Public equity and debt investors
Companies seek finance from different investors as they develop. Renewable energy companies with unproven technologies will typically seek funding from venture capital and/or private equity investors willing to accept a higher level of investment risk. As a technology becomes more established, investment risk is reduced and the types of finance available increases.
Public equity investors and public debt investors will typically only invest in renewable energy technologies that have achieved manufacturing scale.
Emerging markets
The balance of power in renewables is shifting away from Europe and the US towards developing countries. China, with its consistent policy direction on low-carbon growth, recently overtook the US and Germany to have the biggest installed base of wind capacity globally. However, due to protectionist measures in these markets and intense competition with domestic suppliers resulting in lower average selling prices, European alternative energy companies have not necessarily benefited.
This shift has led to big changes in the location of initial public offerings and manufacturing plant investments by renewable energy companies.
Lack of opportunity
In the UK market, there are no pure play alternative energy investment opportunities for large-cap equity fund managers to invest in. Some exposure to the alternative energy theme can be achieved by investing in the ‘conventional’ listed electricity and gas producers whose generating portfolio contains some clean energy assets alongside conventional fossil fuel generation.
However, in no case is alternative energy the bulk of these companies’ portfolios.
At the small-cap end of the equity market, there are a larger number of opportunities but these typically suffer from illiquidity (making trading difficult) which is often a major deterrent to investors.
The bond model
A lack of liquidity is often also an issue for bond investors in this area. In addition, the nature of many renewable energy projects, which require a large up-front capital investment to fund construction and then limited initial cashflows, does not lend itself well to the traditional corporate bond model. Infrastructure bonds, which comprise a pool of already operating infrastructure assets and are backed by rating agencies (and so are of investment grade) are widely used by institutional bond investors.
However, thus far, the issuance of ‘green’ infrastructure bonds to refinance built and operating low-carbon infrastructure (for example wind turbines) has been limited.
Lack of benchmarks
Traditional long-only fund managers investing in the equities of UK-listed companies would typically benchmark performance against the FTSE All-Share or some component of that index. While the FTSE All-Share includes a range of industrial sectors, it does not currently include an official alternative energy sector.
As a consequence, there is less of an obligation for institutional investors to assign capital to this very small sector of the market since effectively there is no index weight.
Sensitivity to the economic cycle
Investment in alternative energy remains sensitive to the economic cycle. Historically, alternative energy technologies have not been cost competitive with conventional electricity generation (although this is beginning to change) and therefore have had to rely on subsidies to stimulate demand.
Investment in alternative energy has suffered as investors have become concerned that the subsidisation of the industry will lessen as governments struggle to reduce budget deficits. High unemployment rates also mean that governments may be less willing to burden consumers with the higher electricity prices associated with a switch to low carbon generated electricity.
Muted electricity demand growth due to weaker economic performance in developed markets has resulted in ample generation reserve margins in Europe. This, combined with the general decline in credit availability and falling global gas prices due to shale gas technology, has meant that the utilities sector, which has typically been the major developer of alternative energy projects, has been unwilling to make further investment in the low carbon component of portfolios.
As orders for their products have declined and there is temporary industry overcapacity, companies have seen alternative energy manufacturing unit costs increase, impacting operating margins negatively.
Additionally, like many other sectors, the reduced availability of credit has also impacted alternative energy companies directly. European alternative energy companies have been particularly exposed to the declining economic situation in southern Europe where the credit situation has driven up borrowing costs.
Performance
As a consequence of these factors, listed alternative energy companies have significantly underperformed other sectors of the economy since 2008.
One of the strongest catalysts for the sector would be international agreement on climate change, which would set investment grade policy, i.e. domestic and international policy frameworks and incentives that would shift the risk/reward balance in favour of less carbon intensive investment. We continue to be strong advocates for such an arrangement.
