Navigating the turbulence of renewable energy

It has been a bad couple of weeks recently for the renewable energy agenda. The government is planning to scrap its boiler tax, while Labour is rowing back on its commitment to green energy infrastructure. The world’s largest wind company Ørsted announced it was suspending its dividend and cutting jobs, while SSE said its renewable output was around 15% below expectations*.

The recent fortunes of the renewable energy sector have been a tough lesson in why a compelling growth story doesn’t always lead to strong investment returns. The sector has faced a perfect storm from rising interest rates and rising inflation, in spite of a strong commitment from governments across the world to renewable power.

The problems facing the wind sector

The wind sector in particular has been in the eye of the storm. It has been hit by two significant problems: the first has been rising interest rates. Along with many assets that generate a reliable, inflation-adjusted income, wind farm investments had become a proxy for fixed income during the lean years following the financial crisis. As interest rates rose, and yields jumped higher, investors returned to fixed income, creating significant outflows for the sector.

However, the sector has also had some idiosyncratic problems. It has struggled with rising inflation which has increased the build-cost for many offshore wind projects. At the same time, national operators have been slow to upgrade electricity grids, meaning wind power hasn’t come on stream as fast as it could. The sector has also struggled with supply chain disruption from the pandemic.

This has created difficult newsflow around the sector. In October, Ørsted announced that it would abandon its Ocean Wind I & II projects, just off the New Jersey shore, with losses estimated at $5bn**. Vattenfall decided to scrap its flagship UK project, the Boreas wind farm off the Norfolk coast, in July. The chief executive blamed global gas prices, which had raised the cost of manufacturing and made the project unprofitable. Avangrid, a subsidiary of the Spanish utility Iberdrola, also said it would stop work on its offshore Park City Wind project in Connecticut.

Continued commitment to renewables

However, the long-term need for wind power remains and there are good news stories. In October, the world’s largest wind farm – Dogger Bank in Norfolk - connected to the UK’s national grid via HVDC technology, providing renewable power to homes and businesses for the first time***. When complete, it will be capable of powering up to six million UK households***. In January, wind turbines started sending electricity to the US grid from the sites of two large offshore wind farms for the first time.

National Grid announced its ‘great grid upgrade’ in June, expanding the capacity of the UK’s electrical infrastructure, allowing wind power to come online. Scottish Power is also upgrading its capacity, a pattern seen across the world as governments and the private sector scramble to remove the blocks to renewable power. Governments around the world have made offshore wind a key tenet of their climate ambitions. The UK has a target of tripling its offshore wind capacity by the end of the decade****.

Long-term growth

Francesco Conte, manager of the JPM Climate Change Solutions fund, believes government support for renewable energy solutions will continue: “With energy independence being a growing focus of governments worldwide, there is a significant implication for policies and subsidies to support large-scale investment into climate change solutions. These accelerated timelines come on top of growing efforts of companies and consumers worldwide to target a carbon-neutral environment by 2050”.

Inflation is stabilising and interest rates appear to have peaked. The share prices for renewable energy companies such as Ørsted, SSE and RWE have already seen major share price drops and now look better value than a year ago. The bad news is arguably reflected in market pricing.

However, recent volatility should give investors pause for thought. Whilst there is a compelling long-term growth story, it has proved a difficult period for investors. It is also worth noting that share prices became significantly inflated during the pandemic and, while this was good on the way up, it has proved painful on the way down.

How to invest

As with all major trends, investors need to be careful how much they pay for long-term growth. It is easy to make a compelling case for areas such as renewable energy, artificial intelligence, or any other major trend. The growth can be exciting. However, if too much capital is directed at a sector, can create a bubble that is vulnerable to a significant sell-off on the smallest bit of bad news.

If investors want a dedicated climate fund, they could consider an actively-managed option, such as the JPM Climate Solutions fund. It has a balanced portfolio, encompassing five key trends – sustainable food and water, sustainable construction, sustainable transport, renewables and electrification and recycling and reuse. This means that it is not exposed to any individual part of the market and is less vulnerable to these cycles of exuberance and disappointment.

The VT Gravis Clean Energy Income is another option. This invests in a portfolio of companies involved in the operation, funding, construction, generation and supply of clean energy. The fund currently has 43% of the portfolio invested in wind projects^.

For investors who don’t want to make these decisions themselves, they could take a look at the VT Chelsea Managed Fund range, which attempts to harness these growth ideas, allocating to them at the right time in the cycle and in a proportionate, balanced way in a portfolio. In the Aggressive fund, for example, there is a position in the Ninety One Global Environment fund^, which aims to benefit from the growth in renewable power.

Greencoat UK Wind, an investment trust that owns parts of various wind farms, makes up one of the largest holdings in the VT Chelsea Managed Fund range. The trust has continued to maintain dividend growth and generate surplus cash, despite scenarios of falling power prices and elevated inflation. The trust has also recently announced an increased dividend to 10p per share - representing a 14.2% increase on the 2023 target that the board had set^^.

Renewable energy is a powerful long-term trend, but markets can periodically get too excited about its prospects, which creates volatility. However, share prices have come back a long way and there may be opportunities emerging in the sector.

*Source: Proactive Investors, 8 February 2024
**Source: Reuters, 1 November 2023
***Source: SSE, 10 October 2023
^Source: fund factsheet, 31 December 2023
^^Source: Proactive investors, 16 November 2023

Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. The views expressed are those of the author and fund managers and do not constitute financial advice.

Published on 14/02/2024