Revenue cap rumours spark renewable energy trust sell-off

The booming investment sector is coming under pressure from the government due to high energy prices, with rising bond yields also a headwind.

Reports that the government will introduce a cap on revenues for renewable energy companies has sent shares of investment trusts in the sector plummeting.

Amid soaring wholesale power prices, electricity generators are seeing bumper profits and revenues, including Britain’s solar and wind producers. But this has attracted unwanted attention from the government.

The Financial Times reported the government is drawing up plans for a temporary revenue cap, similar to in the European Union, where “excess profits” are collected by the government when power prices are above €180 per megawatt hour.

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The report said that that a price of £50-£60/MWh could be a starting point for negotiations on an “excess profits” tax. Electricity and gas prices are currently around £500/MWh, according to Ofgem, the energy regulator.

Liberum, the investment trust analyst, calculated that there was an average 6.7% share price decline among six renewable energy investment trusts yesterday, including the two largest UK wind funds (Renewable Infrastructure Group and Greencoat UK Wind), the three largest UK-focused solar funds,  (Bluefield Solar Income, NextEnergy Solar, and Foresight Solar), and JLEN Environmental Assets, which has more than 40% revenue exposure to UK solar and wind.

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This has put a dent in a strong run for the sector, which has benefitted from a government push to renewable energy, high power prices and inflation-linked revenues. The Association of Investment Companies Renewable Energy Infrastructure sector has delivered total returns of 35% over the past five years. However, over the past month the average trust has dropped 9%. 

Numis, another investment trust analyst, says that while uncertainty remains over a revenue cap being introduced, as well as the duration, price limit and implementation of it, it is hard to see renewable energy trusts shares staging a sustained recovery, despite the “attractive qualities” of many business models.

Concerns over a revenue cap come amid problems linked to rising bond yields. Renewable energy trusts, similar to infrastructure trusts, compete with bonds as the income component in an investor’s portfolio.

A higher “risk-free” return from government bonds decreases the appeal of the riskier returns on offer from investment trusts. If an investor can get 4.5% from lending to the government, then taking the extra risk for a 6% yield on an investment trust makes less sense.

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Liberum says: “Sentiment towards several of the largest UK-focused renewable infrastructure funds has turned sharply since the mini-budget.

“Concerns initially reflected a declining income premium provided over risk-free rates (the yield on 20-year gilts has increased by 3.2 percentage points this year to 4.6%) and an expectation that discount rates will have to increase materially to reflect the higher risk-free rates.

“The focus has now shifted to the potential impact of legislation that could result in a price cap on the wholesale price renewable generators can earn before the government takes a significant share of revenues generated above this price point.”

However, there are still key selling points for the sector. Numis notes that trusts offer power price-linked revenues, have healthy dividend cover, relatively conservative balance sheets, and deliver important levels of investment which are key to achieving net zero carbon targets and for delivering lower cost power to consumers over the long term.

Numis concludes: “For those willing to look through the current uncertainty, discounts range from 6.5% to as wide as 17%, with dividend yields ranging from 5% to7.3%. Our preference for Bluefield Solar Income Fund is unchanged as we believe the conservative business model has delivered the most consistent returns in all power markets since 2013.”