Renewables and sustainability – an investment opportunity?

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03/09/2020
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Sustainability is a word we hear being used every day now, and it isn’t just in the investment world - more and more products are being labelled sustainable, from food and clothing to holidays. This change has been a long time coming and is very welcome. But let’s be clear about what sustainability means.

In 1987, the United Nations Brundtland Commission defined sustainability as “meeting the needs of the present without compromising the ability of future generations to meet their own needs.” When you look at it in these terms and when you take the UN’s Sustainable Development Goals (set out in 2015) into account it is clear there is a very long road ahead. The changes the world needs to effect are huge.

A visible sign of this change is renewable energy, to the point where images of wind turbines have become a little cliched. The only way to halt climate change is to decarbonise and a major part of this is to stop using carbon-based energy sources.

The UK’s energy mix has been transitioning from coal and gas towards renewables for a decade or so and during the first quarter of 2020, 47% of the UK’s electricity generation came from wind and solar. Additionally, during the first half of the year there was a two month stretch when no coal-powered electricity was generated. The UK hopes to close all coal plants by 2024 as part of the Government’s net zero emission target. Yet a decade ago approximately 40% of the UK electricity came from coal. All change! An obvious consequence of this is that the carbon intensity (a measure of how much carbon dioxide is emitted for each kilowatt hour of electricity produced) was the lowest recorded by the UK (Energy live news, 2020)

Projections for future electricity production from renewables show a strongly positive trend. When all sources of renewables are included, such as biomass and hydro, the forecast is for around 80% to come from renewables in the UK by 2040 (Numis presentation, August 2020). This pattern is expected to be replicated worldwide, with European countries leading the way. As the sector grows, newer technologies such as biomass and battery storage will become more prominent. Their base costs will fall which then enables wider installations and further integration into the grid system.

We have here an industry driving structural change which is going to play out over the coming decades, and this presents a compelling investment opportunity. And of course, the demand for power is only going one way too.

So far so good, but you may remember that futurists had predicted free and unlimited energy, so could renewables be pointing in that direction? – It’s certainly not just around the corner and if it ever were to happen I don’t think it’ll be in my lifetime, but it raises an important point – power prices. The power price is important because it provides the return for electricity generators like renewables. Current projections are for a steady power price long term (20 years) (Numis presentation, August 2020), which should mean that investment in renewables remains attractive. And those attractions are considerable, firstly a high income which is stable - from an asset-based investment which means the net asset value (NAV) should have low levels of volatility. A part of the income is fixed (there are power price contracts in place), and it also has an element of inflation linking.

The sector is however trading on a premium. This is not surprising given the yield and strength of demand for assets, but I don’t feel it’s expensive given the characteristics and the long-term outlook.

In the COVID-19 market sell-off renewable investment trusts got hit like most securities as almost every asset class became correlated. But the NAV wasn’t impacted and nor was power generation. Thankfully share prices recovered quickly. There are potential risks, such as a change in the long- term outlook for power prices but set against the wider backdrop and the important and tangible contribution renewables are making to sustainability, they look well placed for the medium to long term.

 

 

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