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Generate good returns from renewables despite subsidy curbs

Subsidies are to be scaled back sooner than expected, but this should not affect the trusts focused on this area
June 22, 2015

The government is to end public subsidies for onshore wind farms via its Renewable Obligation Certificate (Roc) Scheme a year early, limiting the range of opportunities for investors in the sector which include three renewables infrastructure investment trusts. Rocs will no longer be available from 1 April 2016, instead of 2017 as previously expected.

After this, onshore wind will be subject to the contracts for difference (CFD) regime. This is not as attractive for developers of wind farms: they have to bid for CFDs so there is no certainty they will get them. With Rocs, as long as projects meet certain conditions, they can receive them. CFDs are also linked to Consumer Prices Index inflation (CPI) rather than Retail Price Index (RPI) inflation like Rocs, which is typically higher than CPI.

However, the government says that it will offer a grace period to projects that already have planning consent, a grid connection offer and acceptance, as well as evidence of land rights, which could affect up to 5.2GW of onshore wind capacity.

The investment trust with the highest exposure to UK onshore wind projects is Greencoat UK Wind (UKW), which has about 90 per cent of its assets invested in this area. "We invest in already-operating UK wind farms which are completely unaffected by the changes," says the trust. "There remains a huge pool of such wind assets built or in construction that we could acquire. As such we remain very happy that the outlook for investment opportunities in UK wind farms is encouraging."

The trust's manager Stephen Lilley adds that he expects the trust to invest more of its assets in offshore wind.

"There should be no immediate impact on the fund from these changes, given the large number of operational onshore wind projects available for purchase," adds Iain Scouller, head of the investment funds team at Oriel. "Over time, Greencoat may increase its exposure to offshore wind, assuming the economics are attractive. As previously planned, offshore wind will remain under the Roc regime until 1 April 2017. We think this change may be a small positive for Greencoat's current portfolio as existing onshore wind projects could see some scarcity value, which will be beneficial for valuations.

But while it is possible pricing will go up for onshore assets due to scarcity there are hundreds of projects, so I think any squeeze in pricing is not likely to be material."

John Laing Environmental Assets (JLEN) has 43 per cent of its assets in UK onshore wind. David Hardy, the trust's investment adviser at John Laing Capital Management, says: "We still see a significant pipeline, and we were changing to the CFD regime in 2017 anyway."

He also highlights the fact that this trust's investment policy is broader than wind, not just limited to the UK and that there is a strong pipeline in Europe, although the trust does not currently hold any overseas investments.

The Renewables Infrastructure Investment Group (TRIG) has around half of its portfolio invested in UK onshore wind. It states:

"TRIG's investments are in onshore wind farms which are operational and where subsidies have already been secured. Therefore the changes in the subsidy regime announced today by the Department of Energy & Climate Change will have no impact on the existing portfolio or acquisition pipeline."

Fund manager Richard Crawford adds that if the level of a subsidy is lower on a project then they would look to pay less for it.

TRIG, meanwhile, announced last week that it is set to acquire a significant minority interest in a portfolio of six operational onshore wind projects in Scotland, which qualify for the Rocs regime, and it expects to issue further equity in the next month.

And Mr Scouller does not anticipate a negative impact on these trusts' dividends, as they do not need new projects to maintain what they are paying.

 

Investment trusts with exposure to onshore wind

Trust% of assets in onshore wind**1 year share price return (%)Yield (%)Premium to NAV (%)Ongoing charge (%)*
Greencoat UK Wind90135.59.21.46
John Laing Environmental Assets Group4395.77.91.63
The Renewables Infrastructure Group5085.78.00.23

Source: Winterflood as at 22 June 2015, *Association of Investment Companies, **trust's manager.

 

Community energy opportunities

This follows the restrictions which came in on 6 April preventing venture capital trusts (VCTs), enterprise investment schemes (EIS) and seed EIS (SEIS) from investing in renewable energy schemes such as anaerobic digestion and hydroelectric power. These have also not been able to invest in solar and wind schemes since July last year.

However, the Department of Energy & Climate Change is looking to continue support for community energy projects. Ones which will in future become eligible for the Social Investment Tax Relief (SITR) are also still eligible for funding from tax advantaged schemes such as VCTs, EIS and SEIS - until SITR comes in. The government will also allow a transition period of six months following state aid clearance from the European Commission for the expansion of SITR before eligibility for EIS, SEIS and VCT is withdrawn. State aid clearance is expected by October.

