Solar offers ‘low-risk’, long-term yields

The low-risk characteristics of solar projects and the structural benefits that can be introduced alongside the asset class are key reasons why this is the case.

Solar projects worldwide experienced a 25 per cent year-on-year increase in investment to $149bn (£97.5bn), or 48 per cent of the total $310bn invested in renewables in 2014, according to Bloomberg New Energy Finance data.

Though driven to some extent by the falling technology costs, it is also part of a longer trend that, in the UK, has seen growth to approximately 5,000MW since 2010, from a negligible base.

According to the Department of Energy & Climate Change, the solar sector is aiming for more ambitious and sustainable deployment, to achieve cost reductions to deliver 11-12 gigawatt (GW) of capacity by 2020. This combination of declining costs coupled with its favourable characteristics, particularly from a risk-adjusted return perspective, is likely to ensure that the development of solar remains a compelling proposition.

Solar developments have limited technical risk and once commissioned, the panels require only daylight to generate electricity. Thereafter, they rely only on the integrity of the physical interconnection, which is standard, robust and well proven.

The capital costs are identified at the outset, and with no fuel input costs (unlike nuclear, coal or gas-fired power plant) there is limited scope for increases on the operational side and modest costs associated with the maintenance regime.

Consequently where a solar plant is acquired as an operating entity, typically following the successful completion of tests to demonstrate commissioning has been achieved, the risks become negligible.

Once operational, solar installations benefit from an index-linked revenue stream, representing the subsidy under the Renewables Obligation that is government-legislated.

This has been ‘grandfathered’ until 2037, and falls within a prescribed budget (entitled the Levy Control Framework) to manage the government’s long-term financial commitments, and which is payable alongside revenues from the sale of electricity.

This produces high-yielding, inflation linked and sustainable income of the type sought by institutions, annuity providers and pension funds.

The low-risk characteristics of solar projects have resulted in deployment of capital from a range of sources. This includes hedge funds, pension and investment funds and bank debt.

Notwithstanding the exclusion of greater than 5MW solar projects from ROC-eligibility and of solar projects from eligibility under EISs, the attractive features inherent in solar transactions will ensure they continue to attract a steady stream of investment, particularly for high net worth investors. With a possible ungeared equity return in the range of 7-8 per cent, solar projects offer the opportunity to deliver a range of structured products to meet the interests of high net worth individuals.

The other key benefit associated with solar structured products is that, if made in conjunction with appropriate planning for inheritance tax, investments can qualify for business property relief after two years, without the complexity of trust and legal structures.

Some institutions are delivering attractive propositions that replace the investment streams with more structured alternatives, aimed at investors with an appetite for a medium term holding.

As a result of the combination of low risk profile and attractive returns (structured or otherwise), together with the benefits of tax planning, it is anticipated that there will be a robust range of solar sector investments to choose from.

Peter Conway is partner of Cocoon Wealth