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The shift from subsidised to cost-effective renewables and why you should care

By Paul Flood, fund manager and strategist, Newton Investment Management

The renewables sector is undergoing fundamental change, as investors consider a future without the support of government subsidies. Here Newton’s Paul Flood asks whether falling wind and solar costs could spur even greater investment in 2018.

The transition to green energy is accelerating, with 2018 expected to deliver new investment opportunities as technological innovation and falling costs drive further momentum for change.

What started as a government-subsidised process to decarbonise the power sector is now shifting to a process driven by expenditure and economics. Over the next 12 months, as the cost of clean technology continues to fall, we expect to see an acceleration in investment, in both developed economies and fast-growing industrialising nations.

Against this backdrop, the ability of renewables to deliver what we think are stable and sustainable income streams, means they are likely to remain an attractive source of dividends and total returns.

Global growth

The speed at which the world is shifting to clean technology has taken even experts by surprise. Almost two-thirds of net power capacity added around the world in 2016 was renewable, with 126 gigawatts of solar and wind dwarfing the 86 gigawatts from coal and gas, according to a report from the International Energy Agency.

This was the  first time global growth in solar power capacity overtook new coal-fired generation. However, this milestone is expected to be quickly eclipsed. Bloomberg New Energy Finance (BNEF) predicts the renewable share will grow to three-quarters of the US$10.2 trillion the world will invest in new power generating technology until 2040.

Diminishing costs

Just a decade ago, high generation costs meant predictions of a move from a coal, gas and oil-fired world to one where solar and wind make up the bulk of energy capacity would have been met with doubt, if not derision. That has all changed, thanks to the steep fall in the costs of solar and wind power production.

Solar photo voltaic modules are down 90% in price since 1990. BNEF predicts wind and solar power will be cheaper than coal- based energy in many countries within five years and could provide up to a third of global electricity within 25 years.

Renewable technology has also become more efficient. Manufacturers are working to almost double the capacity of the current range of onshore wind turbines, which already have wing spans that surpass those of the largest jumbo jets. The cost of storing power in batteries, which in the past has hampered the use of renewable energy, has also declined rapidly.

Emerging markets

From a geographic perspective, we believe both developed and emerging markets hold enormous potential for the continued development of renewables. However, emerging markets are expected to overtake developed markets in their capacity to generate wind and solar power in 2018.

China is already the biggest investor in renewable energy worldwide and is keen to be at the forefront of renewable engineering capabilities and technologies. Other industrialising nations are following its lead, as emerging market governments pursue a renewables approach more aggressively.

Looking forward

In the US, some fear Trump’s stance on climate change could hamper innovation in green technologies. However, the vast majority of decisions are taken at the state level, and many US states, including oil-friendly Texas, have made major commitments to renewables.

Where reductions in government subsidies are occurring, they are being carefully managed. In the UK, for example, projects already receiving subsidies will continue to collect them for the full life of the contract, generally 20 to 25 years. Half of revenue streams are still backed by government subsidies, meaning they are fixed and linked to inflation.

That’s not to say the future is free from challenges. As fixed and inflation-linked subsidies are withdrawn in favour of competitive auctions or tenders, revenues will become more dependent on power prices, introducing potential volatility. More care will need to be taken analysing the trajectory of future revenue streams.

However, it is important not to overstate the threat. Electricity prices would not be expected to change dramatically over time, so revenue streams are likely to still look relatively stable compared to those of other assets. Indeed, we may see the emergence of ‘off-taker’ agreements, where large corporates fulfil renewable energy commitments by striking long-term contractual agreements with renewable suppliers. This should help to guarantee the power price received, providing valuation support for renewable assets.

The value of investments can fall. Investors may not get back the amount invested.

For Professional Clients only. This is a financial promotion and is not investment advice. Any views and opinions are those of the investment manager, unless otherwise noted.

For further information visit the BNY Mellon Investment Management website. INV01149 Exp 17 April 2018.

This article was provided by BNY Mellon Investment Management and does not necessarily reflect the views of Citywire

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