Planning to invest in mainstream renewable energy sector? Read this first!
Investing in renewable energy is actually very popular in some regions. Is this because the technology has advanced so much? Or is it because the risk-return profile is so great?
In fact, it is a combination of several factors.
First, the current macro situation featuring super-low interest rates does not make it easy for institutional investors, such as pension funds or insurance companies, to meet their liabilities. They invest a big chunk of their money in debt, followed by equity, and the rest is in alternative investments. Some governmental notes yield almost nothing; company bonds are also extremely low and equities are probably massively overvalued. That’s why institutional investors tend to look elsewhere, including at alternative investments (e.g., renewable energy).
Secondly, at the same time, some countries have implemented feed-in tariffs (or feed-in premiums, which is basically the same and will be explained in the following sessions) for selected renewable energy technologies (e.g., wind, small hydro or photovoltaic). Such feed-in tariffs lock in the price level for the generated electricity for 10 years or more (depending on the country and particular regulations).
Thanks to the feed-ins, the eligible renewable energy projects look a lot like fixed income from a cash flow perspective – you could even call it asset-backed fixed income. The revenue part of the project can also be very stable (price coming from feed-in tariffs and volume can actually be estimated quite well – at least on a yearly basis).
Thanks to such stable cash flows (the cost part of renewable energy projects is quite stable and easy to estimate / lock in for upcoming years), the risk profile of the project is favorable; institutional investors have noticed this and have become quite familiar with this asset class in recent years.
Institutional (financial) investors are one part of companies that invest in renewable energy projects. Utilities are the second type of buyer. They are not motivated solely by financial return, but are specifically looking for opportunities to diversify their portfolio in terms of merchant exposures. Historically, a large part of the business of the utilities was generation (conventional generation assets), and conventional generation assets were normally exposed to market prices. Massive drops in electricity prices in recent years (especially in continental Europe) evaporated billions of dollars of the market capitalization of utilities, leaving them desperate to find new business segments (e.g., renewable energy generation assets with feed-in tariffs).
In summary, given a super-low interest rate environment and the huge amounts of capital held by financial investors, the search for new opportunities on the utility side and the de-risking of renewable energy projects via feed-in tariffs resulted in a huge demand for renewable energy projects. Is the market overheated? Where is the sweet spot? We will be answering this in upcoming articles.