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

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.

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.

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.

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.

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.

Recommended

Nuclear power might never be popular – but now looks a good time to invest
Commodities

Nuclear power might never be popular – but now looks a good time to invest

Nuclear power gets a very bad press, but it is the ultimate renewable energy source. Interest in it is perking up again, says John Stepek. Which means…
9 Apr 2021
Does nuclear power have a future?
Energy

Does nuclear power have a future?

Fears about safety have long hobbled the industry, particularly in the wake of Fukushima ten years ago. But the fears are overplayed and net-zero carb…
3 Apr 2021
How to profit as uranium prices head for a melt-up
Industrial metals

How to profit as uranium prices head for a melt-up

The supply squeeze in the uranium market implies ample scope for price rises. Here's how to invest in uranium.
29 Mar 2021
Oil price comes off the boil as the pandemic lingers
Oil price

Oil price comes off the boil as the pandemic lingers

Brent crude oil had its worst week since October last week, tumbling by 7%, as continued virus restrictions in Europe weigh on demand.
25 Mar 2021

Most Popular

“Joke” cryptocurrency dogecoin goes to the moon. What’s going on?
Bitcoin

“Joke” cryptocurrency dogecoin goes to the moon. What’s going on?

Dogecoin – a cryptocurrency created as a joke – has risen by more than 9,000% this year alone. Saloni Sardana looks at how something that began as an …
19 Apr 2021
The FTSE 100 has clawed back above 7,000 – how much higher can it go?
UK stockmarkets

The FTSE 100 has clawed back above 7,000 – how much higher can it go?

The FTSE 100 index has risen to over 7,000 for the first time in over a year – it now sits just above where it was in 1999. But its era of neglect cou…
19 Apr 2021
The bitcoin bubble will burst: here’s how to play it
Bitcoin

The bitcoin bubble will burst: here’s how to play it

The cryptocurrency’s price has soared far beyond its fundamentals, says Matthew Partridge. Here, he looks at how to short bitcoin.
12 Apr 2021