Biomethane is the “new front” of energy transformation

This article is sponsored by abrdn

Ruairi Revell, Chief Sustainability Officer, and William Cunneen, Chief Investment Officer, are part of the abrdn Infrastructure team, which focuses on small and medium-sized markets in Europe, investing in the transport, digital, utilities and energy sectors . The company has been active in a range of energy-related investments such as hydropower in Norway, solar power in Poland, UK and German rolling stock, liquid fuel storage in the UK and Germany, district heating in Finland and most recently biomethane in Italy.

Revell and Cunneen believe the energy transition creates an attractive set of infrastructure investment opportunities. They say it will likely take longer than some expect and there will be some hiccups along the way, but it represents a structural tailwind for infrastructure investors who are looking at the bigger picture.

What are the infrastructure opportunities in the energy transformation?

Ruairi Revell

Ruairi Revell: The term has become somewhat nebulous in recent years and has been used to refer to a range of possibilities. As with opportunities in any sector, we need to be able to spot common characteristics of infrastructure, such as regulated or contracted cash flows and high barriers to entry.

For our solar and small hydro investments, this takes the form of long-term Contracts for Difference and Power Purchase Agreements. In the case of heating, we ensure comfort based on competitiveness with alternative heating options and, of course, by ensuring the system is as low carbon as possible.

The remaining stages of transformation are more difficult for infrastructure investors. Currently, energy storage options rarely have strong infrastructure features – there is commercial exposure and potential volatility. Charging electric vehicles also falls into this category. Barriers to entry are very low and there is often poor visibility of future cash flows. These are elements of the transformation that we would like to engage in, but we do not yet believe that they can be invested in as part of our strategy.

Do you have this confidence in the UK?

William Cunneen

William Cunneen: Over the last 20 years, the UK has been at the forefront of transformation in many ways. The direction for decarbonization has been set, but there are certainly significant challenges.

As in other countries, geopolitics and cost of living pressures over the past few years have forced a rebalance of attention to domestic energy security and affordability. These factors may accelerate some stages of transformation, but they may also push some trends further.

The uptake of electric vehicles has slowed, partly due to cost pressures, but also perceptions resulting from political decisions on the timing of the retirement of conventional vehicles. The wind industry has also been plagued by equity and uncertainty issues, which came to a head with the latest round of contract for differences auctions, but we expect this situation to resolve soon.

These issues point to delaying the inevitable, not stopping it. To refer to Larry Fink’s latest phrase, we may be entering a new phase of transformation: “energy pragmatism.”

What about regulations in the EU?

RR: I think it’s very similar to the UK. The ultimate goal of decarbonizing the economy is clear and many of the policy incentives to support this goal by 2050 are taking shape and producing the desired results. However, pieces of the puzzle are missing to make this happen without compromising resilience and affordability.

This is also the case with the “spatial and temporal” elements of the transition; delivering renewable energy where it is needed, at the right time. There are many solutions to fill these gaps, but it is a complex web of political, technological and commercial factors that will determine the winners and losers of the transformation. As long-term infrastructure investors, we spend a lot of time analyzing these factors as part of our investment process.

Having identified some of the challenges, there are significant opportunities. This is certainly the case in Italy, where we are investing in the biomethane sector. The country intends to cover 30% of its energy demand from renewable sources by 2030 and – in line with the EU’s overall ambitions – fully decarbonise by 2050.

With the support of the EU, the Italian government decided to shift the focus from using biogas to generate electricity to upgrading it into biomethane, which directly replaces fossil gas from the network. Italy currently has a €4.5 billion incentive program for biomethane, part of a broader EU strategy to increase domestic production to 35 billion cubic meters (bcm) by 2030. It could support new biomethane plants or the modernization of existing ones biogas plants to produce biomethane, all with a requirement to reduce greenhouse gas emissions by at least 80 percent compared to conventional fossil gas.

Italy currently meets about 70 percent of its energy needs from fossil fuels, of which 44 percent is natural gas. About 60 percent of all space heating comes from gas and another 11 percent from oil. There is therefore a huge need to decarbonize this phenomenon. Importantly, the shift to encouraging the use of more green molecules also reduces the country’s dependence on imported fossil fuels.

What future possibilities beyond biomethane excite you?

Ruairi Revell: We are very active in the transport sector. We have long experience in financing rail electrification and are increasingly interested in areas such as decarbonizing airport operations by financing the modernization of ground handling equipment.

We are also very active in the heating sector, having recently made our fourth investment in this sector in Finland. This is a sector that has a vital role to play in supporting the decarbonization of heat in densely populated urban areas.

For us, the most important thing is that the energy transformation does not only concern renewable energy sources; opportunities exist in every sector and industry. It is becoming clear that it will take longer and may be bumpier than some expected, but there is opportunity for those who are able to take a broader perspective on the transformation.

How does biomethane work and what is the justification for the investment?

toilet: Biomethane produced by anaerobic digestion is a natural process in which organic material is broken down by microorganisms in the absence of air, thereby releasing methane and other gases.

Historically, this gas was simply burned at the source to produce electricity and heat, but today there is greater emphasis on separating and capturing methane and using it as a replacement for fossil natural gas.

Interest in the biomethane sector has certainly increased in recent years, accelerated by Russia’s invasion of Ukraine and the resulting focus on energy security through policies such as REPowerEU in 2022. Since then, we have seen the introduction of various policies and incentives to increase biomethane production to achieve the EU target of 35 billion m3 by 2030, a 10-fold increase.

We have been interested in investing in this sector for some time, but in 2022 it became clear that the sector was gaining significant momentum after a series of high-profile transactions with major energy players such as Shell and BP.

We considered several different markets across Europe, but ultimately decided that Italy offered the most attractive risk-adjusted returns, with strong government support, a relatively advanced supporting industry and significant incentives offered. Our fund’s strategy also enabled us to take advantage of the highly fragmented biogas market in Italy.

But how do you navigate this fragmented market?

RR: Our partner Blu-H Energy has a key role to play, particularly in supporting site identification and selection. There are currently around 2,000 sites in Italy, so we can’t check them all.

Moreover, not all sites are created equal. When selecting the right sites, we consider several key criteria. First of all, raw material control.

It’s not like installing a solar panel in a field and waiting for the sun to shine. These crops require large amounts of raw materials such as manure and other agricultural waste, so providing them at the right price and quality is a key determinant of success.

toilet: The raw material is crucial for proper operation. Other important elements are location, proximity to gas markets and an experienced operator.

At this stage, we prefer to acquire brownfield sites given the lower risk profile compared to greenfield sites and the ability to avoid lengthy approval processes, allowing us to scale up more quickly. In addition to identifying attractive opportunities, Blu-H Energy is also responsible for operating, modernizing and managing factories for us.

While we like to roll up our sleeves and get deeply involved in these types of investments, we recognize that having local knowledge, skills and relationships is essential.

Would you go to another country?

toilet: We are constantly evaluating new markets, especially as countries are now creating new policies to support the growth of this industry. However, at this stage we are focused on scaling up our platform in Italy as we see many opportunities in this market.

We also see many future benefits to be captured, such as the upgrading of digestate to produce high-quality fertilizers, as well as the capture of biogenic CO2, which has applications in the food sector and, more interestingly, as input for new transportation fuels such as e-cigarettes -methanol.