,” says Connor Teskey, who heads Brookfield Asset Management’s renewable energy business. “We look for situations where decarbonization and value creation are complementary.”
Some alternative asset managers — such as Blackstone and Apollo Global Management — have vowed not to make new investments in oil, gas, or coal. But none have moved to divest their sizable fossil-fuel holdings. And all are raising capital for what they call transition funds, meaning investments in renewables like solar and wind power, nuclear energy, hydrogen, and carbon dioxide capture and storage.
The market leader by far is Brookfield. Despite a weaker fundraising environment, the giant Canadian manager raised a record sum for an energy-transition fund last year. Brookfield and its peers have even managed to steer clear of the polarizing ESG politics that have tangled up big traditional money managers like BlackRock, Goldman Sachs, and Charles Schwab.
How? While traditional managers cram customer portfolios with highly liquid ETFs and publicly traded corporate shares, the alts firms keep most of their investors’ money in long-term or perpetual capital funds that can’t be easily divested.
There is also a potential conflict of interest for large institutional investors that become limited partners in alts funds. A pension fund might threaten to pull money from a low-rated ESG fund or a fossil-fuel producer. But it will hesitate to pressure alternative asset managers that deliver high returns for its retired teachers, firefighters, and cops.
“There is absolutely a different criteria,” says a financial data firm analyst who monitors sustainable investing by pension funds and endowments. “LPs are feeling more comfortable saying it’s their job to make the best possible returns.”
The transition strategy of the alternative asset managers has gained momentum in the wake of the energy crisis created by Russia’s invasion of Ukraine. The conflict forced countries across the globe to scramble for fossil-fuel sources and accept arguments that a green-energy era was decades away.
The war led Washington to embrace an industrial policy aimed at enhancing energy security and promoting sustainable sources of energy. Last year, the Biden administration passed the Inflation Reduction Act, which earmarks some $800 billion for climate spending over the next decade. According to Goldman Sachs, the act could induce the private sector to match that amount, raising total spending for decarbonization to $1.6 trillion over the next ten years.
The large alternative asset managers are likely to be the biggest beneficiaries. A company hoping to receive an Inflation Reduction Act grant or raise funds from the private sector must be able to spend at least $200 million on a sustainable energy project. It takes a long-term perspective, huge scale, and deep pockets to be a major player in the green-energy game.
Still, despite their promises to invest their fossil-fuel profits into renewable energy sources, alts firms face daunting obstacles. Renewed enthusiasm for nuclear energy glosses over the need to resolve the problem of waste disposal and fears of meltdowns. Technological solutions must be found for carbon removal and storage and the use of hydrogen as a noncarbon energy source. Hundreds of new mines must be developed to supply the lithium, cobalt, and nickel essential to the batteries that power electric vehicles.
But the biggest bottleneck of all is the regulatory approval to build the transmission lines and pipelines that would distribute more energy — whether carbon-based or green — to businesses and consumers. This impasse has turned a dominant pipeline owner like Kinder Morgan into a major toll collector in the energy transition.
All these factors make this energy transition dramatically different from the changeovers from wood to coal to oil and gas. “Those transitions took a century or more,” says Daniel Yergin, a longtime energy expert and Pulitzer Prize-winning author of The Prize: The Epic Quest for Oil, Money and Power. “This transition is meant to happen over the next quarter century.”
Cepsa’s owner, Abu Dhabi sovereign-wealth fund Mubadala Investment Co., had originally hoped to take the firm public. It abandoned the plan after an IPO failed in 2019, as valuations of fossil-fuel companies were plunging over climate concerns and would-be investors were unable to raise bank loans.
That’s when Carlyle stepped in to purchase 38 percent of Cepsa, with Mubadala holding on to the rest, in a transaction that valued the firm at a $12 billion bargain. Not only was the price right, but Carlyle much preferred to keep Cepsa private to carry out a green-energy strategy.
