We are no longer entirely reliant on traditional, finite energy sources. Instead, the world is shifting towards renewable sources of electricity.
Many governments are investing in ‘green’ energy, as they try to curtail the effects of climate change. For example, the European Union (EU) countries have introduced renewable energy targets. These are needed to meet the Renewable Energy Directive’s goals. By 2020, one-fifth of the EU’s energy must come from renewable sources.
Forms of renewable energy include wind and solar farms, hydroelectric, geothermal and biomass power-generating facilities, as well as wave and tidal technology. The need for funding to build and operate these facilities has given rise to renewable infrastructure as an investable asset class.
European cumulative installed power capacity (past and present)
Source: Bloomberg New Energy Finance - New Energy Outlook 2018, June 2018
What drives returns and what are the risks?
Renewable infrastructure funds aim for annual returns in the region of 7% to 9%, including dividend yields of around 5% to 6%. These returns are generated from a mix of government subsidies and the sale of power to utility companies. Given the security of cash flows, funds often raise debt to enhance returns to investors. A loan-to-value ratio of between 30% and 45% is common.
For example, investors in solar assets typically benefit from a 25-year revenue stream. About 50% to 60% of that revenue comes from government subsidies. This is a reliable source of income that increases in line with inflation each year. The remaining 40% to 50% comes from selling energy to power companies and consumers. This is sensitive to changes in power prices but, where appropriate, funds use Power Purchase Agreements to provide some certainty over price.
The amount of electricity generated also influences returns. This is dependent on resource variability – for example, the level of solar irradiation or wind speed – and plant performance and costs.
Government policy on subsidies provides another source of uncertainty. Investors also need to monitor technological changes.
Renewable infrastructure assets typically have long economic lives with relatively reliable revenue streams. Although there is some sensitivity to power prices, returns are not significantly affected by economic or market conditions. Equity market moves have little effect on the prices of infrastructure assets, providing diversification benefits.
Initially, these funds invested primarily in operational UK-based solar and wind farms. In recent years, they have diversified into Ireland, France, Sweden and Australia and the US.
There has also been diversification by technology, with investments in storage devices. These batteries could solve a long-standing problem for wind and solar farms, allowing them to store energy and release it into the grid in times of peak demand. Making fuel from organic materials, using anaerobic digestion, is another area of interest.
How to access the asset class
State funding often fails to provide enough capital to build and sustain sufficient renewable infrastructure. Private funding makes up the shortfall. The capital for new wind farms usually comes from large utility companies. Solar power facilities tend to turn to smaller private developers for funding. However, neither organisation is a natural long-term owner of these assets. This is where other investors, such as closed-end renewable infrastructure funds, come in. As permanent capital vehicles, these funds are well-suited to holding assets with long lives.
Several funds were listed on the London Stock Exchange between 2013 and 2014, with the aim of buying wind and solar farms. To help support the sector’s growth, the UK government invested in Greencoat UK Wind, the first fund to be launched. These funds have accumulated around £5 billion in assets and are major holders of the UK’s renewable energy infrastructure.
RISK WARNINGThe value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.
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