Energy efficiency funds are an increasingly popular part of the infrastructure asset class. Four London-listed funds are currently valued at over £1.5bn – going up in value by the month with new placings and fund raisings – and there will surely be more launches in the wings. I’m a non-executive director of one of these, the battery fund Gresham House Energy Storage (LSE: GRID), so I’m not going to make any comment about the attractiveness or otherwise of any individual fund, but here’s a quick run-through of the basics.
A new kind of infrastructure
These funds look a bit like other infrastructure funds: they are income focused, backed by real assets, and generate inflation-linked dependable cash flows. The average yield over the next few years should be in the 4%-7% range, which explains why all four trade at big premiums to net asset value – 16% for SDCL Energy Efficiency Income Trust (LSE: SEIT).
However, unlike many infrastructure funds, there is little government involvement (ie, no contracts underpinned by the state), although government policy can have an impact on revenues. They also act more like operational businesses, buying and selling services to commercial end-users.
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With the energy-efficiency funds, these users might be corporate clients. For example, SEIT, which listed in 2018, recently invested in a US business called RED Rochester that provides services such as electricity, steam, water and compressed air to customers in a business park. RED has over 100 customers, typically on 20-year contracts, with renewals linked to their tenancies.
Meanwhile, Triple Point Energy Efficiency Infrastructure (LSE: TEEC) raised £100m in an initial public offering in October 2020 to invest in low-carbon heat distribution, social-housing retrofit and industrial energy efficiency, and distributed generation. One deal involves community heat and power (CHP) assets that generate heat for big commercial greenhouses. These are more efficient than the old engines and less carbon intensive. Even the carbon dioxide waste from combustion is used to enhance crop yields.
In both projects, we can see long-term contracts, frequently inflation linked, with defined cashflows. There are no worries about governments, subsidies, or wholesale power prices (unlike renewable energy funds).
Very big batteries
The two battery funds, GRID and Gore Street Energy Storage (LSE: GSF) are rather different. Renewable energy creates lots of power at the wrong times. These funds own storage batteries that take in electricity when it’s plentiful (and thus cheap), and supply it when it’s needed (and therefore expensive).
Clients include the national grid operators, who are keen to make sure that there is spare capacity in the system to cope with peak periods of use or sudden unscheduled outages.
These funds have been busy buying into new projects, some of which are in the fast-growing Irish market. Both have a strong sustainability angle, in that they enable the push towards renewable power in the UK. This may help explain why big institutions have been buying into them.
A victim of popularity
What of the risk? Rising inflation could increase equipment and operating costs. Higher interest rates might make their yields less attractive. Operationally, all these funds depend on complex optimisation and valuation models with varying inputs (forward market pricing, inflation, discount rates) which can change over time. Income investors should keep an eye on operational net cash flows to underpin dividends.
Government policy might change (eg, more nuclear power would make storage less important), although that is unlikely. The greatest risk is that too much money goes into these energy efficiency niches, pushing down rates of return
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