“If you’re going to make this transition, it’s a lot easier to do as a private company with only two shareholders,” says Bob Maguire, who oversees the Cepsa investment as head of Carlyle’s international energy operations. With a publicly listed company, “you have to be responsive to the quarterly expectations of the market and a multitude of shareholders.”
Carlyle and Mubadala agreed to invest at least $8 billion by 2030 to reduce Cepsa’s carbon footprint by creating greener energy sources from biofuels and hydrogen, and by converting gas stations to accommodate electric vehicles. (Thus far, only about 60 of Cepsa’s 2,000 gas stations in Spain and Portugal have been equipped with electric chargers, and plans now call for their installation at highway fuel stops rather than in urban areas.)
Carlyle maintains that it is more cost-effective to clean up a fossil-fuel company like Cepsa than to build a green replacement from scratch. Cepsa has a 90-year existence as a storied company; an extensive infrastructure of ports, pipelines, and fuel stations; engineering capacity; and a strong marketing network.
“You can’t do all that as a standalone developer,” says Maguire.
Best of all, Cepsa has the gushing fossil-fuel cash flow that can finance its green-energy transition while guaranteeing healthy returns on Carlyle’s investment. Last year, Cepsa generated €27.4 billion ($29.8 billion) in revenues, an increase from €17.7 billion in 2021. Net profits were €1.2 billion, way up from only €30.3 million in 2021.
But questions remain on how soon Cepsa can meet its green goals. Its biggest bet is a $3 billion investment in hydrogen to produce 2 gigawatts of carbon-free energy — enough to power 1.5 million homes — by 2030.
Excitement abounds over the uses of hydrogen for ammonia and fertilizer production, in the desulphurization of diesel, and even as a gasoline replacement. “But it gets more complicated when you try to figure out hydrogen’s potential for a market that doesn’t exist today,” says Bridget van Dorsten, senior hydrogen analyst at research and consulting firm Wood Mackenzie. “If I knew the answer, I could probably make a big enough bet to retire.”
Last month, Brookfield launched a second transition fund aiming to raise at least $17 billion. Despite the high interest-rate environment, the firm says it won’t pare back its target returns.
“We have a lengthy track record of mid-teen returns on capital that also provides inflation protection for investors,” says Mark Carney, Brookfield’s chairman.
No alternative asset manager has more capital invested in energy, which accounts for about 20 percent of Brookfield’s mammoth $825 billion in assets under management. Nor does Brookfield shirk from controversial investments. In fact, it seeks them out as high-return opportunities.
“Companies are caught in the energy-transition trap,” says Carney. “They’re returning capital to their shareholders and not dedicating enough to invest for the future as much as they need to. And we can move into that space.”
That’s certainly the case with Brookfield’s investment in Origin Energy, Australia’s biggest coal energy producer.
According to the International Energy Agency, coal accounted for more than 40 percent of energy-related carbon emissions worldwide in 2022. In Australia, rising public sentiment against coal had depressed Origin’s valuation and scared off other potential bidders.
So Brookfield teamed up with EIG Global Energy Partners in March to acquire Origin for A$15.35 billion ($10.2 billion). EIG took control of Origin’s gas division, while Brookfield got the energy generation business. It promises to transform Origin with a A$20 billion investment in renewable sources of energy — mainly wind power.
Brookfield’s bet on a coal energy producer pales by comparison to its gamble on nuclear power. The asset manager acquired Westinghouse Electric Corp., the world’s top provider of services to nuclear power plants, in 2018, when memories of the nuclear plant meltdown in Japan — the worst ever — were still vivid.
But in the wake of the Ukraine war, there has been a growing public acceptance of the need for nuclear plants. Westinghouse services about two-thirds of the world’s nuclear reactors, and it is launching a new generation of reactors that it claims to be safer, cheaper, and more suitable for the varying needs of customers.
“It’s not going to be one size fits all,” says Teskey, Brookfield’s chief executive for renewable energy.
A country with a sizable economy can opt for the AP1000, a large-scale Westinghouse reactor. Last year, Poland contracted to purchase three of those reactors, and it’s planning to buy three more. China already uses AP1000 technology in four of its nuclear plants and has six more under construction.
