Clean energy is growing in the grid but there is still plenty of risk for big investors.
Anyone walking a city street will have noticed bus sides and posters loudly declaring the green aspirations of banks and superannuation funds. It means one thing: they want you to know they plan to invest in renewable energy. Their marketing fails to mention the risks. Values of assets and the companies that own them rely on the outlook for energy prices, the rate that coal generators are retired and the tenor of contracted offtake agreements for clean generation, not to mention government energy policy, pressure from other developed nations, the 10-year bond rate, inflation forecasts and the odd pandemic.
“The risks are broad and nuanced,” says Angela Ruchin, a senior consultant in the infrastructure team at Jana, an asset consultancy.
Data from BloombergNEF showed new investment in renewable energy projects and companies for the six months to June 30 totalled $US174 billion, the highest for the first half of any year. As funds flood into the market, prices are being driven up. “There is definitely interest in the subsector, which is compressing returns.”
Valuing an energy infrastructure asset on expected future earnings from selling its product – electricity – is “exceptionally challenging”, Ruchin says. “The energy sector is in the biggest state of flux it has ever been in and it is very hard to predict what energy prices are going to look like.”
Without a clear idea of what energy mix is going to be around in the next few years, not to mention the next 10 to 30 years’ time, it becomes very hard to value a wind or solar farm, say, with an expected life of 20 to 30 years. “It’s very hard to predict that far ahead when people are struggling to predict a few days out,” says Ruchin, who advises institutions in Australia and New Zealand on listed and unlisted investments.
Infrastructure is meant to be a relatively dull investment class, where predictable income from highway tolls or airport fees and rents is a step up on the risk curve from government and corporate bonds. But renewables assets can be assessed using the same criteria, Ruchin says, if a wind or solar farm has a long-term contracted offtake agreement.
“As a starting point you would say, if we didn’t have any more cashflow apart from what’s contracted, what does that return look like?” she says, explaining the valuation process in its simplest terms. It then becomes a case of estimating how sensitive a valuation is to other factors before a range of returns is calculated, “to manage expectations”.
A deeper and longer-term market for corporate power purchase agreements (PPAs) would help the local clean energy industry, she says. PPA tenors can extend up to 20 or 30 years – the expected lifetime of some assets – and the energy utilities have been active buyers in Australia.
Lately, PPAs have been written on much shorter tenors, some as short as seven years. “We struggle with that being true infrastructure,” she says. “You need a PPA to be at least 20 years to have a material impact on your return.” Short tenors can lead to negative internal rates of return. In this market, a 3% annualised return for a contracted PPA is a good outcome, she says.
Investors looking to manage risk within the clean energy bucket in a portfolio will look at various technologies in different geographies. If they favour one technology – solar, for example – they will be taking less risk if assets are spread across different regions. (Ruchin advises on energy infrastructure investments in Australia and around the world.)
The big unknowns
If clean energy sounds like a sure thing, there are still blind spots: Australia lacks a clear energy strategy at Commonwealth level, and a schedule for retirement of the dominating coal generators is unknown. These are industry-wide concerns, but owners of projects that have long-term contracted offtake agreements will be less bothered by them. “There will always be winners and losers from policy,” Ruchin says.
Additional risk that is created by a lack of policy needs to be compensated in higher returns. If funds are flowing into a market that’s hyped, evident risks may not be compensated for. “There is uncertainty globally, but in Australia that uncertainty is heightened.”
Nevertheless, she says, once the challenges are understood it is possible to capture investment value in Australia’s complex but inevitable transition to clean energy.