Power Prices and Premiums, Photo by Jan Kaluza on Unsplash

Pondering Power Prices And Premiums

A couple of negative broker notes have caused some pretty hefty share price declines in the renewable energy infrastructure sector this week. One of my holdings, Bluefield Solar Income, has been hit the hardest and I’ve been tempted into a tiny top-up.

Having been wakened from my usual slumber, I thought it was worth departing from my usual Tuesday schedule to get my thoughts in order.

Unstoppable renewables

The soaring premiums and rampant capital raising in the renewable energy sector was one of the stories of the investment trust world in 2019:

  • 3 new funds were launched, taking the total to 13;
  • total assets rose from £5.9bn to £8.2bn, mostly due to capital raisings by existing funds;
  • the average premium hit 19.6% having started the year at 8.1%; and
  • it probably didn’t hurt that a young lady called Greta took the climate change debate to another level.

Bubble. Bubble. Bubble?

Cold water arrives

On Monday, Citywire reported that analysts from JPMorgan Cazenove had highlighted that share prices in the sector could fall by 40% if one long-term forecast for energy prices turned out to be correct.

This was a combination of the premiums to net asset values disappearing and net asset values falling by a third as well.

The day after Jeffries put the boot in, using the same price forecasts it would appear, but suggesting it could hit dividends as well. Although part of these funds’ income is backed by subsidies, a significant chunk is exposed to power price movements.

Many of these funds aim to increase their dividend by the RPI measure of inflation each year. But if their income is curtailed, this may become harder and harder to maintain.

Of course, were NAVs to fall by a third, it would seem pretty obvious dividends would follow suit to some extent.

For example, if you assume Bluefield dividends rose by 2% a year then they would be about 16p by 2040.

If NAV fell by a third, it would be around 78p. That would imply a dividend yield of just over 20% — which is bonkers.

What’s a few percentage points between friends?

Both brokers seem to be using forecasts by Bloomberg New Energy Finance that suggests that power prices could fall 4% a year in real terms (i.e. after inflation) between now and 2040, taking the price to £19/MWh, with a further fall to £15/MWh by 2050.

Good news for our joint account, less so for my holding in Bluefield Solar.

Bluefield’s 30 June 2019 valuation said:

The blended forecast used within the latest Directors’ Valuation is based on forecasts released in April and June 2019 and implies a compounded annual growth rate, in real terms from 2019, over the 30 year forecast of -0.2% per annum from a starting point in the low £50s / MWh to final life price post 2050 of c.£50/MWh.

According to Jeffries, other funds are using slightly higher price assumptions. Citywire reported, “Foresight Solar, JLEN Environmental Assets, NextEnergy Solar and Greencoat UK Wind predicted 0.4% to 1% annual real growth“.

The analysts also reckon the power price falls are being masked by other assumptions being tweaked in the other direction — such as slightly lower discount rates, longer asset lives, and not reversing out the abandoned 17% corporation tax rate.

The share price falls for most of these funds were 5-6% from Monday to Thursday although they have bounced back a little while I have been writing this article. Bluefield was the hardest hit, down around 12% at one point I believe.

That encouraged me to have a nibble. It’s still a small position for me and I was hoping to top it up at some point this year anyway.

The long wait for NAVs

Both JLEN and Greencoat have released their December 2019 net asset value numbers this week, and they both fell largely because they included the power price falls that took place in the fourth quarter of last year.

JLEN saw its NAV decline from 104.7p to 101.8p with power prices hitting NAV by 4.3p and other factors dragging it up by 1.4p:

JLEN uses a blended curve informed by the central case forecasts from two established market consultants, with adjustments for project-specific arrangements as appropriate. Electricity price forecasts have reduced by c. 7.5% from the Half Year report on a fairly uniform basis across the forecast curve, reflecting the consultants’ views on continuing deployment of off-shore wind and strong supply of natural gas. This has reduced the portfolio valuation by £21.6m (4.3p per share) compared to the Half Year valuation.

Greencoat saw its NAV decline from 122.9p to 121.4p, and also cited weaker power prices, but didn’t break down the specifics.

It’s always worth remembering that the quoted net asset value figures can be quite out of date for these funds. They are usually updated each quarter, but often on a piecemeal basis with just a few assumptions changed. The full valuations are usually only reworked half-yearly or yearly.

For example, we’re not likely to get Bluefield’s end of 2019 NAV until late February when its interim results are published. By that time, the 116.6p figure we currently have will be five months out of date.

In some respects, this isn’t really a problem. NAVs for these trusts tend to move pretty slowly. Bluefield’s NAV has edged up from a low of 95.5p in early 2014 to a high of 118p in late 2019, an increase of 4p a year over that timeframe.

