Ask yourself this: would you be happy with equity capital tied up in an industry whose operational performance is poor, which is addicted to subsidies paid by increasingly unhappy taxpayers, and which runs on dodgy finances? Probably not, but welcome to the UK’s wind power industry.
Of course, this is hardly the official line. That tells us the UK is on its way to being a global superpower in generating cheap electricity from its inexhaustible supply of wind. Thus earlier this month, the government – via its sententiously-labelled Department for Energy Security and Net Zero – published updated estimates for the future costs of generating electricity in an industry increasingly dominated by renewables technology. Such estimates are “a fundamental part of energy market analysis”, says the government department, and are “important when designing policy to make progress towards net zero”.
True enough, yet the government’s estimates of future costs for wind power were immediately labelled “a fairy story” by Net Zero Watch, a pressure group consistently sceptical about the real costs of waging war on greenhouse gas emissions.
These costs are important to Investors’ Chronicle readers both as investors and as consumers of electricity. They are in the comparatively fortunate position of having the opportunity to offset the costs of the pursuit of net zero with possible profits from investing in the players in and around the renewables industry. True, it’s a cynical game since so much of the renewables industry’s profits come from subsidies paid by taxpayers who don’t have the resources to be players, but there it is.
In that context, Bearbull has long been an advocate of holding a sensible amount of CO2 emissions allowances. The point is, if something approaching net zero by 2050 is to become a reality, that must be reflected in a much higher price for carbon. The easiest way for investors to benefit is via an exchange-traded fund (ETF) that invests in emissions allowances. Bearbull’s favoured fund is SparkChange Physical Carbon (CO2P), whose particular merit is that it holds allowances in the European Union’s emissions-trading scheme. The alternative is to use a fund that bets on the carbon price via contracts for difference with a counterparty. But the limitation of such a ‘synthetic’ fund is that, unlike the SparkChange ETF, it does not actually prevent emissions of carbon.
In addition, the Bearbull Income Portfolio has a holding in Greencoat UK Wind (UKW), which is where the wind power industry comes in. This fund – we’ll simply call it UKW – has a narrow focus on UK-based wind farms. Its £5.8bn portfolio has interests in 46 of them dotted around the UK, more than half of which are wholly owned and most are onshore. However, by value invested and by generating capacity, the figures are skewed by UKW’s biggest holding, its 12.5 per cent stake in the first phase of the massive Hornsea Wind Farm, 75 miles off the Yorkshire coast. All told, UKW controls approaching 1.7 gigawatts (GW) of generating capacity, which gives it about 6 per cent of the UK’s wind capacity and somewhere around 2 per cent of the UK’s generating capacity from all sources.
That does not mean UKW generates about 2 per cent of the UK’s electricity in any given year any more than it means UK wind farms in total generate their pro-rata share of the national capacity. In electricity generation, capacity to generate and power generated are not the same thing. That’s true for every source of power – be it nuclear, solar or whatever – but it’s especially true of wind power, and that’s a problem.
True, the problem is well known, but that doesn’t mean it’s going away. In industry jargon, it is labelled ‘intermittency’, which basically means the wind doesn’t blow all the time or when it’s needed. Then – annoyingly – sometimes it blows too strongly, which means generating turbines have to be shut off (and operators get a subsidy for that).
The chief effect of intermittency is captured in the lines in Chart 1 that show the average load factor of both onshore and offshore wind power in the UK. Load factor – or capacity factor – compares how much power is generated by a source compared with its maximum possible output. As the chart shows, for onshore UK wind this is both low – about 26 per cent – and steady. To put that figure into context, a nuclear plant is well capable of an 80 per cent load factor and a combined-cycle gas plant can cruise at 60 per cent. For plant located offshore, where the wind blows faster and more often, load factors are higher, clear of 40 per cent and still rising. That said, they remain well short of levels produced by nuclear and combustible sources.
