InvestmentsMar 2 2015

Government pledges and renewable energy

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Going green has not just been a thing for hipsters, it’s also been a trend for investors hoping to get access to a market that are backed by assets and provide consistent yields.

Access to the renewable energy sector is generally found through investment trusts, which dominate a sector where many of the opportunities are major capital projects with characteristics that are more akin to infrastructure.

Ian Scouller, analyst at Oriel Securities, says: “The projects typically have 20 year lives and cashflows. The lack of daily liquidity makes these unsuitable investments for open-ended funds and much more suited to investment trusts”.

‘Double-edge sword’

In 2014, investment trusts that focus on renewable energy infrastructure raised £773m from new shares issued. This was up from £93m in 2013, according to figures from the Association of Investment Companies (AIC).

Indeed, energy investment trusts in general have also started to increase their allocation to renewables.

James Smith, manager of the £79m Premier Energy and Water trust, has increased his exposure to renewable energy in the past few years. At the end of 2012 he had about 5 percent of his fund; a year later this was at 8 per cent and at the end of last year it was up to 12.6 per cent.

However, Mr Smith is not completely convinced by the sector and thinks that renewable energy companies are “more volatile”. He adds: “The hesitation is the planning and political system.”

Part of the incentive for investing in renewable energy is because it is underwritten by the government.

But while there are often visible earnings from government subsidies, intervention is a double-edge sword as it makes investors nervous about changes and political commitment to a sector.

Money often flows in to catalyse growth for particular policy ends, but then ceases when the immediate needs are met. This was the case with incentives to boost solar provision in recent years, with solar farms no longer able to benefit from feed-in tariffs for new projects.

Matt Setchell, head of renewable energy at Octopus Investments agrees. He said investors are “nervous about the politics of energy and cautious about investing in renewable energy, unsure of long term political commitment to the sector”.

He adds: “Financial advisers and investors often have concerns about the impact of subsidy or policy changes on renewable energy funds.”

This anxiousness is amplified by the upcoming general election.

Mr Setchell continues: “Inevitably with a general election only a few months away there will be political posturing around the appropriate way to deliver on renewable targets while tackling concerns around the impact of renewable subsidies on energy prices.”

Pricing pledges

When you are in the right place at the right time, however, government incentives can tangibly boost the returns on offer - or, as upcoming changes could be set to prove, particular energy policies could ensure price stability and remove some of the market volatility for some renewable routes.

The UK has committed to evolving its energy infrastructure and plans to have 27 per cent of its energy supply to come from renewable sources by 2030.

Renewables made up 18.1 per cent of electricity generation in the first nine months of 2014, according to data from the Department of Energy and Climate Change. This compares to 2003, when it was just around 3 per cent.

More changes are already in the works. In April 2015 solar energy will be under a new regime: the current Renewables Obligation Certificate structure will be replaced with a Contracts for Difference scheme.

The ROC structure was enacted in 2002 to encourage the generation of electricity from renewables. It places an obligation on licensed electricity suppliers in the UK to source an increasing proportion of electricity from renewable sources.

Under the new CFD regime the government will pay the difference between the variable wholesale electricity price and the fixed “strike” price of the technology for 15 years.

This changeover will happen for other renewables, including wind power in 2017.

There are six renewable investment trusts that focus on solar and wind energy: Bluefield Solar Income, Foresight Solar fund, Greencoat UK Wind, John Laing Environment Assets, Next Energy Solar, and Renewable Infrastructure Group.

Investors will be provided for more certainty under the new CFD regime, as the companies generating the power should receive more stable returns and will not be exposed to market caprice for the first 15 years of the project.

Indeed, price is the one of the largest risks for the renewable energy sector, according to Mr Scouller.

He added that while a small change in short term power prices is “unlikely to result in any material change,” a long-term change could have a substanital impact.

The oil price plummeted at the end of last year and the beginning of this year, but the price of gas, which is more important for renewables, has been rising.

While overall sentiment for the CFD scheme seems positive, a report from Oriel Securities noted: “There is a feeling that details on the new regime have been slow to be released by the Government and there remain unanswered questions.”

This change in government policy has been thought to be quite positive in the long term, but in the short term it could hinder renewable energy investing.

The Oriel Securities report said: “As with any change in policy, there is likely to be some hiatus in new developments as investors become familiar with the practicalities of the new method of working.”

Investor demand

However, despite investor apprehension investment trusts in the sector are likely to continue issuing shares and grow in the coming years.

Mr Scouller says: “The sector continues to grow with significant pipelines of new projects which will need to be funded in the next few years. It is likely that there will be continued equity issuance from the sector in the next few years”.

This continued surge of issuance is important, as the investment trusts currently in the market are trading at “significant premiums,” according to the managing director of Tilney BestInvest, Jason Hollands. This reflects the demand for the “attractive and stable yields on offer,” he explains.

“Investors should therefore principally be looking for IPOs or new fund raising’s to participate in these.”

kathleen.gallagher@ft.com