Jelly on a plate

Of course, the fact that these figures are updated infrequently can help us. We’re less tempted to react to every tiny bit of news.

But they can also lull us into a false sense of security. I certainly wasn’t aware that power prices had continued to fall in the last quarter of 2019.

It’s also worth remembering the nature of these valuations. They aren’t that precise.

It’s a bit like trying to catch a plate of jelly that’s been thrown at you at high speed. In the dark.

Most of these assets have lives of 25 years plus. Even a small difference in any annual percentage change assumption can significantly impact the final result.

And there are several factors like this and they all sort of inter-relate to some extent.

And you also need to consider the portfolio of assets held by any given trust is likely to look completely different in 20-30 years’ time. Those owned now could be a tiny proportion of a trust’s future portfolio, certainly in terms of value.

Final thoughts

I see Citywire are now running a few articles on the sector under the ‘Risky Renewables’ heading.

That might be overegging things a little but this affair is a welcome reminder that these funds are far from a sure thing.

I don’t have a firm view on which power price forecast is likely to be correct. I suppose I’d lean towards flat prices if anything, but it’s an area I’ll be watching much closer after this week’s events.

The seemingly steady progress of alternative asset funds can certainly be deceiving. Asset values tend to creep upwards but lurch downwards when you’re least expecting it.

We’ve had infrastructure funds hit by political concerns in the last year or two, aircraft leasing funds clobbered by reduced estimated final sale values for their Airbuses, and debt funds find their credit quality was somewhat lacking.

Renewable infrastructure funds are still in their infancy of course. The old guard only dates back to 2013 and half the sector doesn’t even have a 3-year track record yet.

The big premiums these funds have enjoyed have helped new funds launch, with punters keen to snap up shares near their net asset value.

But even the 3 funds launched in 2019 already command a premium of around 10%. And all 13 funds stand at a premium.

The renewable/infrastructure funds I have – HICL, Bluefield, and Gresham House Energy Storage – only account for some 4% of my total portfolio. I have a vague plan to get that to perhaps 5% with opportune top-ups, if possible.

But I don’t think I would want to go much higher than that.

As these funds mature, and we start to get a better idea of what subsidy-free renewables might do to power prices, I may get a little bit braver.


Disclaimer

Please note that I may own some of the investments mentioned above -- you can see my current holdings on my portfolio page. Nothing on this website should be regarded as a buy or sell recommendation as I'm just a random person writing a blog in his spare time and I am not authorised to give financial advice. Always do your own research and seek financial advice if necessary!


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6 Replies to “Pondering Power Prices And Premiums”

  1. Hi

    Enjoyed the article (as usual – great blog).

    Re:” I’ll be watching much closer after this week’s events.”

    You can get UK OTC Day Ahead power prices here:
    https://www.nordpoolgroup.com/Market-data1/#/n2ex/table

    You can get UK forward curve / futures prices here:
    https://www.theice.com/about

    Need to register (free), and then look for ‘UK Base Electricity Futures (Gregorian) – UK Grid’.

    For example, current rolling 12-m baseload is £42.00/MWh; this time last year, £60/MWh (recent highs £70/MWh)

    Basically, everything down on the back of the UK/Europe being awash with gas (e.g. storage in Germany is still 90% – unprecedented for time of year) and recent months of high renewable output.

    Low gas prices / high wind generation = lower power prices (remember The Economist’s front page from a few years ago? Something like: Renewable Energy’s Dirty Little Secret).

    Then there is the impact of the Balancing Mechanism (under whelming for small generators so far) and the recently re-instated Capacity Market (yesterday’s T-3 auction closed at £6.44/kW (way below currently years’ around £20/kW)

    Re: “Of course, the fact that these figures [NAV] are updated infrequently can help us. We’re less tempted to react to every tiny bit of news”

    Is this working in the favour of the investor or the investment manager, though?

    As I said, enjoyed your summary, agree with your observations, and also hold
    BSIF, GRID and JLEN. Am wondering about TRIG and UKW – might wait on see results on 18th and 27th Feb first.

  2. Many thanks for those links, Andrew. Nordpool I have looked at before, I think, but not theice.com – will check them out.

    It will be interesting to see how these recent price moves end up affecting the PPA chart that BSIF publishes. That’s always been considerably less volatile than the wholesale price and seems to have been more or less flat from June 2014 to June 2018 on the latest verion they published (page 6 of http://www.bluefieldsif.com/media/148208/BSIF-Annual-Results-Presentation-2019.pdf)

  3. Hi

    Sorry for the delay in replying.

