Earlier in the year, we wrote about the state of play on decarbonisation in the infrastructure sector and discussed the frameworks being developed to support investors, managers and companies to make and measure progress.

To coincide with the publication of our 2023 Sustainability Update Report, we zero in on utilities. What are the challenges and opportunities at play in what has traditionally been seen as a solidly core infrastructure sector?

Utilities – strong, stable and flexible?

Utilities provide a wide range of essential services, including the transmission and distribution of electricity and natural gas; district heating; waste treatment; and water supply and treatment. They come in all shapes and sizes, from large water companies serving millions of customers, to small specialist operators serving a specific town or region. They can also be state-owned entities or private businesses, depending on the country and sector.

Utilities operate and maintain the infrastructure between the producer and the consumer, providing a web of connections that support economic activity. Given their importance, they operate in a quasi-regulated or regulated environment to ensure security of supply and value for the consumer. This means they can provide long-term stable cashflows and strong downside protection – the hallmarks of core infrastructure investments.

However, trends like decarbonisation, electrification, decentralisation, the protection of ecosystems, and the circular economy present new risks and opportunities for the sector. Utilities can be well-placed to provide solutions to these challenges. But they can also be vulnerable to technological and policy shifts, given the potential for inflexibility and lock-in.

For example, how we decarbonise heat presents very real questions for some companies. How long will we use natural gas, coal or peat? What role will there be for other molecule-based fuels like hydrogen and biomethane? What is the role of district heating versus heat pumps in different geographies?

For long-term infrastructure investors, these questions require careful consideration.

Identifying the opportunities

Our strategy is to invest in majority positions, or substantial minority positions, in small- to mid-cap infrastructure assets. We are focused on a core and core-plus strategy. We aim to drive value through active ownership over the long term. When managing our investments and assessing new opportunities, we plan for the dynamic and changing world in which we operate. This includes understanding trends in environmental policy and regulation, politics, technological developments, and customer expectations.

In the small- to mid-cap segment of the market, we find that utilities are often nimbler, making them more resilient and better able to respond to a changing world. When we combine these characteristics with our approach to long-term active asset management (board representation and proactive work with management teams), we can identify the right opportunities where we can create real long-term value in this sector.

Applying this thesis, we've made several investments in the utilities sector. We have a strong presence in Finland, where we own a gas distribution operator, electricity distribution operator, and three district heating companies. These companies supply renewable and low-carbon heat to residential, commercial and industrial consumers. Auris Energia, our energy-services business, owns and operates the largest gas distribution network in Finland and currently serves over 25,000 customers. It plans to decarbonise its supply mix by 2040.

Defining the decarbonisation pathway that we can work with management to deliver has been key to our investments. This approach is described below for another of our assets, Loimua Oy.

Towards zero-carbon heat in Finland

District heating plays an important role in Finland. It has an overall 45% market share for heating and hot water, which is much higher in densely populated urban areas. Across the sector in Finland, the fuel mix for heat production is still dominated by coal, natural gas and peat. This sits in the context of a national target for Finland to be net zero by 2035.

We currently hold three district heating companies in Finland, all of which are substantially less emissions-intensive than the national average. They supply more than 90% of their heat from renewable sources or energy from waste facilities.

The largest company in the portfolio is Loimua Oy. It owns and operates 760 megawatts of heat production capacity and 17 district heating networks across Central and Southern Finland. This covers over 500 kilometres of network, with over 85,000 end-customers. The company is on track to meet its target to fully decarbonise its heat supply by 2030, which supports the national net-zero target and protects against increasing carbon prices. It has gradually decarbonised its fuel mix by increasing the share of sustainable biomass it uses. Loimua Oy has reduced its emissions intensity by over 60% since 2019, by accelerating the phase-out of peat. Given the scale of the forestry sector in Finland, there's a good supply of certified sustainable biomass feedstock from sawmill offcuts, sawdust and residues. In 2022, there was a small uptick in the use of peat because of the relative pricing in the aftermath of Russia’s invasion of Ukraine, but we expect the long-term trend will continue in 2023 and beyond.

In its role as a heating provider, Loimua Oy is also looking to expand into energy services. This would support its industrial customers as they progress on their energy-transition journey.

What’s next?

We believe utilities that can support decarbonisation, while still maintaining security of supply and affordability, will ultimately prove successful. There is a strong pipeline of opportunities with these characteristics. We aim to create long-term value for our clients and to contribute to the decarbonisation of the energy system.

For more information about our approach to sustainability and examples from our portfolio, please see our latest Sustainability Update Report