Shares in under-pressure renewable infrastructure funds slid today after weekend reports that the government was considering imposing a cap on how much money they could make during a period of heightened power prices.
Greencoat UK Wind (UKW), which has had the highest exposure to wholesale power market prices, tumbled nearly 8%, followed by more than 7% declines in Bluefield Solar Income (BSIF) and NextEnergy Solar (NESF) with JLEN Environmental Assets (JLEN), Renewables Infrastructure Group (TRIG) and Foresight Solar (FSFL) down between 3.5%-5.4% as analysts said the move could flatten their valuations and stall dividend growth.
Reports suggest the government is drawing up plans for a temporary revenue cap that will parallel one set out by the European Union in a bid to reduce wholesale energy prices. The cost of gas and oil has surged since Russia’s attack on Ukraine and has ramped up the cost-of-living crisis, forcing the UK government to deliver an emergency energy price cap.
Now it plans to go further, following Europe in capping revenues made by non-gas generators, with companies forced to pay member states the excess profits they generate beyond a threshold of €180 per megawatt.
It is understood the UK government had started negotiations at a threshold of £50-£60 per megawatt for the likes of wind and solar energy firms, although the final threshold could be far higher as there are fears that setting the threshold too low would stifle investment in renewables, which are needed more than ever.
Chancellor Kwasi Kwarteng had hoped energy companies would agree to scrap the long-term, fixed power purchase agreements they had signed, often with the benefit of government subsidies, and replace these deals with fixed 15-year rates. He had also hoped they would stop selling cheaper renewable energy at high wholesale prices.
However, the talks broke down and the government is switching from a carrot to a stick strategy.
‘Serious implications’ for funds
Matthew Hose, an analyst at Jefferies said the cap was ‘tantamount to a windfall tax’ and would have ‘serious implications’ for renewable infrastructure funds on the London Stock Exchange. Their previously highly-rated shares had already suffered in a post-Budget selloff as investors worried the jump in government bond yields would force up the ‘discount’ rates used to value their cashflows, thereby depressing their existing valuations.
Numis analyst Gavin Trodd said the renewable energy trusts have had ‘a torrid period for performance’ since the mini-Budget, and a threshold heaped more pressure on shares.
Trodd said UKW had ‘greater exposure to merchant pricing compared with the peer group, prompting fears that it may be worst hit by any cap’.
However, Hose said renewable funds should still be able to maintain covered dividends beyond the current year.
‘The unhedged UKW would absorb the impact via the robustness of its high dividend cover model, with cover before the recent increase in prices of typically 1.7x each year,’ he said.
Power price plunge
Renewable energy companies were unenthusiastic about Kwarteng’s initial proposals, but Hose said the 15-year contracts could have been advantageous to the listed investment companies. The certainty provided by the contracts would have lowered discount rates and financing costs as well as giving ‘funds contractual certainty over revenues for an extended time period, whereas the opposite is arguably now the case’.
However, capping prices at £50-£60 per megawatt was ‘close to those captured by the funds pre-2021’, said Hose, and would ‘entail material downside to near-term cashflow assumptions’.
JP Morgan Cazenove also warned on the impact of falling future power price forecasts, which also affect the net asset values (NAVs) of renewable infrastructure funds.
Forecasts for trusts in the renewable infrastructure sector show ‘a high near-term 2022 price declining sharply in the next five years before settling at a much lower price for the remainder of the forecast period’, said JP Morgan Cazenove analyst Christopher Brown.
He said forecast prices for 2023 vary from £160 per megawatt at BSIF and FSFL to £110 at UKW, with NESF confirming it had fixed a 2023 contract at £78 per megawatt.
‘If any new policy puts a much lower cap on power prices, including on hedged fixed revenue, this could have significant downside for net asset NAVs for all six companies, as well as damaging sentiment, already affected by rising gilt yields,’ Brown said.
Discounted opportunities
Renewables are swiftly giving back the gains they made last year in the rush for green investments and Trodd said it was ‘hard to see’ the renewable trusts ‘staging a sustained recovery, despite the attractive qualities of many of the business models’, but not all is lost.
Trodd said trust portfolios offer a mix of regulated and power price-exposed revenues, and operated ‘effective hedging strategies’, and have ‘healthy dividend cover ranging from 1.5-3.8x.
‘[They have] relatively conservative balance sheets, and deliver important levels of investment which are key to achieving net-zero carbon targets, and for delivering lower cost power to consumers over the long term,’ he added.
Trodd said recent problems since the mini-Budget had left trusts in the sector trading at discounts ranging from 6.5% at JLEN to 17% at NESF, and dividends ranging from 5%-7.3%.
‘Our preference for BSIF is unchanged as we believe the conservative business model has delivered the most consistent returns in all power markets since 2013,’ he said. Numis is Bluefield’s broker.
