Branded as 'not for the faint of heart' in the early days, direct UK renewable assets have become a staple ingredient of infrastructure funds of varying risk profiles. However, the investment landscape is shifting considerably.
The phasing out of subsidies for solar projects has slowed down sector growth. Onshore wind has been made more complex by the removal of subsidy support and planning permit issues. Therefore, the traditional model of rapidly increasing capacity – while relying on subsidies to generate revenues several times higher than the market – has all but fallen away. Instead, direct infrastructure investors will increasingly need to focus on new business models, operational efficiencies and financial structure to preserve returns.
The solar sector is benefiting from sharp declines in equipment costs. This can make projects feasible even without subsidies. The biggest hurdle to non-subsidised projects is undoubtedly their exposure to wholesale power prices which are notoriously difficult to model and forecast accurately.
We have seen the emergence of long-term contracts with large corporate electricity consumers as well as new forms of derivatives as ways of insulating projects against power price volatility. These can improve the stability of cashflow and investment appeal of these assets. Another strategy is a much more hands-on role for asset owners in equipment procurement, construction and day-to-day management. Asset owners that are able to buy panels on favourable terms have a good track record of constructing solar farms and managing day-to-day operations will be best positioned to seek to maximise value and gain access to financing on favourable terms.
Offshore wind currently accounts for the largest share of the pipeline of expected additional renewable energy capacity in the UK. Here, the sector remains dominated by a handful of large developers, while rapidly expanding project sizes mean ever increasing investment requirements and a rising involvement of institutional investors in the sector. Going forward, the sharp drop in new project subsidies (and asset cashflows) may hinder the ability of some offshore wind projects to sustain high levels of debt. This could mean a new balance will need to be struck between offshore wind project developers – who wish to maximise equity returns and may be tempted to maximise leverage – and institutional debt providers who require strong credit structures.
Finally, the energy transition is stimulating growth in relatively new asset types. As generation moves towards more intermittent renewable sources, energy storage, as well as assets that can quickly adjust their power consumption when requested, will increasingly be needed to manage the impact of renewable generation on the grid. Investors in these assets will need to become comfortable with additional technology and market risk. Deep technical expertise, detailed due diligence and strong industry networks will be needed in order to single out investable assets with confidence.
Creating assets that facilitate the transition from fossil fuels to renewable energy remains crucial and credit discipline is key to an investment approach. Within the team, we have strong views on appropriate levels of gearing in various sub-sections of the infrastructure market, which feed into credit assessment and pricing of potential investments. This philosophy – that combines credit discipline and an in-depth understanding of the way the industry is evolving – is a large part of the way we approach direct investing in the UK renewables sector.
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