    Yes, saw that previously, and looked mainly at the next page (p.7), where they illustrate their ‘Revenue Generation Process’.

    Key figures here are the subsidies’ (ROC/FIT) rate v the PPA (£80.20/MWh v £52.00/MWh).

    The PPA price is worth 39% of the total price. Assuming for the moment that the PPA price = wholesale market price (it isn’t) and then amend it by the 10% sensitivity analysis then this leads to a 4% decline the headline rate (i.e. £127.60/MWh v stated £137.60/MWh). If we change the PPA to say current 2023 baseload prices (as far out as ICE goes) and use £40.00/MWh then this leads to a 9% drop in revenue.

    (The PPA price will be made up of commodity + Embedded Benefits (EB); the main EB is BSUoS and Ofgem announced just before Christmas that this will be scrapped from April 2021. This is calculated each half hour but worth approx £2.50/MWh. This has caused considerable anguish in the renewable generation community)

    What to make of this? I couldn’t get much further, as then I read about companies ‘changing their discount rate’ (on CityWire, I think) and we can see this would also have a meaningful impact. The largest influence is generation (or yield) and this naturally is quite varied, month to month, year to year.

    As the era of subsidy free renewables is here (or nearly) then clearly it becomes a balance between falling cost of new plant and equipment v. lower power prices. I don’t suppose anyone really knows the investment return answer to this (given so many variables). Interesting that players are looking to expand into Spain and Italy, though.

    As I say, looking forward to results / analyst commentary later this month (incl your write up).

  4. Hi Andrew,

    I came across a research note from Hardman on Twitter which has a comparison of the discount rates used.
    https://www.hardmanandco.com/research/corporate-research/uk-renewable-energy-infrastructure-funds-a-20-20-vision/

    According to the table on page 39, the main 6 funds vary between 7.0% and 8.1% at the moment, although 5 are between 7.0% and 7.5% and Greencoat UK Wind is somewhat of an outlier at 8.1%.

    A snippet from the report:

    “It should be noted that Greenfield UK Wind’s discount rate is calculated on an unleveraged basis, a factor that materially distorts any direct read-across comparisons. Indeed, if Greencoat UK Wind were to use a leveraged discount rate, its figure would be nearer 10%.

    It is also salutary to compare the discount rate changes between Greenfield UK Wind and Bluefield Solar. Greencoat UK Wind’s unlevered discount rate has barely fallen since its listing in March 2013; by contrast, Bluefield Solar’s discount rate has been cut by ca.2.5% since its own initial listing some months later.”

    I wasn’t planning to write up BSIF’s interims, but given recent events I might do a quick piece on them. Looks like they have set the date as Tue 25 Feb.

  5. Hi

    Thanks for the link to the report – enjoyed reading that.

    In summary, then: it is about decreasing subsidies v cost of plant v price of electricity (plus amendments to discount rate, yield, inflation…)

    In respect of electricity prices:

    – short to medium term, looks okay (re: NextEnergy Solar 76% of revenue i.e power with ROCs/FITs to March 2021; Bluefield has 64% of revenue covered if power price falls to zero; though on p. 40 “ Nonetheless, power prices remain a key factor in NAV appraisal. In Bluefield Solar’s case, it assumes a ca.£32m each way impact on revenues arising from 10% changes in power prices”

    UK gas and Day Ahead prices are very volatile at the moment –the author doesn’t really touch on this (not sure of the relevance of the bar chart on p. 21 – a very cursory mention of ‘gas input driver’ which appears to take in gas usage).

    – He talks about the need for them arranging attractive PPAs…well, yes, but what is a PPA? It is a LT bi-lateral agreement based on market/commodity prices (and likely to be % discount)

    – I did smile when reading, on p. 21, ‘power price projections to 2040’: “it was compiled by two leading independent energy market consultants”. This phase is in almost all the companies’ annual reports. This ‘group think’ card seems to have been well played (as it is/was in their interest)

    – Of course, there should be a premium on these types of investments in a low-interest rate environment – just what level, and should sentiment turn re perceived impact of lower electricity prices becoming more widespread / mainstream news

    – Of course, lower power prices is leading to a cut in the NAVs which leads to even higher premiums

    However, I do wonder if what will actually cause a drop in the share price will be if one of these companies makes a cut to their dividend?

    Am now wondering if I should be in Greenfield UK Wind rather than Bluefield Solar.

    I would be interested to hear your views, and up-coming commentary (on all matters IT – my SIPP and ISA are solely IT based).

    My final 2p’s worth:

    “it would be no surprise if a bidder were to emerge – and especially one seeking to acquire a portfolio of valuable renewable energy assets” – Shell?

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