Renewable energy investing has been a booming business for the past five years with significant swathes of wind and solar generators now competing head on with heavyweight incumbents across the globe. We expect this trend to continue, however, the withdrawal of subsidies has prompted a change in investment style and direction to maintain attractive risk-adjusted returns.

A dazzle of zebras

Global investment in renewable energy held steady in the third quarter of 2018 as transactional volumes matched the US$70 billion spent in the same period in 2017. The strong second quarter to the year means year-to-date volumes are only marginally down 4% on the same period last year, to US$210 billion. This is expected to deliver total global renewable investment in excess of US$275 billion in 2018, a good outturn in what is widely considered a challenging investment environment. Technology cost reductions realised in the period are an influencing factor but transaction volumes recorded demonstrate the resilience of the sector despite local and global headwinds.

Global renewable energy transaction volumes

However, with government-backed support mechanisms being withdrawn across the globe, investors previously geared up to invest in wind and solar are having to reconsider what they are looking for in a post subsidy world and where to go next.

A confusion of wildebeest

The UK has one of the most advanced energy markets in the world and often is considered a bellwether for energy-related investments. In this context we can view the impact of recent withdrawals of UK subsidies on investor behaviour in the global market. While the UK remains one of the world’s most liquid renewable energy markets, a changing policy environment means year-to-date transaction volumes in 2018 are down 35% to US$9 billion compared to 2017.

UK renewable energy transaction volumes

This decline primarily tracks the withdrawal of Renewables Obligation and Feed in Tariff support mechanisms, which have historically underpinned investment decisions in construction projects across the renewable energy asset class. Onshore wind and solar have been most affected with the number of new developments being advanced slowing to a trickle. In contrast the secondary market for operating assets is in a period of consolidation with a small pool of established investors defined by low costs of capital acquiring several large portfolios.

A sounder of warthogs

The overall slowdown in investment volumes in the UK is despite increasing awareness from both public and private entities on the potentially catastrophic impacts of global warming, starkly highlighted in the latest International Panel on Climate Change (“IPCC”) report, which warns of the risks of not meeting a 1.5oC target. Bucking this declining trend is offshore wind which has sustained investment volumes approaching US$5 billion annually in the past couple of years on the back of continued UK government support.

Other areas showing increased transaction activity include associated energy and infrastructure sectors such as transmission and water plus new investment in energy related service businesses ranging from energy trading and supply companies to electric vehicle infrastructure developers and Independent Distribution Network Operators (“iDNOs”).

A journey of giraffes

To better understand the emerging investment trends, we compare prolific UK renewables investors from the last five years with those currently active in the wider energy market today. Of note is how many investors with a track record in wind and solar are still active today but often with diverging investment themes.

This shift in investment behaviour can be considered within five broad categories (the ‘Big Five’) namely adaptation, migration, evolution, hibernation, and reinvention. Evidence of the different journeys investors are taking is reflected in the varied mix of transactions JLL’s Energy and Infrastructure Advisory team have been involved with this past year.

A pride of lions

Adaptation is identified where investors previously active in UK onshore wind and solar have diversified into related renewable energy asset classes often benefitting from continued government support, notably offshore wind and bioenergy. While the technology and preferred ticket size can vary considerably these investors still place significant emphasis on the secure revenue profile afforded by continued UK government support or robust alternative PPA contracts where available.

Offshore wind has been the primary beneficiary of this adaptation in investment focus with transaction volumes from traditional onshore wind investors like Macquarie, Equitix, Greencoat and TRIG on the rise. New market entrants such as JPower, a Japanese utility advised by JLL, have further bolstered the sector as illustrated in their recent acquisition of a minority stake in the Triton Knoll Offshore Wind Farm.

Underpinning this growing interest is reduced technology costs, a growing understanding of the risks surrounding offshore wind and the UK government’s Contracts for Difference (“CfD”). Together these have contributed to significant yield compression in the sector. Similarly, the bioenergy and waste to energy sectors continue to be of interest attracting investments from the likes of Octopus, Foresight, Peel Environmental and Copenhagen Infrastructure Partners. Projects are considered particularly attractive where they have secured government support or can access additional contracted revenue streams, such as waste gate fees and heat revenues.

An obstinacy of buffalo

Migration is where investors rely on their core expertise to invest in solar and onshore wind projects in new geographies and often at an earlier stage of development. Target new markets are typically defined by combinations of strong natural resource, low native development costs, availability of government support programmes and stable regulatory and trading environments.

The migration trend can be evidenced through country transaction volumes with the Nordics and Ireland emerging as strong performers for onshore wind while Australia, the Netherlands and France are proving popular for solar. Investors including Octopus, Foresight, John Laing and Blackrock can all be seen to be active in new markets within carefully defined investment strategies aimed at delivering stable portfolio returns from a diversified portfolio of onshore wind and solar assets.

The Nordics are proving particular attractive to onshore wind investors at present due largely to the fact Nordpool is the largest single traded market in Europe with liquidity stretching out to ten years. This along with the potential for corporate Power Purchaser Agreements (“PPAs”) is expected to help Sweden alone develop out an estimated 70-90TWh of wind over the next ten years. In contrast the Netherlands and France are representative of markets with enduring government support programmes that draw significant interest from both onshore wind and solar investors not comfortable with higher levels of merchant exposure.

