While consumers and businesses are appalled by the soaring price of energy, the renewable-energy industry is looking beyond the next 18 months to a bright future. “Our cash generation from current power prices is huge,” admits Stephen Lilley, co-manager of the Greencoat UK Wind fund (LSE: UKW).
He and the rest of the sector are focusing on the inevitability of reform in an electricity market whose price is based on volatile wholesale gas prices. Lilley is relaxed about government intervention: “the build-out of offshore wind is so important that it will be fine”.
Consultants AFRY note that although today’s markets are extreme, wholesale electricity prices have always been highly volatile owing to movements in fuel prices and the weather. Russia cutting off supplies has compounded volatility, but European gas imports from Russia had already fallen sharply in both 2020 and 2021. Germany has announced plans to cease imports by 2025 and Italy by 2026, but AFRY regards this as optimistic without a replacement source.
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In the UK, renewables have replaced coal in electricity generation over the last ten years, but gas still accounts for more than half of generation. This leaves plenty of room for growth in renewables, especially as rising adoption of electric vehicles and the production of hydrogen through electrolysis will underpin the rise in demand for electricity.
High energy prices lead to low energy prices
AFRY forecasts that European gas prices will peak this winter and then steadily fall back to more “typical” levels by 2026. UK prices will fall a bit more slowly as the UK’s very limited storage capacity means there are no reserves to be drawn down. Forward electricity prices, which fall sharply over the next five years, support this view, as does past experience. Sky-high prices of hydrocarbons resulting from shortages always lead to subsequent gluts and much lower prices.
This makes it highly likely that renewable generators will be happy to sacrifice current high prices in return for protection against very low prices in the future. The government will be keen to increase energy security, which means favouring fully domestic generation. This means that the full market-reform negotiations will be complex and could, according to one participant, take “four to five years”.
Aurora Energy Research expects total electricity generation to increase by 37% by 2040 and almost 100% by 2060. Onshore wind generation is forecast nearly to double by 2040 and then flatten out, presumably owing to a shortage of sites. Offshore generation is expected to multiply 2.7 and 5.6 times respectively. By 2060, wind would account for over half of overall output (and offshore wind more than 40%), while solar would comprise a little more than 10%. Nuclear output is set to treble to 25% of output, while gas is expected to be displaced in the 2030s.
Renewables have a bright future
Offshore wind is generally faster and more reliable than onshore. Improved technology and engineering, notably larger turbine blades, have significantly enhanced the relative competitiveness and growth rate in offshore wind in the past few years. That a huge part of the shallow and windy North Sea lies within the UK’s territorial boundaries gives it a huge advantage, which floating turbine platforms will further enhance.
This suits Lilley’s ambitions very well, though he does point to the problem of demand for electricity coming primarily from the south while wind generation is mainly in the north and Scotland. “Offshore build-out will have to accompanied by investment in transition,” he says. He is also “interested in nuclear” and sees a bright future for hydrogen to replace natural gas in transport and heating, although that too is some years off.
Iain Scouller, analyst at Stifel, points out that although the renewables sector has performed well in the last two years, the average premium to net asset value (NAV) has fallen from 15% to near zero. The proposed cut in corporation tax “is not priced in”, but other worries hang over the sector. These include pricing reform, such as the proposed move to long-term contracts, the rise in gilt yields to above 3%, which could increase the discount rates at which future cash flow is valued, power price volatility and windfall taxes. Liz Truss has ruled the last out, but the Labour party advocates them.
Against this, the imperatives of energy security and the end of reliance on imported hydrocarbons, plus the relentless improvement in technology, assure a prosperous future. Carbon emissions in the UK have fallen by 47% since 1990, according to the Climate Change Committee, and major further falls lie ahead.
Renewable energy funds to buy now
The uncertainties will not be resolved quickly and the ability of politicians to make a mess of the energy market should not be underestimated. But the growth momentum in the renewables sector looks assured. Long-term contracts will mean that investment in renewable energy will not make you rich quickly, but steady long-term returns are possible.
Lilley is proud of UKW’s 150% total shareholder return (10.6% a year) since flotation in 2013, but competitors have also done well. The Renewables Infrastructure Group (LSE: TRIG) has returned an annualised 9.3%, but is better diversified geographically and in terms of methods of generation. As co-manager Minesh Shah notes, solar is more predictable than wind.
The solar funds Bluefield Solar Income (LSE: BSIF, all UK), NextEnergy Solar Fund (LSE: NESF, 90% UK) and Foresight Solar Fund (LSE: FSFL, 70% UK) have also done well. JLEN Environmental Assets group (LSE: JLEN) also invests in anaerobic digestion, as well as in waste and bio-energy. Yields in the sector range from 4.5% at UKW to 5.9% at NESF; all should grow at least in line with inflation. For the yield-seeking, risk-averse investor, the sector remains a long-term buy.
Max has an Economics degree from the University of Cambridge and is a chartered accountant. He worked at Investec Asset Management for 12 years, managing multi-asset funds investing in internally and externally managed funds, including investment trusts. This included a fund of investment trusts which grew to £120m+. Max has managed ten investment trusts (winning many awards) and sat on the boards of three trusts – two directorships are still active.
After 39 years in financial services, including 30 as a professional fund manager, Max took semi-retirement in 2017. Max has been a MoneyWeek columnist since 2016 writing about investment funds and more generally on markets online, plus occasional opinion pieces. He also writes for the Investment Trust Handbook each year and has contributed to The Daily Telegraph and other publications. See here for details of current investments held by Max.
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