Advertisement

Renewable energy investment funds are warming up

The green energy sector is growing, but investors shouldn’t rush in to renewable energy investment funds.

922_MW_P22_Funds
In the 2018 heatwave, solar energy made up 27% of electricity generated

Copyright (c) 2018 Shutterstock. No use without permission.

Electricity generation from renewables rose more than 10% year-on-year in the first quarter of 2018 in the UK to comprise more than 30% of the total. In the summer heatwave, the share of solar energy alone reached 27% at times. Although the share of renewables in total energy consumption (electricity, heat and transport) was just 1% in 2004, this had risen to 10% by 2017, and the government wants it to reach 15% by 2020.

Advertisement - Article continues below

This growth was the consequence of a great deal of investment and, inevitably, there has been no shortage of entrepreneurs offering investors a compelling opportunity. Six renewable UK energy funds have been launched since 2013 with combined net assets of £4.5bn, three specialising in solar energy, one in wind farms and two with mixed assets.

Returns have been healthy

The performance of the renewables sector has been good, with a compound return of 8.5% per year over three and five years (though only three funds go back that far). These returns have lagged behind the mainstream infrastructure sector, whose seven funds have returned more than 11% compound over three and five years. Yet the average dividend yield of nearly 6% is 1% higher than for the infrastructure funds, and they trade at lower premiums to net asset value.

Advertisement
Advertisement - Article continues below

The catch is that revenues, and hence earnings, have persistently undershot targets set out at flotation. Sometimes this is because the wind doesn't blow or the sun doesn't shine, but mostly it is because wholesale power prices have risen more slowly than the retail-price-index-plus 2%-2.5% expected.

Advertisement - Article continues below

Although between 60% and 75% of the sector's revenues are fixed and predictable, the remainder is subject to market prices. That market prices have been lower than expected is good for the consumer, but not for the producer. All that renewable energy generation has served to depress prices.

What is not good for the consumer is that the fixed-price element of the sector's revenues is fixed at their expense. Larger renewable generators are paid a subsidy to generate an agreed volume of electricity; smaller generators benefit from an agreed "feed-in tariff" considerably above market prices. The cost of the subsidy is passed on to consumers and that cost will approach £9bn a year in 2020/21, according to the National Audit Office, adding £110 to a typical household bill.

The renewables industry proudly points to falling costs thanks to improving technology. New offshore wind farms are now supposedly competitive with gas-powered generation, while onshore wind and solar will be by 2025. This claim is a bit of an exaggeration, as it doesn't take into account the higher cost of transmission, nor the cost of less reliable output, but the downward trend in the cost of renewables is beyond dispute.

Advertisement - Article continues below

The response of the government to this trend was to announce an end to subsidies on new projects in the 2017 Budget. This has led to "a dramatic fall in investment" according to a parliamentary committee, but this may be good news for investors in the sector. Falling dependency on subsidies improves the business model of the industry, while lower investment could result in firmer prices.

Prices are unpredictable

An increase in the real growth rate of power prices from 1% to 1.5% would add 3.5 to 5% to net asset values, though a corresponding decrease would have the reverse effect, estimates Iain Scouller of brokers Stifel. He expects many of the funds to take advantage of their premium to asset value to issue more equity, and recommends waiting for such issuance before buying a spread of funds. However, the unpredictability of power prices may make sticking with the mainstream infrastructure funds a better bet.

Advertisement
Advertisement

Recommended

Visit/520181/how-the-fear-of-death-affects-your-investment-process
Investment strategy

How the fear of death affects our investment processes

Many of our investment decisions are driven by one simple fact: the knowledge that, one day, we will be dead. Here, in an extract from his new book, J…
2 Jan 2020
Visit/520060/the-good-and-the-bad-investments-of-2010s
Stockmarkets

The good investments of the 2010s – and the bad

John Stepek takes a look back on which investments did well and which did badly in the decade that’s about to come to an end.
26 Dec 2019
Visit/investments/funds/investment-trusts/601249/solid-income-from-a-renewable-energy-tortoise-fund
Investment trusts

Solid income from a renewable energy "tortoise" fund

GCP Infrastructure plods along compared with its rivals, but offers an attractive yield at the current price
4 May 2020
Visit/investments/stockmarkets/601258/royal-dutch-shell-slashes-its-dividend-what-now-for-income
Stockmarkets

Royal Dutch Shell slashes its dividend: what now for income investors?

Shell's dividend cut – its first since WWII – has come as a nasty surprise. And it leaves income investors wondering where to turn now. John Stepek lo…
1 May 2020

Most Popular

Visit/investments/commodities/gold/601444/these-seven-charts-show-exactly-why-you-must-own-gold-today
Gold

These seven charts show exactly why you must own gold today

Covid-19 is accelerating many trends that were already in existence. The rising gold price is one such trend. These seven charts, says Dominic Frisby,…
3 Jun 2020
Visit/economy/eu-economy/601463/why-a-stronger-euro-is-good-news-for-investors
EU Economy

Why a stronger euro is good news for investors

The fragile state of the eurozone has for a long time brought the threat of deflation. But the ECB’s latest moves have dampened those fears. John Step…
5 Jun 2020
Visit/investments/stockmarkets/emerging-markets/601465/putins-grip-on-power-is-slipping
Emerging markets

Putin’s grip on power is slipping

The Russian president had been looking forward to a spring of triumphs, including a new constitution that strengthens his hand. Now he faces multiple …
6 Jun 2020