A leap of leopards

Evolution is seen where investors in the UK have accepted the removal of subsidies and are now comfortable investing on a fully-merchant basis in subsidy-free renewables or flexible generation assets. Investors active in this space are willing to accept greater trading and volume risk on the back of informed views on macroeconomic drivers and perceived value extraction potential from an increasingly volatile contracting and trading environment.

Top 10 subsidy-free markets 2015-2018 (MW)

To date 8GW of subsidy-free renewable energy transactions have already taken place globally, supported in part by an increasing volume of corporate PPAs expected to reach 900TWh in 2018, double the 2017 volume.

The UK has been at the forefront in the surge of flexible generation and storage assets including gas peakers, battery storage and Demand Side Response (“DSR”). Recent rulings by the European Court of Justice aside, this growth in flexibility has been stimulated through the Capacity Market in response to security of supply in the GB market. To date the delivery body has procured availability from 9GW of new-build generation capacity, 3GW of unproven DSR and more recently over 2GW of new interconnector capacity.

New flexible capacity participating in UK Capacity Market auctions per delivery year (MW)

Both merchant renewables and flexible capacity assets are typically combined with novel route to market products including bespoke trading strategies and corporate PPAs where available. Key issues to negotiate in these route to market agreements include tenor, price, volume, profile, and credit worthiness. Well-crafted contracting structures, including tailored PPA terms, can deliver attractive returns on investment underpinned by Capacity Market availability payments projects and the availability of project finance from a growing pool of lenders.

JLL have advised several developers and investors on the intricacies of subsidy free renewables and flexible generation and storage assets recently including Infinergy, who concluded a development funding agreement with Boralex in Q3 2017, and a UK gas peaking developer, who disposed of a 60MW portfolio of gas-fired reserve power projects to Quinbrook Infrastructure Partners in Q3 2018.

A key theme for success in these types of transaction is enabling flexibility within contracts between developers and strategic or financial partners that delivers a balanced risk-sharing approach while ensuring target returns are delivered with upside-sharing. Transactions of this nature are further supported by detailed trading strategies, risk mitigation measures for electricity price cannibalisation and strong partnerships with technology providers.

A memory of elephants

Without subsidies some previously-active investors are moving away from new investments in solar and onshore wind in the UK and for now are refocusing on investment opportunities outside the renewable energy sector. For investors primarily focused on securing stable yields infrastructure assets such as transmission, transport, water, and broadband can be attractive. Others prefer to revert to development plays in real estate or other core business areas.

A trait common to all investors within this category is the preference for a significant portion of contracted or regulated revenues. Without this there is a reluctance to embrace the merchant model whether through equity or debt. It is feasible to consider these investors will re-engage with the onshore wind and solar markets in future but only where route to market contracts can de-risk the revenue profile while still maintaining minimum investment hurdle rates.

A crash of rhinoceroses

Some individuals and investors previously-active in onshore wind and solar are now reinventing themselves by looking to target development and investment opportunities outside core renewable energy technologies in a variety of new areas including related energy service businesses ranging from energy trading and supply to electric vehicles (“EVs”)and iDNOs.

Transaction activity in these areas is increasing with notable transactions including the investment by Mitsui & Co. into Erova Energy, an independent energy trading and services company based in Dublin advised by JLL. Other examples include Magnetar’s investment into Bulb, a newly founded electricity supplier and the joint venture by Ancala and Peel Group in Leep Utilities, an iDNO which owns and operates regulated and non-regulated utility networks.

A business of mongooses

Changing market conditions as seen in the UK highlight how traditional investors in renewable energy are changing their investment focus in the absence of government backed support mechanisms. Traditional investors including utilities, oil majors, infrastructure funds, private equity and tax based investors are all involved in the move into new markets and sectors. Alongside these traditional players new investors are employing innovative business models aimed at capturing value from volatility and flexibility which have the potential to significantly disrupt and challenge the status quo.

Funding first mover investments in this space requires a detailed understanding of merchant, contracting and regulatory risks. This ensures businesses can access multiple revenue streams simultaneously and contract for different revenues seasonally as opportunity costs change. In this context, establishing a robust investment case for new build projects is more about route to market and deep collaboration between project participants as it is about securing land, grid and planning.

An armoury of aardvarks

An evolving regulatory environment gives cause for uncertainty and unexpected outcomes can impact sharply on the direction of investment flows. However, the macro trends underpinning global investment volumes in core renewable energy technologies and across the wider energy and infrastructure space are robust while the urgency surrounding the need to decarbonise is only growing. The constant across all market movements is reducing renewable energy technology costs alongside new and growing digital innovation. These value drivers can more than offset the removal of subsidies in the short term and in the longer term will radically redefine consumers’ relationship with energy.

In 2019 we anticipate sustained investment volumes across the energy and infrastructure spectrum despite the reduction in renewable energy subsidies. Offshore wind will remain a hotspot for both UK and international investors as the sector continues to mature. For onshore wind and solar, innovative route to market solutions and flexible contracting structures will be the focus. Finally, we expect to see growing investment volumes in related energy and infrastructure assets and service businesses as EV adoption picks up and growing digital innovation allows for greater consumer engagement in the energy market.