Will solar energy investment funds keep shining?

Investment funds designed to profit from the solar energy have done well, but now look expensive, says Max King.

Solar energy panels in Spain ©  Pablo Blazquez Dominguez/Getty Images

Subsidies for solar energy are falling

Investment funds designed to profit from the solar energy have done well, but now look expensive.

When renewable energy funds were first listed, it was easy to be sceptical. In the early days of wind and solar energy generation the technology was expensive and inefficient. So public subsidies accounting for half or more of expected income were required to give investors a competitive rate of return.

The other half of the funds' income was to come from electricity sold to the grid at wholesale prices that were expected to rise steadily. They didn't, perhaps because of the additional capacity.

Understandably, the UK government saw this enthusiasm for investment as an opportunity to limit the subsidies by closing what is known as "the Renewables Obligation" for new generating capacity in March 2017.

This caused howls of outrage from the industry and the environmental lobby but it was a shrewd move, recognising and encouraging the improving economics of renewable generation.

Solar energy is getting cheaper

Ricardo Pineiro, a partner of the Foresight Group, which manages the Foresight Solar Fund (LSE: FSFL), estimates that construction costs in the UK have fallen from £2.5m per megawatt in 2011 to £0.5m now, thanks mainly due to lower equipment and installation costs. In addition, technological improvement in panels has led to a 30%-50% increase in generation output. The "levellised cost of energy", or breakeven electricity price, has dropped by 70%. This means that in Spain and Portugal, where the sun shines more reliably, solar costs are below unsubsidised wholesale prices. Iain Scouller, analyst at Stifel, estimates that point will be reached in the UK, where solar-energy yields are 40% lower, within ten years.

Foresight plans to invest in unsubsidised projects in the Iberian market, though not necessarily through FSFL. The UK would surely follow. Competitor Bluefield Solar (LSE: BSIF) is also targeting unsubsidised solar in the UK but, given the high cost of buying operational assets, intends to construct them itself.

The prospect of a renewable energy sector able to compete with fossil-fuel generation without subsidy is an attractive one and it is tempting to assume that long-term growth will ensure continuing good returns for investors.

A note of caution

Chris Brown of brokers JP Morgan Cazenove, however, is cautious. While FSFL shares yield 5.4% and BSIF 6.3%, they trade at premiums to asset value of 15% and 13% respectively.

FSFL has returned 7.6% per annum since launch in 2013 but that return has been helped by a steadily falling rate now 6.5% at which future cash flows are discounted to arrive at the net asset value. Returns to shareholders are bolstered by borrowings of up to 40% of gross assets of £1.1bn, but this adds to the risk. Brown's main concern is that unsubsidised solar projects selling electricity at market prices "require much higher returns at least 8.5%". He prefers BSIF, with less debt and a UK-only focus (FSFL also has assets in Australia), but the logic of his caution is the same.

Scouller is also less than enthusiastic about the sector. He projects a gentle long-term uptrend in power prices but notes that, having spiked to £70 per megawatt hour in September 2018, they have since fallen to £40.

The pressure on professional investors to embrace renewable energy could easily drive valuations higher still. But the funds are taking advantage of investor demand to raise new equity, whether to invest or to reduce debt. That promises a better opportunity to invest for those under less pressure to be seen to be doing good.

Recommended

Larry Fink: the undisputed king of Wall Street
People

Larry Fink: the undisputed king of Wall Street

Larry Fink survived two big financial crises and went on to build a massive asset manager, doing for investing what Henry Ford did for cars. He has hi…
23 Oct 2021
Green finance is set to be the most powerful financial repression tool yet
Bonds

Green finance is set to be the most powerful financial repression tool yet

The government has launched its “green savings bond” that offers investors just 0.65%. But that pitiful return is in many ways the point of “green” fi…
22 Oct 2021
Coal makes a comeback
Coal

Coal makes a comeback

The environmental case against coal may be clear, but that hasn't stopped the price rising more than fourfold in the last year.
22 Oct 2021
If you want to get exposure to bitcoin, I have this great idea for you
Bitcoin & crypto

If you want to get exposure to bitcoin, I have this great idea for you

As bitcoin climbs to new highs, you can now buy a bitcoin ETF. But if you really want to get some exposure to bitcoin, there’s a much better way, says…
20 Oct 2021

Most Popular

Properties for sale for around £1m
Houses for sale

Properties for sale for around £1m

From a stone-built farmhouse in the Snowdonia National Park, to a Victorian terraced house close to London’s Regent’s Canal, eight of the best propert…
15 Oct 2021
How to invest as we move to a hydrogen economy
Energy

How to invest as we move to a hydrogen economy

The government has started to roll out its plans for switching us over from fossil fuels to hydrogen and renewable energy. Should investors buy in? St…
8 Oct 2021
How to invest in SMRs – the future of green energy
Energy

How to invest in SMRs – the future of green energy

The UK’s electricity supply needs to be more robust for days when the wind doesn’t blow. We need nuclear power, says Dominic Frisby. And the future of…
6 Oct 2021