But lately, global interest has mounted in so-called small modular reactors, and Westinghouse claims to be ahead of rivals in SMR development.
By the end of this decade, it is planning to offer the much smaller, quicker-to-build, and easier-to-service AP300 to utilities as a replacement for a single fossil-fuel plant at a time. The company envisions locating the reactors close to coal-fired plants nearing retirement — a marketing strategy aimed at enhancing the appeal of nuclear energy as an alternative to heavy carbon emitters.
Westinghouse is also developing an even smaller reactor — the eVinci — which it expects to begin selling before 2030. The eVinci is designed for use at isolated business operations, like mines, that aren’t connected to electrical grids and depend on fossil fuels for their energy. The reactor is compact enough to be transported by truck and can operate for up to eight years before it needs to be trucked back to a uranium refinery to refuel its core.
“The eVinci could be an absolute game-changer,” says Teskey.
Brookfield is emphasizing the eVinci’s potential to cover the energy needs of remote military bases — a subject of rising concern in Washington as U.S.-China relations deteriorate. “The nature of the design will allow the reactor to be rapidly transported to sites as needed to create an abundant and resilient power supply to support advanced defense systems,” notes Westinghouse’s website.
Nothing underscores the intransigence of regulatory obstacles like the lengthy struggle over the Mountain Valley Pipeline. The $6.6 billion pipeline is supposed to connect the shale gas fields of West Virginia to users in Virginia, who now depend on dirtier fossil fuels.
But because the 303-mile pipeline would cross streams and wetlands, opposition from environmentalists and many Democratic state lawmakers has delayed the project for nine years.
It took the frenzied effort to raise the federal debt ceiling in June and avert a catastrophic default to finally get bipartisan congressional and White House approval for the pipeline. Senator Joe Manchin, the West Virginia Democrat, made permits for the project a condition for the debt deal.
The Manchin plan also set a two-year limit on environmental reviews of large federal energy projects involving both renewables and fossil fuels. And it fast-tracked at least 25 energy projects designated as essential by the White House.
But natural gas pipeline companies remain skeptical that these moves will amount to a regulatory breakthrough.
“There are still multiple federal, legal, and local challenges to the permitting process that add risks and potential delays to all new projects,” says Tom Martin, incoming president of Kinder Morgan, which moves 40 percent of U.S natural gas production through its 70,000 miles of pipeline.
The near absence of new permits means that Kinder Morgan’s existing pipeline network is more valuable than ever, allowing the company to charge higher contract rates.
Unsurprisingly, alternative asset managers are eager to own ever more valuable pipeline networks. In 2021, Brookfield paid $6.8 billion to acquire Inter Pipeline — a leading Canadian midstream company engaged in the transportation and processing of energy products.
Pipelines are projected to play an essential role in the transportation of hydrogen for clean-energy uses. But here again, delays in permits are tempering enthusiasm. And technical obstacles to converting natural gas pipelines for hydrogen appear intractable.
Kinder Morgan has conducted technical analyses on some of its pipelines to determine the feasibility of using existing infrastructure to transport hydrogen. But the early results haven’t been favorable.
Because hydrogen atoms are so small, they could leak through seals and joints or corrode pipelines that were initially designed for natural gas. And hydrogen is colorless and odorless, making it difficult to detect leaks.
It is also doubtful that previous regulatory approval of fossil-fuel pipelines would allow companies to build hydrogen pipelines alongside the existing infrastructure. This has led Kinder Morgan and some of its peers to conclude that plans for long-haul pipelines from hydrogen supply areas to market may prove unfeasible. A more likely scenario is having hydrogen supply and demand centers near each other. But this strategy could be more expensive and take more than a decade to implement.
In the meantime, Kinder Morgan predicts that its high-carbon business will continue to account for most revenues and profits.
“We are going to be careful on how we transition from a fossil-fuel company to a more sustainable energy company,” says Martin. “This transition is going to take much longer than most people realize.”