Community energy schemes are set up by community groups or co-operatives rather than larger fund management groups, and these small projects are potentially higher risk than VCTs and portfolio EIS because they are focused on a small number of assets.

"Diversification is a key point as this represents investment in a single enterprise compared to investing in an EIS 'fund' which makes a spread of different investments," says Philip Rhoden, director at discount broker Clubfinance. "Investors (or their financial adviser) are selecting the investment directly rather than a fund manager, and also need to look at diversification in the context of their whole portfolio. Making an individual investment means you should know very specifically what you are investing in."

He also says that with a very small scheme you need to look carefully at costs as there is less potential for economies of scale, as well as the expertise, experience and resources of the team involved and their advisers. The directors of community energy schemes may not have the financial expertise of those involved with larger tax advantaged schemes. And investors should also consider if the scheme has received advance assurance from HMRC.

"Investors need to be comfortable that the team can manage the investment and ensure it meets all the criteria needed to qualify for tax relief throughout the qualifying period," says Mr Rhoden. "Above all, investors must be comfortable that the risks associated with the investment match their risk appetite."

Other things to check include: development risk, the quality of the contractors as small schemes may not have the finances to use high quality ones, and if something goes wrong whether the scheme has the resources to see this through.

David Lomas, director at Amberside Capital, says you should consider what the scheme's objectives are and if its directors are seeking to create a return for investors. You should also do due diligence on the underlying technology, what sort of returns it can make and what its life cycle is.

Jon Halle, director at Sharenergy co-operative which promotes community energy schemes, says these are not necessarily as liquid as larger EIS run by fund management groups so may not be as easy to get out of. This means you need to be able to commit your money for a long time.

But he adds: "Sharenergy has been involved in around 30 share offers. Of those that have made it to share offer has only one has failed to date - a small hydro project which had difficulties with its technology. The others have performed as expected and in some cases somewhat better."

The minimum investment for community energy schemes can be as small as £100 whereas with larger EIS you typically need to put in a minimum of anything between £3,000 and £50,000.

One of the first UK community energy projects was Baywind Energy Cooperative, which owns six wind turbines in Cumbria. Since its formation in 1996 it has paid investors a return on their investment of between 5.6 per cent and 6.6 per cent gross, which with EIS relief on the initial investment increases to between 7 per cent and 8.2 per cent.

Examples of community energy schemes currently raising funds include Heartland Community Wind seeking £1.35m to install two 250kW wind turbines near Aberfeldy in Scotland. It aims to be generating electricity by the end of 2015 and get revenue from the sale of electricity and the feed in tariff (FIT) subsidy.

The projected return over the 20-year expected project period equates to an internal rate of return of 7 per cent.

Other examples include Dorset Community Energy seeking £135,000 under SEIS to install solar panels on the roofs of three schools and three village halls, and Corwen Electricity Co-operative looking for £300,000 to invest in a 55kW hydro generator via SEIS and EIS schemes.

 

EIS and SEIS tax reliefs

EIS offer their investors 30 per cent income tax relief if they hold them for three years or more, but you have to wait until the money goes into a company and starts trading so it could be longer than this.

If you hold EIS for two years or more they do not form part of your estate for inheritance tax purposes.

You can defer capital gains tax (CGT) if you reinvest gains in an EIS, only paying it once you realise gains on the EIS. If you die before this happens the CGT liability dies with you.

EIS benefit from loss relief so the maximum loss a 45 per cent taxpayer will suffer in a single investment is 38.5p in the pound, which is not offset against other gains in the portfolio.

Because of their high risk nature you should only consider EIS if you have used up your individual savings account (Isa) allowance, and annual and or lifetime pensions allowance and are looking to save beyond these in a tax-efficient way.

Seed Enterprise Investment Schemes (SEISs) share a number of similarities with EIS but tend to invest in even riskier start-ups or very early-stage companies, so offer 50 per cent tax relief if you hold them for three years.

If you hold your SEIS shares for at least three years and qualify for income tax relief you do not incur capital gains tax upon disposal. You can also qualify for loss relief as with an EIS.

Social Investment Tax Relief (SITR) will be similar to EIS but these should be able to issue debt rather than just equity stakes, and invest in a wider range of assets.