When wind power was a marginal source of electricity – say, below 10 per cent – this mattered little. Now, however, wind accounts for almost 25 per cent of UK electricity generated so its unpredictability makes the UK’s transmission and distribution system both less efficient and more expensive to run since reliable sources of power, such as combined-cycle gas or even coal, must be kept on stand-by.
No worries, goes the official line: if the past was a price worth paying to get wind power breezing along, the future will be cheap emissions-free power thanks to rising load factors and falling running costs. The energy department’s latest report on costs suggests load factors for offshore wind will rise impressively. They will be 61 per cent over the operating lifetime of offshore plant commissioned in 2025 and 65 per cent by 2030.
To which, Net Zero Watch says “it is hard to be polite about these figures”. It adds that since “wind farms’ output declines steadily as they get older, if we take an absurdly optimistic estimate of that decline – 1 per cent a year – it would mean that first-year output would need to be 70 per cent”. Similarly, for onshore farms, the energy department suggests that load factors, for so long stuck at 26 per cent, will rise to about 40 per cent.
The source of the department’s optimism seems to be the effect of bigger turbines and, in particular, longer blades that catch more wind and so generate more kinetic energy. Fine in theory; however, Gordon Hughes, an energy economist with the University of Edinburgh, warned in a 2020 report for the Renewable Energy Foundation that “the inferior reliability of new turbine generations leads to a more rapid decline in performance with age”. Besides, he continued, “the modern wind turbine is now a mature technology and has been so for some time”.
Factors such as those were less important when energy was cheap and the drive to take CO2 emissions out of daily life was barely noticed. Now, however, energy is expensive and the campaign for net zero has all the charm of Big Brother. Thus matters such as the economics of wind farms are fast becoming political problems since those consumers, who for years were blithely unaware they were providing subsidies to the renewables industry via their electricity bills, now feel they are the patsies in the game. Understandably, they don’t like it.
Combine these factors with the effect of rising interest rates and renewables funds, such as Greencoat UKW, are under pressure. Higher interest rates both raise the cost of capital for wind farms, which often use lots of debt in their funding mix, and reduce the value of their projected future revenues. Thus UKW’s share price, at its current 145p, is 12 per cent down on its 12-month high, which was also the all-time high since its listing in 2013. Additionally, in May, for the first time since the listing, its share price fell below net asset value; currently the discount is 12 per cent.
Arguably, UKW is not helped by its manager’s ambitious investment objective – to pay dividends rising in line with the retail price index of inflation (RPI) while preserving the inflation-linked value of its invested capital. As Chart 2 indicates, so far UKW is well ahead, but for most of that period inflation was running at minor levels whereas now RPI is still on the high side of 10 per cent.
Then again, high inflation works both ways. UKW’s managers point out that the penalty for discounting future likely revenues with a higher interest rate is more than offset by the boost to revenue thanks to the index-linked nature of much of wind farms’ cash flow. Besides, as renewables funds go, UKW’s portfolio is not highly leveraged with debt. At the end of June, in relation to its £3.8bn of equity, it ran £2bn of debt split between its own balance sheet and its non-consolidated subsidiaries and investments for a leverage ratio of 52 per cent. By contrast, UKW’s sibling fund, Greencoat Renewables (GRP), ran with leverage of 89 per cent.
Yet the leverage is symptomatic of the point that, as the energy economist Gordon Hughes suggested three years ago, the UK’s wind industry has the characteristics to form a speculative bubble similar to a property boom – the ease with which wind farms change hands, the market presence of big bidders with low costs of capital, the extravagant use of debt. And wind farms come with the added attraction of government subsidies.
Sure, the effects of the Ukraine war on energy prices may continue to cover the faultlines in the UK’s wind industry. But such bubbles rarely end happily. When it bursts the likes of UKW may end up as collateral damage. For all the attraction of its 6.0 per cent dividend yield and a payout rising in line with retail price index inflation, the question may be when to take the money off the table.
bearbull@ft.com
